September 09, 2015
No MAT on FIIs / FPIs: Government accepts Direct Tax Committee's recommendations!
- Direct Tax Committee clarifies inapplicability of Minimum Alternate Tax to Foreign Institutional Investors / Foreign Portfolio Investors before April 1 2015.
- Government of India accepts recommendations of the Committee and decides to amend the Income Tax Act, 1961 in line with the recommendations suggested by the Committee in its Report.
- Report provides that the view of the Committee is that the ruling in the case of Castleton Investment Limited is “completely wrong”.
- Report also provides that Minimum Alternate Tax provisions will not apply to foreign companies not having a place of business in India / PE in India.
Recently, the Government of India (“GoI”) accepted the recommendations of the Committee on Direct Tax Matters chaired by Justice A. P. Shah (“Committee”) which has in its report (“Report”) clarified the inapplicability of Minimum Alternate Tax (“MAT”) to Foreign Institutional Investors / Foreign Portfolio Investors (“FIIs / FPIs”). The GoI has decided that an appropriate amendment to the Income Tax Act, 1961 (“ITA”) will be carried out to provide for the recommendations suggested by the Committee. The Central Board of Direct Taxes (“CBDT”) has also advised the tax officers to take into consideration the recommendations of the Committee and keep in abeyance the pending assessment proceedings in cases of FIIs / FPIs involving the MAT issue. Further, they have also been advised to not pursue the recovery of outstanding demands in such cases.
To rewind to the origin of the controversy preceding the Report, the Indian revenue authorities had issued demand notices demanding close to INR 70000 million from various FIIs / FPIs on the premise that MAT was applicable to FIIs / FPIs. This was due to the inconsistency in rulings of the Authority for Advance Ruling (“AAR”) which had in 2012, in Castleton Investment Limited1, departed from its previous ruling in the Timken Company2 and held that Section 115JB of the ITA (“MAT Provision”) was applicable to foreign companies, even if they have no Permanent Establishment (“PE”) or place of business in India.
With a view to address dampening investor sentiments, the GoI appointed the Committee to consult with stakeholders and review the applicability of MAT on FIIs / FPIs. In its detailed report, the Committee has recommended that MAT cannot be applied to FIIs / FPIs and foreign companies not having a PE in India or a place of business in India. It has further recommended that the GoI should bring an amendment to the MAT Provision clarifying the complete inapplicability of the MAT Provision to FIIs / FPIs; or the CBDT to issue a circular clarifying the complete inapplicability of the MAT Provision to FIIs / FPIs.
SUMMARY OF REPORT
Legislative History: The Report provides for the legislative history and the intent behind introducing MAT in the ITA. MAT was introduced first in 1987 with the sole intention of taxing widely held domestic companies. MAT was introduced as a measure of equity as widely held domestic companies making huge profits were availing tax concessions and incentives and declaring substantial dividends in such a way as to avoid payment of income tax. Post this MAT was made inoperative from assessment year 1991-1992. However, it was re-introduced into the ITA in 1996 for the same reasons as stated above. From then on MAT has always been provided for in the ITA. Further, the circulars issued by the CBDT and notes to clauses to the various Finance Bills provide for calculation of book profit. It states that the book profit shall mean the net profit as shown in the profit and loss account prepared in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956 (“Companies Act”) as increased or reduced by certain adjustments. Further, the Notes on Clauses explaining the provisions of Finance Bill, 2002 specifically state that MAT is to apply to domestic companies.
The Committee having examined the various circulars and directions issued by the CBDT and the legislative history, including the various Finance Acts which introduced / amended the provisions of MAT concluded that the Legislature could only have intended for MAT to apply to companies governed by the regulatory requirement of the Companies Act. The Committee also noted that the Legislature expressly failed to specify any method for the computation of book profits for FIIs/FPIs. This makes it clear that the obligation under Section 115JB of the ITA exists because of the regulatory requirements of the Companies Act and not independent of it.
Interpretation of the term ‘Company’: The term ‘Company’ as has been defined under the ITA covers domestic as well as foreign company. Further, the definition begins with the phrase, “In this Act, unless the context otherwise requires”, implying that as soon as the context limits or otherwise requires an alternate meaning to such a term, the definition cannot be given a strict application. The Report provides that the very structure of the MAT Provision makes it non-applicable to FPIs and the term “Company” needs to be restricted to include only companies covered by the regulatory regime of the Companies Act.
Foreign companies are neither obligated to prepare profit and loss account under the Companies Act nor are they obligated to lay the profit and loss account before an Annual General Meeting3 (“AGM”), as has been provided for under the MAT Provision. If the MAT Provision is extended to FIIs / FPIs, it would require them to prepare their global accounts and lay them before an AGM in accordance with the Companies Act, which is not visible from the legislative intent. Including foreign income in the ‘book profit’ would also be contrary to the principle of ‘territorial nexus’ as has been laid down by the Supreme Court4.
Further, the MAT provision was amended to include companies (e.g. insurance, electricity or banking companies) that are not required to maintain books of accounts as per the Companies Act. In such a case, the profit and loss account is to be prepared in accordance with the respective regulatory provisions governing such companies and such accounts shall be taken as a basis for computing the book profit under the MAT Provision. Thus, the intention of the Legislature was not to cover all kinds of companies, as if it were so, the Legislature would have brought about an amendment for FIIs / FPIs also, to clarify the manner in which their book profits are required to be calculated.
Established place of business: The Report observes that the Securities Exchange Board of India (“SEBI”) casts several obligations on FIIs / FPIs under the SEBI (Foreign Portfolio Investor) Regulations, 2014 (“FPI Regulations”). Under these regulations FIIs / FPIs are required to maintain information with respect to the trade they carry on in India and are not mandated to maintain books of accounts as provided under the Companies Act. Further, the FPI Regulations do not mandate the appointment of a compliance officer to be in India. In fact, the compliance officer appointed by an FPI is usually situated outside India.
The Committee has further relied on various judicial precedents and has come to the conclusion that the expression, “place of business” means a permanent and specific location in that country from where a company habitually and regularly carries on its business. Further, having an “established place of business” is different from merely “carrying on a business” in India. FIIs / FPIs normally do not have their own office or employees in India and carry out their decision-making activities outside India. The dealings of FIIs / FPIs in India are through independent agents like stockbrokers and custodians and thus they do not have any physical presence in the country. Accordingly, MAT provision should not apply to FIIs / FPIs.
Failure of machinery provisions: It is trite law5 that where the computation of a tax against income levied under the ITA is impossible to conduct, the charge of tax against such income too would fail. In the case of FIIs / FPIs not having a place of business in India, there is no requirement for it to lay its accounts before an AGM as provided under the Companies Act. Further, there is no guidance under the MAT Provision as to which portion of the income of a foreign company, having no established place of business in India, is to be taken into consideration for the purpose of Section 115JB of the ITA. There is also no guidance on how such foreign companies segregate their domestic accounts from their global accounts for the purposes of such computation, so as to ensure that the global profits are not offered for taxation in India. Due to this computational failure, a foreign company having no established place of business or PE in India (i.e. an FII/FPI) cannot be taxed under Section 115JB.
Interplay between MAT Provision and Section 10(38) of the ITA: Section 10(38) of the ITA provides exemption of tax on long term capital gains. The proviso to this section makes a reference to the MAT Provision and provides that for the purposes of calculating the book profit under the MAT income by way of long term capital gains, even though exempt, has to be taken into account. The view taken by the income tax authorities in this regard is that by necessary implication, the MAT Provision must apply to domestic as well as foreign companies. This view has not been accepted by the Committee and in the Report it states that long-term capital gains only need to be added in computing book profits under the MAT Provision. However, this can only occur when the company comes under the purview of the MAT Provision. Since the MAT Provision does not apply to FIIs / FPIs, Section 10(38) of the ITA, which makes a reference to the MAT Provision, would also not apply to FIIs / FPIs.
Special provisions for FIIs / FPIs under the ITA: The ITA provides for a separate scheme for taxing income earned by FIIs / FPIs from Indian securities at a concessional rate. Income earned by FIIs / FPIs from their Indian securities is treated as “capital gains”, instead of “business profits”, and is taxed according to the nature of gains under this separate scheme. However, if the MAT Provision was applied, foreign companies, FIIs / FPIs would be liable to be taxed at 18.5% of their book profits, thus effectively losing their concessional tax basis, specifically provided under this scheme. This would render the separate scheme for FIIs / FPIs under the ITA otiose. This is further clear from the fact that the set off provisions and MAT credit, which can currently be carried forward for up to ten years immediately succeeding the assessment year in which MAT was paid, becomes redundant since FIIs/FPIs will never be able to avail of its benefits6.
Thus, the Committee concluded that the Legislature could not have intended one part of the ITA to render another part irrelevant and otiose. Accordingly, the MAT Provision would not apply to FIIs / FPIs and they would continue to be governed under the separate scheme provided under the ITA.
- Interpretation of the MAT Provision in light of the 2015 amendment: The Finance Act, 2015 has specifically excluded the income of foreign companies earned in relation to capital gains arising in transactions in securities, interest, royalty or fees for technical services etc. from the chargeability of MAT. In light of this amendment, an argument that was made by the income tax authorities was that since the amendment is prospective in nature, FIIs / FPIs are liable to pay MAT prior to the amendment. However, the Committee rejecting this argument states that since FIIs / FPIs are not governed by the regulatory scheme of the Companies Act, they are not liable to come within the ambit of the MAT Provision at all. Accordingly, the amendment was not actually required and can only be considered as clarificatory in nature.
- Tax Treaties and the MAT Provision: The Report specifically provides that FIIs / FPIs hailing from those jurisdictions with which India has a double taxation avoidance agreement will override the provisions of the ITA (including the MAT Provision) if they contain more beneficial provisions for the taxpayer company. In such cases, FIIs / FPIs will clearly not be taxable under the MAT Provision. The Report further provides that the intent of the non-obstante clause of the MAT Provision cannot be interpreted to override a specific treaty obligation as it would be in against the spirit of the Constitution of India7.
Tax certainty as a desirable goal: Apart from the commercial and policy arguments, the Committee makes an important point in relation to the importance of tax certainty to foreign investors. The Report provides that most FIIs / FPIs are well-regulated investment funds or pooling vehicles, being “collective investment vehicles”, which pool investments from different investors to access diverse Indian securities in a cost-effective manner. They are open-ended investment funds, which permit their investors to enter and exit daily, based on the Net Asset Value (“NAV”) of the investment fund. Thus, investors in an FII keep changing on a daily basis. This makes the need for tax certainty even more important, inasmuch as the NAVs are directly affected by tax liabilities and the burden of an unanticipated tax liability relating to previous years has to be borne by the investors participating in it presently.
The Committee has analyzed the sudden change in the interpretation of the MAT Provision. It states that since the time the MAT provisions were introduced, they have never been levied on FII / FPIs. Instead, the beneficial tax scheme was always applied to FIIs/FPIs and the beneficial ruling of the AAR in Timken was accepted and no appeal was filed. In fact, even after the Castleton ruling in 2012 no notices were issued by the income tax authorities in the assessment years 2013 – 14 and 2014 -15. FIIs / FPIs were not called upon to file global accounts with the Registrar of Companies; which is goes on to show that despite the ruling in Castleton, FIIs / FPIs were not intended to be liable under the MAT Provision. It was only in August 2014 that notices were sent to FII / FPIs calling upon them to pay MAT. A change in this settled position so late in the day is unfortunately perceived as a retrospective amendment to the law.
Comparative international practices: The Committee also provides for a comparison of levy of MAT between different countries. It notes that while none of the other BRICS countries levy MAT, some of the OECD countries levy MAT. However, MAT is not levied on foreign companies / persons unless they have a physical presence in such countries. Accordingly, India seems to be an outliner in its tax treatment of FIIs / FPIs.
No doubt that acceptance of the recommendations by the GoI is a welcome step for the FIIs / FPIs who had started to become weary of the situation in this regard. Interestingly, while the Report concludes that MAT should not be applied to FIIs / FPIs, in certain parts it also categorically states that MAT will not apply to foreign companies not having a place of business in India / PE in India. In fact, in an interview, Justice A.P. Shah clarified that since the reference made to the Committee was about FIIs / FPIs, the recommendation is also in that respect. However, he stated that the view of the Committee is that the judgment in Timken8 is correct law and the MAT Provision will not apply to a foreign company without a place of business or PE in India.
The Report also states that in the Committee’s view the ruling in the case of Castleton is “completely wrong” The Committee further takes notice of the fact that while this is not an actual case of retrospective levy of tax on FIIs/FPIs, the Castleton ruling and subsequent action of the Indian tax authorities has raised significant concerns in the foreign investment community. By providing a comparison of laws of other countries with respect to levy of MAT, the Committee has suggested that the laws of our country should also be made in consonance with laws of such other countries.
The GoI’s acceptance of the recommendations made by the Committee is also a step towards its commitment towards no ‘tax terrorism’ which is the need of the hour. As the Report also suggests, tax certainty is the desirable goal. It is imperative that certainty, fairness and stability should continue to serve as guiding principles for framing tax regulations and not the amount of tax that can be collected. It is necessary to guarantee and enforce internationally recognized taxpayer rights and safeguards with the objective to counter excessive discretion and corruption.
1 (2012) 348 ITR 537
2 326 ITR 193
3 Section 210 of the Companies Act, 1956
4 As per GVK Industries vs. ITO,  332 ITR 30 (SC) and Ishikawajima-Harima Heavy Industries Company Limited vs. Director of Income Tax, Mumbai, 288 ITR 408 (SC).
5 CIT vs. B.C. Srinivasa Shetty,  128 ITR 294 (SC) - The Court in that case held that ‘goodwill’ cannot be described as an asset within the meaning of Section 45 and hence, any capital gain arising on the transfer of such goodwill cannot be subject to income tax under the head “capital gains.
6 Under the MAT Provision, the tax credit earned by a taxpayer company is the difference between the amount payable under MAT and regular tax (under the normal computation of total income of the company). It can be availed in the year regular tax becomes payable, which in the present case would always be lower than 18.5% prescribed under the MAT Provision.
7 Article 51(c) of the Constitution of India provides that the State shall foster respect for international law and treaty obligations in the dealings of organised peoples with one another; and encourage settlement of international disputes by arbitration.