They say stock prices reflect theperformance of the business andnot foreign institutionalinvestor (FII)/foreign portfolioinvestor (FPI) flow. Investmentsby FIIs/FPIs have seen a steady growth inIndia since the opening of the equitymarkets in 1992. They have contributed tothe economic growth of the country. FIIshave changed the face of the Indian stockmarket. Today Indian stock markets are anattractive investment avenue. But of late,foreign portfolio investment flows intoIndia have slowed down. FPIs have soldRs 3,467 crore worth of equities in May,according to official data. The data revealthat they have offloaded stocks worthRs 13,110 crore. The benchmark indices, theBSE Sensex and the National StockExchange’s Nifty have tumbled ninepercent each during this period.
The data also suggest that the FIIs/FPIs aremoving to more greener pastures such asChina, Korea, etc. According to a report inthe media, Adrian Mowat, Chief EmergingMarket and Asian Equity Strategist at JPMorgan, has said that JP Morgan hasmoved some money out of India into SouthKorea and Taiwan. Moreover, threeAustralian fund managers said they hadreduced their Indian exposure in favour ofChina. Why is there a flight of capital? Isthis a sign of businesses not doing good orsimply bad economics?
The lack of clarity around minimumalternate tax (MAT), originally meant toexpand the tax net to companies thatdistributed dividends to their shareholdersbut did not pay taxes due to various taxincentives, is the major reason for bearishFPI sentiment. The revenue department hassent notices to FIIs demanding 20 per centMAT on their capital gains till March 31,2015. A large number of FPIs haveprotested the notices and demands sayingthey were exempt from long-term capitalgains tax. The government claims that it ismaking an effort to make investorsunderstand why issue of MAT (on capitalgains made by them) has arisen and how itcan be resolved. Government has also saidthat for the future MAT will not beapplicable. And in a bid to reassure foreigninvestors on tax policies, top governmentfunctionaries in May held meetings withFPIs, but refused to relent on Rs 40,000crore past tax demand saying the remedylies in judicial appeal. A fund manager,Arild Johansen, FMG EM Funds, whiletalking about the MAT controversy told theforeign press Reuters, “The debate overretro taxes on capital gains is noise forinvestors, who may take the opportunity toreduce their Indian equity exposure andlook for value elsewhere.”
In the words of the Finance Minister, Arun Jaitley, tax policy and administrationshould incentivize compliance. “Theyshould be administered fairly, transparently,with minimum discretion with noharassment of taxpayers but also ensuringthat tax evasion is dealt with firmly,”said Jaitley.
Now let us look what happened which ledto the flight of capital in the recent daysfrom the stock exchanges in India and howthe ground reality does not reflect whatwas expressed by the FM.
MAT was first introduced into the Income taxAct, 1961 in 1987 by the insertion ofsection 115J. An entirely new Chapter XIIBwas introduced into the ITA vide FinanceAct, 1987. The rationale for bringing inthese provisions were that as a result ofsome deduction and concessions, certaincompanies were making huge profits bymanaging their affairs in such a way as toavoid payment of income-tax. So a newprovision to levy minimum tax on booksprofits of certain companies was introduced.
Further, the Explanation to section 115JBreads as under
Explanation [1]. —For the purposes of thissection, “book profit” means the net profitas shown in the profit and loss account forthe relevant previous year prepared undersub-section (2),
From 2012 to early 2014, the Income taxdepartment did not send any notices. In theend of 2014, the department decided to useAuthority for Advance Ruling (AAR), givenin August 2012 in the case that CastletonInvestments Ltd. to send notices of pastcapital gain tax by the FPIs. It was ruled byAAR that the Castleton was liable to payMAT when they transferred shares from aMauritius entity to a Singapore entity. Thecase is currently with the Supreme Court.According to experts, at the time ofintroducing the MAT provisions, the thengovernment, had domestic entities in mind.So, in the petition to the government theFPIs maintain that because provision ofSection 115JB is in plain languageapplicable only to domestic companies andgiven the fact that the petitioner is aforeign company, which has no place ofbusiness in India, the imposition of MAT onthe petitioner is an illegal extension of alaw meant to apply to domestic assesses tobook profits that are in financial statementsoutside India — thereby imparting extraterritorial application to domestic tax law —and that too in a manner contrary to itsplain language. The petition further argues,because holding that the provision ofSection 115JB applies to the petitioner,defeats the objective of the law to exemptFIIs from regular tax on such income,thereby to promote investments in Indiancapital markets by FIIs.
A number of FPIs make investments intoIndia through jurisdictions such asSingapore and Mauritius which havedouble taxation avoidance treaty withIndia. In their current form, the wordings ofthe MAT provisions are ambiguous and as aresult there have been many cases wherethe benefit of the treaty has not beenpassed to FPIs served with notices.However, the Revenue Secretary hasrecently made a statement that where treatybenefits are available on capital gains, suchbenefit will continue to apply. The CentralBoard of Direct Taxes has subsequentlycome out with an instruction to the fieldofficers to expeditiously decide matterswhere treaty benefit is available.
In the Finance Act 2015, the governmenthas passed the prospective exemption toFPIs from MAT in relation to capital gainsfrom transfer of securities (except capitalgains from transfer of unlisted securitiesheld for less than 3 years and listedsecurities held for less than one year andtransferred off the floor of the stockexchange). The government has alsoextended this exemption to all foreigncompanies and to the following streams ofincome: (i) all capital gains from transfer ofmarketable securities, (ii) interest, royaltyand fees for technical services accruing to aforeign company.
However, the amendment will not impact orbenefit FPIs that have been receiving taxnotices in the past couple of months on thebasis of applicability of MAT to past gainson investments.
According to experts, when MAT provisionswere introduced, the intention was clearlyto tax certain companies who wereotherwise profitable but who were notpaying income-tax on account of variousdeductions. And clearly it did not apply toFPIs, because company as per theprovisions of the Companies Act here andIncome Tax Act should not include foreigncompanies, including FPIs. As for the issueof permanent establishment, there is aclarity in the law that mere existence of afund manager of off-shore funds does notconstitute a PE. In this situation, is it notright to call the present notices to FPIs taxterrorism? According to the government,tax terrorism is a legacy issue, and theywill remove this in their own regime. Butthe Business Standard reported in May thatwhen 20 chief executives of companieswere asked if tax terrorism has decreased,seventy-five per cent said it has not.
An article in the media says that taxterrorism means putting illegal or extralegal pressure on the taxpayers to extractduty or deny refund which is not due ordue only after following due process of law.It says that there are many examples of taxterrorism and the most common is to denyall refunds or pass adverse adjudicationorders in the name of realising target ofrevenue.
It further says that another atrociousmethod of inflicting tax terrorism is to filean appeal against tribunal’s order in thehigh court even where the issue is one ofclassification or valuation for which,according to section 35G and L of ExciseAct, the appeal lies in Supreme Court, andthe Calcutta High Court in the case of CC vsImpex, 2014(305) ELT 38 Cal, has reiteratedthat appeal lies with Supreme Court. Thereport then rightly points out that once thecase goes to high court, it takes thenseveral years for the case to come up whenthe high court will say that the case is forSupreme Court to decide. In the meantime,the tax authorities will go on raisingdemands on the party every month andnever finalise the case and pressurise theparty to pay. This is a classic example oftax terrorism. So, it suggest that remedylies in the finance minister making it clearto CBEC and CBDT that they mustimplement his statement when he said atthe HT Leadership Summit “Unsustainabletax demand will not get taxes but only earnbad name”.
Even as the matter is before the Court andthe government has set up a committeeunder the chairmanship of JP Shah to lookin the applicability of MAT on FPIs beforeApril 2015, the government or the RBI isnot looking to take any step to halt theflight of capital. However, according toGeoff Lewis, Executive Director-GlobalMarket Strategist, JPMorgan AMC, reportedin the media, history, however, seems toshow that India is blessed with a greaterdegree of persistence than the averageemerging market (EM) when it comes toportfolio inflows. He writes that therecovery in portfolio flows after eachdisruption has tended to come sooner andmore convincingly in India’s case than forother emerging markets. As a turbulent Julylies ahead, his words are a great hope.
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