Tax demand on FIIs

The ghost of MAT continues to lurk…

So, you thought that the issue of minimum alternate tax (MAT) on FIIs was settled in the Union Budget? Wrong! What the budget has settled is the issue of prospective taxation and not retrospective taxation. And the notices worth $7 billion sent out to FPIs pertain to retrospective MAT on FPIs. Therein, rests the catch!

Can an FPI be subject to MAT?

This issue has been settled in many rulings but the confusion still prevails. An FPI, being a global investor, invests in multiple markets including India. For them, Indian equity is simply one of the many asset classes. They do not prepare income statements for the India business alone. Hence the question of levying MAT on profits should not technically arise in the first place.

What about prime brokers?

Prime broking is an important activity of foreign investors. These FPIs invest their own money as also act as prime brokers for other hedge funds who want to invest in India. Many hedge funds did not want to register as FIIs in India due to the regulatory and compliance-related hassles involved. Therefore, they preferred the Participatory Note (P-Note) route to invest in India. P-Notes save them the hassles and also give these hedge funds the required degree of anonymity. This gives rise to a very peculiar situation. Let me explain.

Assume that SAC Capital had invested in India through a P-Note opened by Morgan Stanley. Although, the ultimate beneficiary of the profit on the transaction would be SAC Capital, the Indian IT department will consider it as profits generated by Morgan Stanley, which is the registered FPI. Now if these profits get taxed, then Morgan Stanley will have to go back and recover this MAT from the hedge fund. It creates a complication as SAC Capital would have already closed the accounts of previous years and distributed profits to its end investors. Confusions galore!

Can India afford to act pricey?

That is the million dollar question. Let us face it; India cannot afford to act pricey. The US Department of Justice can impose a penalty of $10 billion on CSFB; and in all likelihood CSFB will pay up. The reason is simple. For CSFB the prospect of being cut off from the lucrative US market is a lot more devastating than paying up the penalty.

India’s case is a little more complicated. Most FPIs know that a few billion dollars of selling in the markets is enough to bring the Nifty and the rupee to a precarious situation. With India’s clear dependence on portfolio flows, she can ill-afford this situation. The finance minister should realize that after 20 years, India is still to find an alternative to bridge its fiscal deficit. They could have surely avoided this bravado! ©

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