It's the same old story

The MAT issue shows why the government should issue a guideline on how to deal with tax treaty claims

Illustration: Kishore Das

The current government has promised at every possible forum that it will bring in tax reforms. While it has taken some laudable steps such as advance pricing agreements (APA) roll-back, decision not to appeal the Vodafone ruling and course correction on the definition of place of effective management (PoEM), its policy-making process is still very wanting.

While the budget proposal to exempt foreign institutional investors (FIIs) from the levy of minimum alternate tax (MAT) going forward was a positive move, the lack of clarity on the past and the outstanding demand notices have, in an oblique way, affirmed the revenue authority’s position on the levy of MAT on FIIs (which have no physical presence in India) for the past years and also exposed all other foreign companies having a source of income from India to MAT levy.

This speculation has spooked the market, resulting in a major fall as some FIIs wound up their positions. The government tried to pacify the investor community by offering them tax treaty protection and instructed its officers to decide on notices of MAT levy on FIIs after considering tax treaty benefit within one month. This instruction, however, is again guarded and merely directs tax officers to decide on eligibility of FIIs to claim tax treaty benefit within a month. It would have been helpful if the government had issued a guideline on how to deal with the tax treaty claims. Leaving it to each tax officer’s discretion might result in another round of litigation and one would not be surprised to see some interesting reasons for not granting tax treaty benefit to FIIs on a MAT levy. 

Calling this a legacy issue is a myopic political ploy as it is hurting the economy real-time. The government has announced the setting up of a committee under Justice AP Shah to look into the grievances of FIIs, but it seems like too little, too late.

It’s complicated

The dispute of MAT levy on foreign companies is multi-fold. One needs to first determine whether MAT can be levied on a foreign company on its India-sourced income. If yes, should MAT be levied only on foreign companies having a private equity in India? And would the double tax avoidance agreement (DTAA) benefit be available to foreign companies over MAT liability? To give a perspective of the judicial evolution on this facet, the Authority for Advance Rulings, as early as 1998, had held that application of Section 115JA should not be confined to domestic companies or Indian companies only.

It further held that the effect of article 7 of DTAA is to limit the quantum of the taxable income of the applicant-company but it does not absolve the applicant-company from paying any tax which is payable by a resident-company. It also noted that some practical difficulties have been pointed out for imposition of the tax levied by Section 115JA. But it is a well settled principle that once the charge is clearly established the machinery sections should be construed in a way to effectuate the charge and not to nullify the charge. Thus, almost two decades back, the judiciary in India had taken a view that in case of a PE in India, a foreign company can be obligated with a MAT liability. 

The above ruling was, however, distinguished by the AAR wherein it was analysing applicability of MAT provisions on a foreign company earning capital gains from transfer of shares held in an Indian company. AAR said the applicant was doing business and had a PE in India. Its income was being assessed under the head “Income from business and profession”. It was required to maintain accounts under Section 44AA of the Income-tax Act and prepare accounts under section 594 of the Companies Act, 1956, which is not the fact in the case of share transfer transaction. It thus held that section 115JB is not designed to be applicable to the case of the applicant, a foreign company, who has no presence or PE in India. 

However, the AAR disagreed with above rulings in the case of Timken and Praxair wherein it held that Section 115JB (1) imposes the liability to be taxed and sub-section (2) only charts out the procedure for calculating the taxable profit. In fact sub-section (2) casts an obligation on a company to which sub-section (1) is attracted to prepare an account in terms of the Companies Act, 1956. The above principles were followed by the AAR in the case of Castleton Investment Ltd., In re [2012] 24 150 (AAR), where it held that by reading Section 115JB as confined in its operation to domestic companies alone, one may be doing violence to the special scheme of taxation adopted for taxing certain companies. There is no compelling reason to jettison the scheme of taxation adopted by the Act by reading down Section 115JB as confined in its application to domestic companies alone. The AAR, however, did not analyse availability of tax treaty benefit over MAT liability on capital gains income computed under the domestic law. Thus, this issue is still open for debate.

Keep it transparent

This pending litigation and the divergent views possibly played on the mind of the finance minister, who left it to the wisdom of the apex court to decide on the issue of applicability of MAT on foreign companies in the case of Castleton Investment which is currently pending before it. 

While in the end one can expect a resolution to the issue, the fear is that by then, it would have caused enough damage to the credibility of the current government’s claim of providing an investor-friendly tax policy. The government needs to work not only on its tax policy but also the process of making it. To avoid such conflicts and surprises in future, the tax policy making process should be more consultative and transparent so that views of all stake holders are taken into consideration before a proposal is announced in Parliament. This would help both the sides understand each other’s point of view. While the intention of the current government seems to be good, tax policy formulation and administration needs to be made equally effective!