Much ado about MAT bl-premium-article-image

GOPAL SRINIVASAN Updated - January 23, 2018 at 07:36 PM.

The latest Budget grants waiver to future foreign investors, so what’s the hullabaloo about?

Take a closer look There’s nothing to fear Bplanet/shutterstock.com

Can India, a developing country in dire need of capital, afford to displease foreign investors? This broad-brush argument seems to crop up whenever Indian regulators or policymakers attempt to apply the laws of the land to foreign investors. Whether it is SEBI trying to get foreign portfolio investors to disclose their basic identity before investing in Indian markets (by discouraging participatory notes) or the government trying to enact a law to crack down on tax avoidance (by way of GAAR), these moves have been repeatedly scuttled on the assumption that it would trigger an exodus of foreign investors.

The latest to fan such fears is the tax department’s issue of demand notices to the tune of about ₹40,000 crore to some foreign funds, on their liability to pay Minimum Alternate Tax (MAT) for share transactions made in the past. Some foreign investors have complained that the BJP government is inflicting ‘tax terrorism’ upon its constituents and is indulging in retrospective taxation, as did its predecessor. Others have gone so far as to label the tax demands unconstitutional, extra-territorial and violative of India’s tax treaties with other nations. The facts are otherwise.

MAT dismantled

For starters, the latest Budget actually dismantled the perverse MAT regime for foreign investors by exempting their long-term capital gains from MAT, with effect from April this fiscal. In doing so, it has created a special dispensation for FIIs, as domestic companies will continue to pay MAT on their long-term capital gains from shares.

The Budget has also gone out of the way to bolster foreign investor sentiment by deferring GAAR by two years (to April 1, 2017), granting overseas portfolio managers operating out of India ‘safe harbour’ from the applicability of permanent establishment rules and by providing pass-through tax benefits for certain categories of venture funds.

What the government has refused to do, and with good reason, is to apply this MAT exemption with retrospective effect, so that foreign investors can avoid responding to tax notices already issued by the IT department for earlier years. The government is not insisting that MAT is a good law or even that foreign investors have to perforce comply with the demands. Its stated stance is only that, if foreign investors feel aggrieved by these demands — which are backed by a favourable ruling by the Income Tax Authority for Advance Rulings (AAR) — they are free to go on appeal in a judicial forum.

In any case, not all MAT demands have been issued to DTAA-protected investors. Any exemptions, therefore, need to be granted on merit, based on the facts of each case. Therefore, this debate is best resolved through private dialogues between the aggrieved investors and the tax department, instead of through alarmist media campaigns that paint a doomsday picture of imminent FII withdrawals.

Where we stand

The applicability of MAT to foreign companies which do not have a place of business in India, and those operating out of DTAA-protected regimes, has been a bone of contention between foreign investors and the Indian tax authorities for several years now. The tax department has based its recent MAT notices to foreign investors on an August 2012 advance ruling by the AAR, in the case of Mauritius-based Castleton Investments.

In 2012, Castleton had sought the AAR’s opinion on its liability to pay both long-term capital gains tax and MAT after it effected a transfer of shares in an Indian company to a Singapore-based firm. The AAR ruled that MAT provisions did indeed apply to foreign companies and not just to domestic entities. It also ruled that while the specific transaction was not subject to long-term capital gains tax (due to the tax treaty), it was subject to MAT on book profits.

Now, foreign investors and their tax consultants argue that this ruling cannot be applied as a precedent and that there have been other decisions by the AAR in the foreign investors’ favour. Equally, the IT department is of the view that the 2012 Castleton ruling is the final word on the subject. However, there is nothing in these arguments to suggest that one side has a better understanding of the legal position than the other.

Even tax lawyers admit that it is an over-reaction to term the demands over MAT as extra-territorial, as no one can question a government’s sovereign right to levy taxes on any of the market constituents it chooses. Some of these arguments seem to be stuck in a time machine that suggests past laws when detrimental to foreign investors be done away with but those favourable be maintained, embodying the notion of “private profits social losses” that the world experienced during the global financial crisis of 2008.

Others allege that publicly taking on FIIs and making a political statement was the key intention behind the MAT notices. But if this was the intention, why amend the law in the latest Budget to specifically exempt FII from MAT on capital gains? In fact, it was to smooth the ruffled feathers of foreign investors that the Modi government has unambiguously stated that it will not appeal against the victims of the earlier MAT tax ruling in an appellate process.

ROI matters

Finally, to insinuate that foreign investors will shun India en masse unless the Modi government extends its long arm across the judicial process to exempt foreign investors from MAT, is unduly alarmist. For one, it must be recognised that this government has inherited an unenviable legacy of arcane laws, some inherited from the pre-Independence era. Indeed, if the MAT demand notices have created uncertainty in the minds of foreign investors already in India,, then the MAT waiver granted to future foreign investors in the Budget, should be an FII magnet.

It won’t, because it is not tax incidence alone that influences a foreign investor’s decision to choose an asset over scores of other investment destinations. What global investors primarily seek is an attractive return on investment and a government that is responsive to business needs.

On the first aspect, if India sustains relatively healthy economic growth amid a slowing global economy, foreign investors can hardly choose to ignore it because they will be subject to MAT on the returns they make. Let’s not forget that for all the brickbats that India earned for its mis-treatment of Vodafone, the telecom major does continue to do business in India.

On the second, contrary to the actions of foreign investors and their representatives, the Modi government has acted in a transparent and exemplary manner by responding quickly to the backlash on MAT.

The immediate and unusual action taken by the finance minister to hold a conference call with foreign investors, to address their queries on MAT and reassure them that tax treaties will be respected, surely shows that the Centre is open to free and fair discourse, even when its adversaries don’t always play fair.

The writer is the chairman of TVS Capital Funds

Published on April 23, 2015 15:46