A fascinating tale of two relatively new concepts coming head-to-head—Foreign Portfolio Investors (FPIs) and Minimum Alternate Tax (MAT)—is unfolding in India currently.
Tax Treatment of FPIs
As of January 2014, the Securities and Exchange Board of India (SEBI), the securities market regulator in India, had introduced the concept of FPIs by merging all other classes of foreign investors who interacted with the Indian securities market, namely foreign institutional investors (FIIs), qualified foreign investors and sub-accounts of FIIs. What emerged was a more harmonized classification of foreign portfolio investors. In keeping with the drive of simplification, the tax treatment for FPIs was streamlined as follows:
- FPIs would be entitled to a capital gains tax treatment in India on all profits realized on sale of their Indian securities.
- Long-term capital gains (LTCGs) realized on transactions on which securities transaction tax (STT) has been paid would be exempt from tax in the hands of the FPI.
- Short-term capital gains (STCGs) realized on transactions on which STT has been paid would be taxable at the rate of 15 percent as against 30 percent on business income.
- There is no tax on STCGs for funds routing investments through Mauritius and Singapore.
- Certain FPIs that establish an office in India and move fund managers from offshore destinations like Hong Kong will not face any extra tax burden. Thus, fund managers could relocate to India without exposing their funds to additional tax risk.
MAT Provisions – Square Peg in Round Hole?
All seemed fine until an innovative tax assessment officer in Mumbai rolled out the MAT provisions to FPIs and issued show-cause notices for MAT violations. Simply put, the MAT applies, in the case of companies, if the tax payable on their taxable income for any assessment year is less than 18.5 percent of their "book profit." If that is the case, then tax payable on the total income shall be approximately 20 percent of such book profits.
Since there are around 8,000 FPIs operating in India, this development appears worrisome because many FPIs are structured as funds via Singapore or Mauritius and thereby claim the tax benefits under the treaty; coming under the MAT umbrella would likely dent profits and take away the structuring advantage on which they relied. Further, given that a bespoke regime for FPIs was created of 0 percent and 15 percent for LTCGs and STCGs, respectively, imposition of the MAT would tax them at an effective rate of 20 percent, disregarding the nature of the capital gain. This is a classic case requiring harmonious interpretation of the tax code to ensure a specific exemption is not wished away by application of a generic provision.
If a tax show-cause notice arrives requiring MAT on an FPI, it may be worthwhile to:
- Revisit the calculation of "book profits" for the purposes of MAT, as these calculations can frequently be erroneous.
- Draft and file a bespoke clarification request with the Central Board of Direct Taxes, while at the same time, addressing the inapplicability of the MAT provisions to FPIs at the assessment officer level in parallel.
- Revisit any Authority for Advance Rulings orders obtained at the time of structuring the fund into India.
- Ensure that all filing requirements with the SEBI are up to date and procedural formalities are completed, as they will become relevant in case further judicial proceedings are involved.
This is unlikely to be a satisfactory situation for several FPIs facing proceedings with the income tax department in India, but the above steps should be considered to help ensure a potentially more favorable outcome.