Parthasarathi Shome: Minimum alternate tax on foreign companies

The government has given clear and rational signals by avoiding taking aggressive litigatory positions and attempting to stay or resolve contentious matters with respect to selected international taxation issues. A case in point was the decision not to appeal against the judgment of Bombay High Court in the Vodafone transfer pricing case that related to a dispute between the income tax department and the multi-national corporation over a Rs 3,200-crore tax liability arising out of differences in share valuation. It is, therefore, surprising why the matter of imposition of minimum alternate tax (MAT) on foreign institutional investors (FIIs) was allowed to reemerge. In particular, as I shall explain, the matter was at the cusp of resolution a year back. In a few cases, such unanticipated income tax action seems to be followed by a retreat by the policymakers. Such actions tend to blemish the friendly assurances of top leadership.

A public stakeholder consultation window was created by the last government, called the Tax Forum, that addressed 47 indirect tax and 29 direct tax issues and resolved most of them through meetings that were held in a two-month period during August-September 2013. Industry and tax authorities participated in incisive dialogue on individual issues in a template framework. The FII-MAT issue under consideration was one of them. That meeting was held on September 26, 2013. Industry chambers Federation of Indian Chambers of Commerce and Industry (Ficci) and Confederation of Indian Industry (CII) represented.

On that day, a memorandum from industry raised the issue, to the Tax Forum, of applicability of MAT to foreign companies in the financial services sector. The genesis of the issue lay in the context of particular observations and conclusions of the Authority for Advance Rulings (AAR). It pertained to the case of Castleton Investment Ltd (AAR No 999 of 2010). In its decision, the AAR departed from the view expressed in a previous ruling in the case of Timken Company 2010 (326 ITR 193) (AAR). In the Timken case, it had been held that the MAT provisions – Section 115JB of the Income Tax Act – would not apply to a foreign company that had no presence in the form of a permanent establishment (PE) in India. This was obviated in the Castleton case by the AAR.

Industry represented that the AAR had failed to appreciate the fact that, in case of non-PEs, or foreign companies having no presence in India, there was no requirement under law to prepare profit and loss accounts (which in other cases had to be prepared in accordance with the provisions of Parts II and III of Schedule VI of the Companies Act, 1956). Accordingly, it would not be possible for a foreign company having no presence in India, that is, a non-PE, to comply with the requirements of Section 115JB(2) of the Income Tax Act.

Industry also represented that the AAR failed to appreciate the beneficial provisions of Article 13 of the India-Mauritius Tax Treaty. Under Section 90 of the Income Tax Act, foreign companies were entitled to enjoy beneficial tax treatment under applicable tax treaties. If the proposition that MAT applied to every foreign company was accepted, then in every case, despite treaty protection, income tax in the form of MAT would be payable. Such an interpretation would give MAT an overriding effect over the tax treaty, or, an unintended and certainly unexpected, treaty override. Such a consequence was contrary to the intention of the Income Tax Act and would render tax treaties ineffective and otiose.

Finally, industry asserted that the context and the legislative history of MAT provisions had to be interpreted to read as limiting the applicability of Section 115JB to Indian companies, that is, companies formed and registered under the Companies Act, and foreign companies that had established a place of business within India, as enunciated in Section 591 of the same Act.

Reflecting the industry position described above and the income tax department’s indication that non-PEs were indeed not supposed to prepare India-specific accounts, the Tax Forum concluded that non-PE FIIs were not liable to pay MAT. The conclusion was the outcome of understanding and agreement between industry and the tax department in a consultative environment. Accordingly, the Tax Forum suggested to the then finance minister that the ministry of finance should clarify the matter to avoid unwarranted litigation on this issue, and that instructions should be given to the tax authorities to the effect that MAT should apply only to foreign companies that had a PE in India in case of a treaty country, or established a place of business in India within the meaning of Section 591 of the Companies Act and where the foreign company was required to maintain accounts in India.

Accordingly, in the last days of the previous government, on May 12, 2014, the then finance minister took a decision that an amendment to 115JB be drafted for the Finance Bill to be introduced by any forthcoming government. This could have been done even through an explanation in the law in a way that would avoid any legacy issue that could be detrimental to past investment.  

Following international practice between outgoing and incoming administrations, as well as taking into account the positive ramifications for industry in line with the new government’s intentions, a list of already considered issues was conveyed to the new authorities prior to their 2014 Budget itself. They included the FII-MAT issue as well as several Tax Forum and other pending issues that could be relatively easily addressed since they were essentially awaiting drafting. In particular, in the instance of FII-MAT, it was clear that the two governments were on the same wavelength; hence, action was anticipated to be quick and decisive in the 2014 Budget itself and, if that was too soon, then at least in the 2015 Budget.

If the information so provided fell through the cracks, the question still remains if and how the matter was flagged to the new policymakers reflecting what had already been debated and decided through the Tax Forum by the outgoing administration with planned action for the 2014 Budget. The appearance of demands on FIIs citing the AAR ruling was, therefore, surprising. Using the AAR to issue tax demands was not only not imperative for the department, but it went against already arrived-upon understandings. One must ask, can a non-adversarial approach from tax officials be expected, leave alone assured, by the new regime despite its multiple assertions to investors. Reflecting the joint work concept and approach of the Tax Forum, it may be time for Ficci, the CII, the Associated Chambers of Commerce of India and others to initiate active re-engagement, rather than immediately jump into the litigation route (as has just been reported with respect to AFISMA). Cooperation must continue in order to contain disputes and avoid litigation. As for the department, a well-drafted circular should be quickly issued, followed by legislation as necessary.

In particular, where the Central Board Of Direct Taxation and the Central Board of Excise and Customs had already agreed to take action at the Tax Forum deliberations, those matters should be methodically brought to the attention of the current policymakers. Otherwise, confidence of industry would erode in the face of government statements that appear unmatched with policy application that follows. Wrong signals that move in contradiction to prevailing policy intentions escalate the already high opportunity costs for doing business. After all, the Tax Administration Reform Commission (TARC)’s final Feedback volume that also listed all its recommendations highlighted deep reforms needed in customer focus, stakeholder consultation and dispute management. The finance minister had indicated in his 2015 Budget speech that the TARC recommendations were in their final stage of consideration and that they would be implemented in 2015-16.

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