29 April 2015 EY Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: http://www.ey.com/gl/en/ Services/Tax/International- Tax/Tax-alert-library#date Indian tax authorities impose minimum alternate tax on foreign portfolio investors Executive summary The Indian tax authorities have imposed minimum alternate tax (MAT) on various foreign portfolio investors (FPIs) investing on the Indian stock exchanges. Under the Indian tax law, MAT is payable at a maximum rate of 20% of the book profits if the tax under provisions designed for FPIs is less than MAT. The MAT provisions in essence negate any beneficial capital gains tax rate or exemption afforded under the regular tax provisions under which, capital gains earned by foreign investors from investments in Indian securities are exempt in India or taxable at a rate lower than 20%, depending on the type of security, holding period and whether benefits under a given income tax treaty are available. Recent news reports indicate that the Indian Finance Minister appears to have verbally confirmed imposition of MAT on income earned by FPIs in India, based on a private ruling of the Castleton Investments Limited case, which held that foreign investors are subject to MAT provisions in India, and that an exclusion of capital gain introduced in the Finance Bill, 2015 for FPIs would not have retroactive application to years prior to 1 April 2015. This Alert summarizes the legislative intent of MAT and its applicability to FPIs. Detailed discussion Taxation of FPIs Historically, FPIs have been subjecting their gains from investment in Indian securities to tax as capital gains 1 under the specified regime in the domestic tax law which has been in place since the year 1993. 2 Further, FPIs have been taking a position in their income tax returns that the MAT provisions should not apply to them since they do not have any place of business in India and are therefore not required to maintain books of accounts in India, supported by various internal
indicators in the MAT provisions under the domestic tax law and the legislative intent of enactment of the MAT provisions. The indicators include but are not limited to: MAT provisions were intended to tax zero tax companies and companies paying marginal tax. The rationale outlined by the legislature on several occasions at the time of enactment of and amendments to the MAT provisions indicates that the MAT is a levy of tax on domestic companies to neutralize the impact of tax incentives. A foreign company, especially an FPI, is unlikely to claim any of the specified incentive reliefs under the domestic tax law. In calculating book profit, preparation of the profit and loss account under the provisions of the Indian corporate law is a prerequisite. Since an FPI does not maintain the accounts separately for Indian investments, it is not possible to compute book profit for MAT purposes. In addition, several adjustments to net profits that relate to deductions are available only to an Indian company. The MAT provisions require that depreciation be calculated using the same method and rates that have been adopted for the purposes of preparing the profit and loss account and presented before the annual general meeting of the company. A foreign company does not hold an annual general meeting in India; consequently it could not apply to the foreign company. The intent of the legislature could be said to have always been to apply the MAT provisions only to domestic companies and not to foreign companies; otherwise, the legislature would have clarified the manner in which book profits of the foreign company is required to be calculated. Further, in certain private rulings, 3 the Authority for Advance Rulings (AAR) has held that foreign companies, not having presence in India, were not liable to MAT provisions. In addition, the Delhi Income-tax Appellate Tribunal in a certain case 4 observed that the intention of the legislature was very clear that the MAT provisions are not applicable to foreign companies. The Finance Minister based his position solely on one AAR ruling 5 that held that the MAT provisions applied to a foreign company. Castleton Investments Limited subsequently filed a special leave petition before the Supreme Court of India (SC) against the AAR ruling which has been admitted by the SC. Amendment proposed by the Finance Bill, 2015 (FB 2015) The FB 2015 proposes to amend the MAT provisions to be effective for taxable years beginning on or after 1 April 2015, to provide that capital gains earned by FPIs from the sale of securities on a recognized stock exchange in India will be excluded from book profit computation; however, all other income earned by FPIs would be included in the book profit. Application of the MAT provisions to income and capital gains earned by FPIs (for years prior to 1 April 2015) will: Effectively deny the long-term capital gains exemption available to FPIs for the past several years, resulting in such gain being taxed at 20% Raise the applicable 16.22% tax rate on short-term capital gains and 5.4% on interest income to 20% Tax authorities position For financial year 2011-12, 6 being prior to the proposed amendment, the Indian tax authorities have issued decisions subjecting capital gains and other income earned by corporate FPIs to MAT. However, it appears that in the recently concluded scrutiny proceedings, MAT has not been invoked in the case of FPIs being tax resident of countries with a favorable income tax treaty with India. The Indian tax authorities have started issuing notices to reopen past financial years to apply the MAT provisions to income of FPIs as far back as the seventh preceding financial year, i.e., a financial year 2007-08. If the Indian tax authorities apply the MAT provisions, it will also cause the FPIs to be subject to potential interest and penalties on tax due but such interest and penalties as well as tax due may be refunded if an appellate proceeding holds in favor of the FPI. 2
Endnotes 1. This position has also been accepted by the Indian tax authorities over the years. To provide further certainty to FPIs with regard to characterization of their income, the Finance Act, 2014, amended the domestic law to provide that any security held by a FPI in India shall be treated as a capital asset and hence the income arising from sale of such a security would be in the nature of capital gains. 2. Section 115AD of the Income-tax Act, 1961. 3. Timken Co. v. DIT [2010] 326 ITR 193 (AAR). Praxair Pacific Ltd, In re [2010] 193 Taxman 1 (AAR). 4. The Bank of Tokyo- Mitsubishi UFJ Ltd v ADIT (ITA 5364/ Del/ 2010 dated 19 September 2014). 5. Castleton Investment Ltd [2012] AAR New Delhi. 6. Financial years 2012-2013 through 2014-2015 are yet to be audited. 3
For additional information with respect to this Alert, please contact the following: Ernst & Young LLP (India), Mumbai Sudhir Kapadia +91 22 6192 0900 sudhir.kapadia@in.ey.com Ernst & Young LLP (India), Hyderabad Jayesh Sanghvi +91 40 6736 2078 jayesh.sanghvi@in.ey.com Ernst & Young LLP Indian Tax Desk, New York Riad Joseph +1 212 773 4496 riad.joseph1@ey.com Amit Gouri +1 212 773 7096 amit.gouri1@ey.com Ernst & Young LLP Indian Tax Desk, San Jose Neeraj Khubchandani +1 408 947 4975 neeraj.khubchandani@ey.com Ernst & Young LLP Indian Tax Desk, Chicago Romit Patel +1 312 879 2526 romit.patel1@ey.com Ernst & Young LLP, Asia Pacific Business Group, New York Chris Finnerty +1 212 773 7479 chris.finnerty@ey.com Kaz Parsch +1 212 773 7201 kazuyo.parsch@ey.com Bee Khun Yap +1 212 773 1816 bee-khun.yap@ey.com Ernst & Young LLP, Asia Pacific Business Group, Houston Trang Scott +1 713 751 5775 trang.scott@ey.com 4
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