$6 bn tax demand: FM Jaitley lacks clarity on FII taxation and babus are cashing in

When you indulge somebody excessively and one fine morning pull him up, he is bound to bristle with indignation. That precisely is the saga of FII taxation in India.

Ever since their entry into India in 1993 on the back of liberalisation and globalisation initiatives, the Indian government has been swooning over them, rolling the red carpet.

Majority of them came to India via Mauritius, secure in the knowledge that the double taxation avoidance agreement (DTAA) India has with that country would insulate them from any capital gains tax on profits made from the Indian bourses. The pact says if you are a resident of Mauritius, you would be taxed for capital gains earned in India in Mauritius and not by the Indian government.

The Mauritius government after signing the treaty, post haste abolished capital gains tax in Mauritius thus playing dog in the manger to the hilt. In the last two decades and more thus FIIs have had it so good that any talk of taxing them angers them no end.

The CBDT has been saying in the past that what FIIs earn in India is business income and not capital gain. It is on dot except that then Finance Minister P. Chidambaram went out of the way to humor them and said specifically that what they earn is capital gains, period.

With this official imprimatur, Mauritius, and to some extent Singapore the DTAA with which is fashioned after the Indo-Mauritius agreement, continues to cocoon them. Chidambaram went on to say they cannot be taxed for business income because under a typical DTAA, existence of a permanent establishment in India is a prerequisite.

He said smugly they didn’t have one, much to the delight of the FIIs which have raked in considerable moolah from India over the years thus contributing to the volatility of the exchange rate in no small measure.

But the tax administration has been itching to put its shovel on the enormous income earned by FIIs. Last year, therefore, it set about assessing their income under the Minimum Alternate Tax (MAT) regime on the ground that it applied as much to Indian companies as to foreign companies.

In other words, a frustrated tax administration peevishly wants to collect some tax at least from FIIs when that is simply not on because once you grant that a person is not liable to tax then it follows he is not liable to MAT either.

Furthermore, MAT is not a non-refundable tax but only an advance tax to be adjusted against normal tax liability within the next 10 years. Where is the scope for such adjustment on set-off against normal future income when they enjoy tax immunity in perpetuity?

The finance minister sought to smoke the peace pipe with them apparently in deference to their mover and shaker status on the Indian bourses. Vide the Finance Act, 2015, he has assured them that FIIs would not be deemed to be having a place of business in India merely because the fund managers thereof were located in India.

In other words unless the FIIs themselves can be treated as Indian residents, they will not be taxed in India on the limited ground that their fund managers were in India. Of course, he has inserted a few stiff conditions on the fund managers so as to enable them to protect the FIIs they are working for but these need not detain us. This amendment is prospective, and takes effect from the AY 2016-17.

Jaitley should have made a retrospective amendment where it was merited. This issue merits a retrospective amendment the absence of which has emboldened the tax administration to go on slapping tax notices towards MAT on FIIs.

At last count some 100 FIIs have been targeted with an aggregate demand of $5 to 6 billion. When you smoke a peace pipe you must smoke fully – a half smoked pipe fouls the atmosphere. Alternatively, Jaitely should have had the guts to call the bluff of Chidambaram and demanded tax from the FIIs from the Day One.

He has not done that for the fear of rocking the foreign investment boat further. He should have offered the olive branch to them fully and completely. The tax department is acting squeamishly in the meanwhile by clutching at the MAT straw.