On FII MAT, Jaitley had said India cannot be a tax haven: Here’s why he made a U-turn

By accepting the recommendations of the AP Shah panel on the issue of retrospective tax demand on FIIs, the Narendra Modi government has added one more item to the long list of its U-turns. And at the face of it, this one definitely is a wise one, though the question why the government takes unwise steps only to reverse it later remains.

For the uninitiated, it all started with the income tax department issuing tax notices to FIIs in April this financial year. A PTI report said about 100 foreign investors may have to cough up about $10 billion if the income tax department pressed with the notices.

The investors panicked and started selling Indian assets pulling down the markets. The backlash forced Finance Minister Arun Jaitley to offer a partial relief to the FIIs in May. The government also appointed a panel under AP Shah to study the matter.

The government has now accepted the recommendations of the panel and decided against demanding tax retrospectively from FIIs.

Here are all the key details on the issue.

What is the issue all about?

It is about tax demand on foreign investors with retrospective effect. The income tax department sent notices to a few FIIs demanding minimum alternate tax on their book profits prior to 1 April 2015. The demand notices were sent after Jaitley in his budget for 2015-16 announced that MAT will not be applicable on these investors after 1 April 2015. A CNBC-TV18 report explains MAT as a tax introduced to tax those companies that pay no or a marginal tax due to the various concessions and exemptions they enjoy. “MAT was thus envisaged as levying a minimum tax on such companies by deeming a certain percentage of their book profits, computed under the Companies Act, as taxable income,” the article said citing Shah panel report. A ruling in the Castleton case by the Authority for Advance Ruling, which settles tax disputes, had in 2012 said that this tax is applicable on multinational companies too. The demand notices were sent based on this order.

Why were the FIIs irked?

FIIs contented that the tax is applicable only to domestic companies that had their base in India. By virtue of not being established in India, they should be “exempted”. They also argued that as ever since MAT was introduced they were always exempted from it. So, the demand notices were arbitrary. The MAT was introduced in 1987. Moreover, they felt cheated as the notices were sent soon after the budget which actually exempted them from such tax post 1 April 2015. The disappointment was all the more deep as they were gung-ho about Indian markets after the NDA government assumed power. There were also hopes the new government will resolve tax issues and bring about a stable tax regime as Jaitley had in the run-up to the elections termed the tax policies of the erstwhile UPA regime tax terrorism.

After the market fell reacting to the tax demand notices, the government set up the high-level panel under Shah to study the issue.

What did the Shah panel say?

The panel recommended doing away with the MAT on FIIs prior to the 1 April 2015. Shah in an interview to CNBC-TV18 said since FIIs are not required to file accounts in India under the companies law as they have no place of business here and are not covered by the law. So not only the machinery section but also the computation section would fail in calculating the applicable tax. “There is no guidance, as a result the whole global income would be considered,” he said. Giving another reason for the decision, Shah said: “…The FIIs are covered by a fixed tax regime and the minimum tax cannot be more than the maximum. We considered that and we felt that it is a completely different tax regime and obviously 115JB is not attracted.” Section 115JB is the section in the Income Tax Act 1961 that deals with the MAT provisions.

Why did the government do a complete U-turn on the issue?

The government was definitely in no mood to go back on the issue and the decision to not apply retro tax is a complete U-turn. In an interview to NDTV, the finance minister justified the tax demand on the FIIs. “FIIs went to a tribunal, which is called Authority for Advance Rulings (against levy of 20 percent Minimum Alternate Tax on capital gains). They got a judgement against themselves… So, the tribunal has decided against them,” he told the channel on 15 April.

“We are reasonable, so for the future I have waived it. But the tax demand after winning the case, if I waive off, we will be like a tax haven ….how would be I answerable to Parliament that after the case I just waive Rs 40,000 crore,” he said. But then the market fell. And now there is a storm brewing in the global markets due to fears that China’s slowdown will pull down economic growth. The yuan devaluation just added to the worries.

To top it all, the US Fed is also likely to increase interest rates. A rate hike in the US will force the FIIs to pull out of Indian markets and return to safer markets. Already, foreign investors have sold a net Rs 16,877 crore Indian shares in August, which breaks the earlier monthly record of Rs 15,347 crore registered in October 2008, when the global financial crisis broke out. A US rate hike will only exacerbate the exits. A quick decision was warranted because at stake is an ambitious disinvestment target of Rs 70,000 crore for 2015-16. The government has been able to raise only Rs 12,500 crore.

As such, India’s record in raising money through public sector stake sales have been shoddy – in the last five years the simple average has been 57 percent of the target. So without help from FIIs, the government cannot even dream of meeting at least this average. And that is important because the government’s finances are also not in good shape despite the major relief on crude oil front. In just four months, it has already hit the 69 percent of the fiscal deficit target for the full year. Moreover, if India wants to make the most of China’s slowdown, it has to keep the FIIs in good stead.

But will the move make a big impact?

There are different views on this. One section of the experts believe it will boost the investor sentiment. However, there is another section which believes it may have come a bit too late. Ajay Srivastava of Dimensions Consulting is one who thinks the MAT relief may not work much now. According to him, the Castleton case which kicked off the debate is in the court. “In today’s environment you have withdrawn it but who care the bigger thing are at play at this point of time – one. Two, people knew that this is going so I am not very clear. A decisive government needs judges committed to tell them what to do when they themselves in the Budget did it for the future years,” he told CNBC-TV18. Moreover, this pertains only to FIIs. Multi-national companies are still facing such retro taxes.

“If the scope of the Shah committee was widened to cover all foreign companies, that would have helped to resolve the dispute for non-FIIs as well,” Rajesh H Gandhi, partner, Deloitte Haskins and Sells Llp, has been quoted as saying in a report in the Mint. This explains the markets’ subdued reaction to the whole issue today. The Sensex rose 243.23 points to hit an intra-day high of 25939.37. Now it is just up 5.79 points at 25702.23 (at 1pm).