7 things to know about MAT tax notices to FIIs

From Kotak Securities.

The benchmark Sensex fell nearly 1500 points or 5% since the Union Budget presentation on February 28, 2015. This is a major fall considering the Indian market's bullish streak in the past one year.
A key reason for this is the issue about Minimum Alternative Tax (MAT), which has worried foreign investors for some time now. FIIs are one of the biggest players in the Indian market. So, their stock trading affects the overall market directly. Worries about the MAT issue, however, have limited FII participation in the markets in the recent past, leading to the consistent fall.

Here we decode the matter for you in seven simple points:

Minimum Alternative Tax is an addition to the Income Tax, levied by tax authorities. It was introduced in 1997-98 to prevent companies from using loopholes and exemptions in the Income Tax Act to avoid paying tax. So, MAT acts as a threshold tax rate. Every company has to pay tax at this rate of 18% even if its effective tax rate is lower. However, there has been confusion over whether MAT is applicable for capital gains by foreign investors in the Indian markets.

Clarity finally came in the Budget speech, when Finance Minister Arun Jaitley announced that MAT would not be applicable for Foreign Portfolio Investors (FPIs). This means, foreign investors need not pay 18% tax on their book profits even if they do not have any taxable income as per IT Act. This was to be applicable from April 2015 onwards.

The announcement about applicability from April 2015 opened the can of worms. This is because tax officials interpreted that since the MAT exemption applies only from April 2015, investors had to pay MAT in the previous years. They had originally not levied the tax on investors because of the initial ambiguity.

Tax officials then sent tax notices to over 100 foreign investors for the three years preceding 2015. They have demanded for tax payments, which amount to nearly Rs 40,000 crore, according to media reports. Some reports suggest that this figure could rise up to Rs 63,000 or $10 billion as more cases are unearthed. Since the tax notice applies to years gone by, it makes the tax rule 'retrospective'. At a time when the government is trying to simplify tax rules and avoid any retrospective taxation, this issue plays spoilsport.

The finance ministry has been called to clarify the tax rule. The government said that MAT would not be applicable for investors trading from countries which have tax agreements like DTAA with India. DTAA stands for Double Taxation Avoidance Agreements. This includes 85 countries like Mauritius, Australia, Indonesia and US.

This has come as a relief to FIIs, but only some of them. The rest, who trade from other countries, would not enjoy the tax exemption. They will have to approach the Supreme Court, the government said. The matter is now sub-judice. It now depends on the Supreme Court to decide if FIIs will indeed have to pay billions of dollars of tax. However, the matter is not proceeding as fast as hoped. There is no clarity on a date for the court hearing.

Meanwhile, FIIs have limited their participation in the stock markets. This has worried many domestic investors too, who expect a major fall in case the FIIs start selling because of the issue. Such a volatile situation may continue until the SC hears the case. However, this issue only affects short-term capital gains. So, foreign investors who invest for the long term are unaffected. They may continue to trade in the Indian markets, which has been preferred over other emerging countries in the recent past.

From Kotak Securities.

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