There is a strange similarity in the way controversies over the tax treatment of foreign investors flares up every few year in India; the consequent ruffle it creates in the stock market, the hasty retreat of the government thereafter and the eventual signing of the peace pipe. The sections of the tax manual that come up for examination differ, the political provenance of the governments differ but the final results do not differ.
The latest example of it was on display over the proposal by the department to levy the minimum alternate tax on them.
Watch Video: AP Shah Panel Recommends No Retrospective MAT On FIIs- What This Means
This week finance minister Arun Jaitley had to intervene to announce that the tax will not be levied on them, at a press conference on Tuesday.
The issue was a simple one. Budget 2015-16 recognises that FIIs will not be treated as residents of India for tax purposes and so will be exempt from the tax with effect from this fiscal year. The tax department, however, left the question of what will happen to tax demands levied on them before this fiscal year. The department claimed it could not have done otherwise as there is a Supreme Court case currently on regarding this issue. In other words the FIIs who have received the tax demand for previous years have contested it in the Supreme Court and the department says it cannot take a position on it before the court hands down a ruling.
This is a specious argument. If the tax demand is not going to be maintained for this year, it should not be maintained for earlier years too. If the department had followed this simple logic, there would have been no need to appoint the Justice AP Shah committee which incidentally said the same thing but in judicial speak.
The reason why this issue flares up repeatedly has a simple answer. The Indian direct tax department has not been able to raise additional revenue from domestic sources for plenty of years. Across G-20 countries, India has one of the poorest ratio (aggregate) at 15.5. The OECD average is 24.6. China for instance, has 18.9 and USA 18.4. Taxation of the FIIs is a nice next egg to tap into instead of having to do the grunge work of unearthing unaccounted income, case by case. Unless this is rectified the recurrent attraction for taxing this sector will not go away.