The controversy over retrospective tax is a pointer to how India functions, or to be specific, how it chooses not to function
Saw some numbers crunched by a newspaper the other day. For the last eight years, it shows that average monthly foreign institutional investor (FII) flows into India dry up in May and are at the lowest for the year — 1 per cent of total FII inflows for the year. The best month for inflows, according to the deep dive is September when as much as 16.55 per cent of the flows have come on an average over the last eight years. That is why sometimes the adage is completed by saying ‘sell in May and come back in September’.T IS CALLED THE HALLOWEEN INDICATOR — sell in May and go away. This theory points to the fact that November to April are the best months in terms of stock market fund flows. This has been empirically proven across the world markets. It holds good for India too.
Thanks to the retrospective tax overhang,
April was a lousy month this year, with FII inflows strangled. The BSE Sensex, which was going along swimmingly was down close to 3.5 per cent in April. But there is a bigger story that needs attention. Something material to the controversial retro tax and once again throwing into stark reliefhow India functions or, should I say chooses not to function.
Symptomatic of this dysfunctionality is as always a case pending in the courts. The government and Castleton Investment have agreed to expeditious hearings in the Supreme Court on a tax dispute, which is at the kernel of the current problem. The dispute pending since 2013 could settle the Minimum Alternate Tax (MAT) issue one way or the other.
Castleton approached the Supreme Court against a 2012 ruling by the Authority for Advanced Rulings, which said
By Sandeep Bamzai
that it would have to pay MAT on capital gains arising fron the sale of shares. With a similar announcement in the Budget, it allowed the income-tax (I-T) authorities to swoop down again. Since I-T authorities can reopen tax assess ments going back six years, panic gripped foreign portfoli; investors (FPI). Then news came that 68 notices amounting to unrealised gains of Rs 602 crore had been sent out. Statements like as much as Rs 40,000 crore could be garnerec through this route didn’t help; neither did talk that portfolio investment routed through countries with double taxatior. avoidance treaties would not be taxed. The seed of doubt hac been planted. This led to widespread consternation once again, convincing foreign investors that India will allow retrospective taxation through the backdoor. Markets hac slumped nearly 3,000 points from their top. The pervading mood was that FPIs had been dry-gulched.
BMR Advisors tried to provide some clarity on this highly contentious issue, which has led to a flight of capital from Indian stock markets. Here is a quick gander at what BMR said after finance minister Arun Jaitley’s clarification on the Finance Bill in Parliament:
The original Bill proposed an explicit exemption to foreign institutional investors or foreign portfolio investors from
applicability of MAT on income in the form of capital gains from transactions in securities (other than short-term capital gains on transactions on which securities transaction tax does not apply).
While the proposal addressed the controversy on applicability of MAT to FIIs/FPIs for the future, it raised concerns over MAT becoming applicable, by inference, to foreign companies, especially given the conflicting judicial rulings on the matter.
The revised Bill proposes to extend the explicit exemption to any foreign company that earns income in the form of capital gains on securities or earns income in the nature of interest, royalties and fees for technical services, which are taxable on a gross basis, provided tax payable on such income is at a rate less than the rate of MAT, i.e. 18.5 per cent.
The amendment only reasserts the government’s position that provisions of MAT apply to all foreign companies as well. This controversy on applicability ofM AT to all foreign companies is likely to get addressed through a ruling of the Supreme Court, which is currently examining this issue in a particular case that also forms the basis for the government’s view and the controversial notices to Fils/
FPIs to collect MAT on capital gains transactions.
The amendment also does not align with the industry’s demand that explicit exemption be made to apply with retrospective effect. The finance minister excluded this aspect while addressing the Lok Sabha. Several FPIs have filed a writ in the Bombay High Court against the notices issued by the government. The fate of these notices rests materially on the view the court takes in the weeks ahead. The FPI writ, which wants this lethal tax withdrawn, revoked and cancelled states: “because provision of Section 115JB is in plain language applicable only to domestic companies and given the fact that the petitioner is aforeign company, which has no place of business in India, the imposition of MAT on the petitioner is an illegal extension of a law meant to apply to domestic assesses to book profits that are in financial statements outside India — thereby imparting extra ter
ritorial application to domestic tax law — and that too in a manner contrary to its plain language”. The petition further argues, because holding that the provision of Section 115 JB applies tothe petitioner, defeats the obvious objective of the law to exempt Fils from regular tax on such income, thereby to promote investments in Indian capital markets by Fils”.
Under the current regime, foreign institutions are not required to pay any tax on long-term capital gains (gains from investments exceeding one year). Institutions are liable to pay short-term capital gains tax (tax on investment less than one year) at 15 per cent. Given the sensitivities and sentiment
involved and the fact that the matter is pending before the Supreme Court for a couple of years now, and the fact that we are going into a summer recess, an expeditious response from India’s judicial system is vital. The only way out is a vacation bench hearing the matter and giving a decision.
What does all this tell you? That babudom continues to call the shots, tax terrorism is an integral part of the Indian administration, that even reformist politicos succumb to rabid populism and most importantly, we remain one of the most litigious nations in the world. The matter is pending before the apex court for three years and we continue to wait for relief.
Meanwhile, we go ahead and do what we always do: set up a committee. On May 20, the finance ministry constituted athree-member committee to look into the applicability of MAT on Fils before April 2015. The committee is headed by A.P. Shah, chairman of the Law Commission of India. The other members are former chief economic advisor Ashok Lahiri and Girish Ahuja, former associate professor of commerce at Shri Ram College of Commerce, University of Delhi. More damagingly, Reuters put out a story recently, which said the finance ministry ignored warnings on notices sent out September 2014 onwards on this issue, allowing the sore to fester. Typically, doing business Indian ishstyle.