Government has accepted the Recommendation of the Justice A.P. Shah Committee to clarify the Inapplicability of MAT to FIIs/FPIs and has decided that an appropriate Amendment to the Income-Tax Act will be carried out.

Provisions of Income Tax Act, 1961 related Minimum Alternate Tax (MAT) have been rationalized by the Finance Act, 2015 by excluding the income of foreign companies earned in relation to capital gains arising on transactions in securities, interest, royalty or fees for technical services etc. from the chargeability of MAT. It was necessitated by controversy on the applicability of MAT on Foreign Institutional Investors (“FIIs”) due to the inconsistent rulings of the Authority for Advance Rulings (“AAR”).

However, the 2015 amendments are only intended to apply prospectively from 1st April 2015. Thus FIIs/FPIs may still remain liable for MAT for previous years  and tax notices and re-assessment notices have been issued to many of them for MAT liability calculated for the period prior to 2015-16 which have been challenged by FIIs before various forums.

The Direct tax Committee was constituted to look into this issue and the committee has submitted its Report dated 25-08-2015 on Applicability of Minimum Alternate Tax (MAT) on FIIs / FPIs for the period prior to 01.04.2015

The recommendations of the DTC are as under:

A. Summary of the Findings

6.1 Legislative History of the MAT Provisions in the IT Act

In order to interpret an existing provision of a fiscal statute, the legislative history, circulars and directions issued by the CBDT can be used as legitimate aids in the construction of such a provision. Having examined the various circulars and directions issued by the CBDT, including Circular Nos. 495, 762, and 794; and the legislative history, including the Finance Acts of 1987, 2002, and 2012, it can be concluded that the Legislature could only have intended for MAT to apply to companies governed by the regulatory requirement of the Companies Act, 1956. This is further bolstered by the fact that the Legislature expressly failed to specify any method for the computation of book profits for FIIs/FPIs, as it specifically did for electricity, banking and nonlife insurance companies by way of the 2012 amendment. This makes it clear that the obligation under Section 115JB exists because of the regulatory requirements of the Companies Act and not independent of it.

6.2 Contextual interpretation of the term “company” in Section 115JB

6.2.1 The term “company” as defined under Section 2(17) of the IT Act includes foreign companies. Nevertheless, Section 2 begins with the phrase, “In this Act, unless the context otherwise requires….”.

6.2.2 If Section 115JB is held applicable to FIIs/FPIs, they would be required to compile their global accounts in accordance with the Companies Act. However, such an obligation is absent in the legislative intent, as is evident from the insertion of Explanation 3 by the 2012 amendment, which failed to provide any computation mechanism for foreign companies’ book profits. Rather, the consideration of such foreign income in the company’s “book profits” would be contrary to the principle of territorial nexus, which is the basic principle for chargeability of income tax. Evidently therefore, the legislative intent was not to cover all kinds of companies, but to limit the definition based on context. We find that “company” has a narrower scope under Section 115JB than Section 2(17), IT Act, and is limited to entities required to file accounts in accordance with Sections 591 to 594 of the Companies Act, 1956. Thus, Section 115JB clearly does not cover an FII/FPI, and any other interpretation would render the computation mechanism in the Section unworkable.

6.2.3 The Committee is not expressing any view on whether a foreign company having a PE/place of place of business in India is covered by Section 115JB. This issue is squarely covered by the decisions of the AAR in The Timken Company and Praxair Pacific Ltd.

6.3 Whether FIIs/FPIs ordinarily have an established “place of business” in India under Section 591 to 594 of the Companies Act, 1956

The expression “place of business” has been judicially interpreted to mean a permanent and specific location in that country from where a company habitually and regularly carries on its business. The Committee has come to a finding based upon established precedent that having an “established place of business” is different from merely carrying on a business in India. FIIs/FPIs normally do not have their own office or employees in India and carry out their decision-making activities outside India. All their dealings are through independent agents in India. Additionally, the SEBI Regulations do not mandate their maintenance of books of accounts under Schedule VI of the Companies Act. Thus, FIIs/FPIs are, ordinarily, not covered under Sections 591 to 594 of the Companies Act, 1956.

6.4 Non-applicability of the charging provision in light of the computational failure under Section 115JB(2) of the IT Act

Section 115JB of the IT Act is an integrated code and the charging provision contained in sub-section (1) cannot be read in isolation of the computation mechanism under sub-section (2). Thus, where the computation of a tax against such income is impossible to calculate, the charge of tax against must also resultantly fail. The Committee disagrees with the Revenue’s argument that Section 115JB merely prescribes a general standard for preparation of accounts, which should be followed regardless of the company being governed by the Companies Act. Due to the computational failure in light of Section 591 read with Section 594, Companies Act and the absence of guidance on the segregation of domestic and global accounts, a foreign company having no established place of business or PE in India (i.e. an FII/FPI) cannot be taxed under Section 115JB.

6.5 Interplay between Section 115JB and Section 10(38) of the IT Act

The Revenue argued that Section 10(38) is applicable to both domestic as also foreign companies and since “company” was used in both Sections 10(38) and 115JB, then, by necessary implication, Section 115JB must also be applicable to foreign companies. This is a completely incorrect argument in our view. In order to attract the proviso to Section 10(38), the company must be covered under Section 115JB in the first place. As evidenced from the discussion in the Report, Section 115JB is not applicable to FIIs/FPIs. Therefore, even the proviso of Section 10(38), which makes a reference to Section 115JB, cannot be applicable to FIIs/FPIs.

6.6 Section 115AD of the IT Act – A self-contained code for FIIs/FPIs

Section 115AD of the IT Act, introduced in 1993 (when FIIs entered the Indian market) provides for a separate scheme for taxing the income of FIIs/FPIs, arising from Indian securities at a concessional rate. A perusal of this scheme clearly indicates that applying the MAT provisions under Section 115JB would render this separate scheme under Section 115AD otiose inasmuch as FIIs/FPIs will be taxed at a higher rate under Section 115JB and will not be able to avail of the benefits of the set off provisions and MAT credit. This indicates that Section 115AD, not Section 115JB, would apply to FIIs/FPIs.

6.7 Interpreting Section 115JB in light of the 2015 amendment

As discussed elaborately in the Report, FIIs/FPIs are not governed by the regulatory regime of the Companies Act, and thus Section 115JB is inapplicable to them. The 2015 amendment was only clarificatory in nature, and was not actually required to exempt them from MAT liability. Therefore, its prospective nature cannot be used to apply a different interpretation pre-2015.

6.8 Interpreting Section 115JB in light of Section 90 and the DTAAs

Section 90(2) of the IT Act provides that the DTAA provisions will override the provisions of the IT Act (including Section 115JB) if they contain more beneficial provisions for the assessee-company. Thus, regardless of the interpretation given to Section 115JB, it will not be applicable where a beneficial DTAA exemption is available. Castleton’s interpretation to the contrary, based on the non-obstante clause in Section 115JB, is incorrect.

6.9 Tax certainty as a desirable goal

6.9.1 FIIs are mostly open-ended investment funds, which permit their investors to enter and exist daily, based on the NAV of the fund. Unanticipated tax liability (or the fear thereof) relating to previous years, which would have to be borne by the current investors, may be a sufficient trigger for the investors to exit. The sudden change in the interpretation of the applicability of Section 115JB to FIIs/FPIs thus contextualises the need for tax certainty. In the 19 years since MAT was introduced (in 1996), it had never been levied on FIIs/FPIs, which were instead governed by the beneficial tax scheme under Section 115AD. Significantly, the Department also accepted the Timken ruling and did not file an appeal. Even after the 2012 ruling in Castleton, the Registrar of Companies, under the Companies Act, never called upon FIIs/FPIs to file their global accounts, evidencing that FIIs/FPIs were not intended to be taxed under the MAT provision.

6.9.2 A change in this settled position in August 2014 is extremely late in the day. While this may be a consequence of the Castleton ruling, the Committee believes the ruling to be completely wrong.

6.10 Comparative international practices

None of the other BRICS countries, namely Brazil, Russia, China and South Africa, levy MAT. Some of the OECD countries, such as Austria, Belgium, Hungary, Republic of Korea, Luxembourg, Slovak Republic/Slovakia and USA, levy MAT, but do not levy the same on foreign companies / persons unless they have a physical presence in such countries. India is therefore perceived as an exception in terms of its tax treatment of FIIs/FPIs. The position however has significantly changed after the recent amendment brought in by the Finance Act of 2015, which is discussed in detail in the Report

B. Recommendations

6.11 In view of the findings and upon a considered deliberation, we would like to make the following recommendations to the Government:

(i) To bring an amendment to Section 115JB of the Income Tax Act, 1961 clarifying the complete inapplicability of the MAT provisions to FIIs/FPIs; or

(ii) CBDT may issue a circular clarifying the complete inapplicability of the MAT provisions to FIIs/FPIs.

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