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Foreign Portfolio Investors who trade in India’s equity and debt instruments have reduced their exposure to the markets from Jan’15 at Rs 33,688 crore to April’15 at Rs 15,266 crore. In the first 10 days of the current month FPIs withdrew a little above Rs 12,000 crore. This pattern of investments, against the upbeat mood prevailing in the markets since May’14, has been attributed to the Minimum Alternate Tax or MAT.
What is MAT and why are we hearing about this now?
MAT, prevalent in India since the late 1980s, has required companies to pay a minimum of ~20% tax if the company’s income tax is less than this amount. In 2010, Authority for Advanced Ruling (AAR) ruled that MAT was not applicable to companies not having a permanent establishment in India. However two years later the same body ruled that foreign companies would also be subjected to MAT.
In the budget earlier this year, Finance Minister announced that MAT wouldn’t be applicable on foreign companies from April 1,2015 but refrained from talking about transactions that happened in the past. Tax officials interpreted this to mean that foreign investors would need to pay MAT for previous years and issued notices to 68 FIIs totaling ~Rs 602 crore over non-payment of MAT.
Recent Impact on Stock Markets
The reaction of FPIs was predictable. In the first 10 days of May FPIs withdrew ~Rs 12,000 crore while global rating agency, Fitch said that the issue may lead to FPIs thinking twice before investing in India. Five FPIs also moved the Bombay High Court in early May challenging the Income Tax Department’s demand for MAT.
The markets also witnessed a downward trend during this period. Coming on the back of disappointing fourth quarter corporate earnings and a forecast of weak monsoon, this taxation issue spooked the markets further.
However the potential impact of MAT on FIIs investment sentiment is expected to be only on investors not covered by the Double Taxation Avoidance Agreements (DTAA).
Next Steps
The issue of implementing MAT on past years’ earnings is right now on hold. The Finance Minister announced on 7th May the formation of a high level committee headed by Justice AP Shah, Chairman of Law Commission that would give recommendations on issue of MAT on FIIs
Our View
Clarity on MAT and long-term view on the applicability would have been desirable. Taxing firms for previous years’ profits, while generating good revenue, is unlikely to be an incentive for investment. There is merit in the argument that if a firm makes profit here they need to pay a minimum amount of tax here. However it is also true that we need FPI investments which make our markets robust. The next decision by the government on this issue is likely to have long-term impact on FPI strategy, either way.
To contact the author: poulomi.harolikar@icraonline.com
References:
http://www.us.kpmg.com/microsite/tnf-asiapacific/2010/India_Aug6_No10.pdf
