A few weeks ago, Prime Minister Narendra Modi expressed his displeasure with India’s tax administration and asked the Central Board of Direct Taxes to deal with public grievances. Later, the finance minister spoke strongly in support of the income tax (IT) department and stated, surprisingly, that India’s tax regime was not confrontational. It is indeed difficult to reconcile these contradictory statements.
The finance minister went on to state that India was not a “tax haven” and reminded corporate India that “legitimate tax demands” could not be termed as tax terrorism. Nobody, anywhere in the world, can indeed complain against a legitimate tax demand. But what has made India a tax hell is outrageous tax demands, which have made this country a laughing stock in international tax circles.
The retrospective amendments after Vodafone and the persistent abuse of transfer pricing provisions seriously reduced the inflow of foreign direct investment (FDI). And the recent onslaught against foreign institutional investors (FIIs) will seriously cripple the inflow of funds from these institutions. The erstwhile finance minister (and current president) thought that by retrospectively nullifying Vodafone, it would collect more than Rs10,000 crore by taxing overseas’ transfer of shares. Three years later, it has collected nothing, but simultaneously lost perhaps thrice that amount in FDI.
The impact of Vodafone was evident on the FIIs as well. Net investments of Rs 1,68,000 crore dropped to Rs 51,000 crore after the Vodafone retrospective amendment. In the financial year 2014-15, thanks to the Modi wave, FIIs have made a net investment of Rs 2,80,000 crore, which is the highest ever this country has seen.
The latest demand of more than Rs 40,000 crore from the FIIs is seriously flawed and will have disastrous consequences. These demands will certainly get embroiled in litigation for years, with negligible tax collection. Once again, our tax department will admirably succeed in repelling foreign investment and making India as unattractive as possible.
Without question, the gargantuan demand of minimum alternate tax (MAT) against FIIs is yet another example of Indian tax terrorism. In the first place, it is impossible to believe that the IT department would have allowed “legitimate” tax dues of Rs 40,000 crore from FIIs to have escaped assessment for almost two decades. In the same breath, it is equally absurd to suggest that, despite tax audits, FIIs merrily evaded taxes of this magnitude for several years.
Now, MAT is intended to apply to domestic companies that pay little or no tax because of the special incentives that the Income Tax Act itself grants. Indeed, MAT is itself a mild form of tax terrorism as this example illustrates: investments of thousands of crores were made into special economic zones (SEZs) on the promise that profits would be tax-free. SEZs were actually meant to be “tax havens” because all taxes were exempt. But because SEZ units pay zero-tax, the government asked them to pay MAT at 18.5 per cent. A promised tax haven was “legitimately” converted into a mini tax hell.
Most of the FIIs are not Indian companies. They are, however, governed by the Sebi (Foreign Institutional Investors) Regulations, 1995, which require an FII to have a bank account and a custodian. Most FIIs do not have any branch or office in India. Also, from 1995, FIIs have never been treated as domestic companies or as companies governed by the Companies Act, 1956. So, what happened in 2015?
Welcome to the wonderland of the Indian IT department. As the Sebi regulations of 1995 require certain statutory compliances like opening a bank account in India, the tax department now contends that all FIIs are deemed to have a “place of business” in India under Section 591 of the Companies Act, 1956. Consequently, the FIIs are treated on par with domestic companies and liable to pay MAT.
If Infosys or Tata Motors opens a bank account or even has an agent in London, will it be treated as a British company? If an Indian investment company is required to operate a bank account in London because of the UK’s securities regulations, will it become an English company? The entire MAT demand of Rs 40,000 crore is being made by reopening assessments on the foundation of the laughable legal premise that complying with Sebi regulations results in FIIs having a place of business in India. If this was the correct legal position, what was the IT department doing for the last two decades? Indeed, FIIs have paid taxes on their long-term/ short-term capital gains, dividends and interest income — and India has never been a tax haven for the FIIs.
The finance minister and revenue secretary have justified these demands on the ground that a decision of the Authority for Advance Ruling (AAR) was in favour of the Revenue. Therefore, while the FIIs are protected for the future, nothing can be done for the past years.
This is simply not true. In three decisions of the AAR, it was held that the foreign companies are not liable to pay income tax unless they have a permanent establishment in India (Timken, Fidelity and Royal Bank of Canada). In Fidelity, it was also specifically held that an FII, appointing a custodian in compliance with Sebi regulations, did not attract MAT. The two cases in favour of the Revenue are Castleton Investments and ZD, which simply gave a contrary ruling in total disregard for the earlier decisions. What is even worse is that in both Castleton and ZD, the Revenue actually agreed that MAT did not apply to foreign companies. Despite this concession, the AAR strangely went on to hold that foreign companies are liable to MAT in these two cases. Further, the demand against FIIs is not on the basis of the two erroneous AAR rulings but on the ground that FIIs have a “place of business” in India — a point on which the law is decidedly against the Revenue.
If these absurd demands are sought to be justified, India’s financial future is fraught with danger. After a decade, we have a PM who wants to dream big. But all his dreams are guaranteed to be shattered by our tax administration that makes our investment climate highly toxic. Our tax laws and administration destroyed FDI a few years ago. Unrepentant, they will now wreck FIIs too. It requires a steep and arduous climb to make India a haven for investments. But the descent into hell only requires a few absurdly aggressive tax demands.
The writer is a senior advocate of the Madras High Court
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