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FIIs Get Hit by Minimum Alternate Tax Demand of 40,000 Cr. for Thinking Capital Gains Were Tax-Free


Foreign institutional investors must be perplexed. After this government came about and said “No retrospective taxes”, it does the most astounding things ever. The latest in the kit is to hit FIIs with back-taxes.

The history

In 2012, a Mauritius entity called Castleton Investment Limited (CIL), a Mauritius entity, asked an interesting question of the Income Tax Authority for Advance Rulings (AAR, where you can say, Look I’m doing this thing, will you tax it?)

CIL owned shares of Glaxo Smithkline India, since 1993. But it wanted to transfer these shares to a Singaporean group entity. Since it owned shares for 20 years, it should technically have not paid any taxes in India (long term capital gains tax in India is zero). Plus, India has a double taxation treaty with Mauritius.

But the AAR said something weird:

  • Yes, there’s no tax for this transaction in India
  • But wait, transfer pricing rules apply (so it has to be proved to be an arm’s length transaction)
  • And hang on, CIL has to pay Minimum Alternate Tax (MAT) in India.

Whoa. Wait. MAT is now nearly 20%.

An investment company that’s held shares in India since 1993, now would think that because cap-gains taxes are zero, they needn’t pay anything! But with a 20% MAT, that effectively means that any company which sells Indian listed shares will have to pay 20% MAT on the profits.

That’s effectively a capital gains tax! In another ruling in 2012, AAR confirmed the same thing for another company, Smithkline Beecham Port Louis Ltd.

This impacts every single entity that made profits selling shares in Indian companies before April 2015. Even if they were based in Mauritius, it seems, at least from the above ruling.

No MAT since 2015 April

The Feb 2015 budget removed MAT from FIIs hands, but only going forward.

Which meant only one thing: that MAT applied earlier. Which means, FIIs who made profits must pay.

The Big Demand

Arun Jaitley recently affirmed that he would press on with a demand of Rs. 40,000 cr. This demand was made of FIIs who bought (and sold) Indian shares in the past, and considered their gains to be tax free – either as a result of a double taxation treaty (such as being based in Mauritius) or because Long Term Capital gains taxes are anyhow free.

This is no longer the case, considering the AAR rulings.

Meaning: Sure, no capital gains tax. But MAT applies, so give us your 20% please.

Impact: Hedge Funds, Foreign Funds, VCs?

Think of this: A big VC bought into a startup from its Mauritius entity. It got an “exit” by having that company go through an IPO. It sold the shares later on an exchange, and returned the profits to its investors.

Suddenly they get a tax demand saying give us 20% of that old money back. Why? Because MAT is applicable. How are they going to get that money back? Doesn’t sound feasible, does it? But it’s out there.

Hedge funds that invested directly in India for the “long term” too have gotten these demands (i.e. even non Mauritius entities). And this doesn’t end here – even if certain companies haven’t got a demand yet, they can get more demands later, since the tax department will simply work on this one entity at a time.

They had requested Jaitley to please go retrospective on this law which would have cleared past dues – but Jaitley refused. Which means many of them will have to pony up; even if it means taking the money off their own pockets. But will they just choose the other option: Exit India Altogether?

The Impact is also to Indian companies: if your company owns shares and sells them, even after one year of holding, MAT will apply. When you value a company saying it owns shares of THAT company, what you should do now is straightaway put a 20% discount for MAT. Even for long term capital gains on mutual funds or “arbitrage” funds, companies are likely to be hit with MAT, making their effective returns lesser.

You never know when this rule will suddenly begin to apply to LLPs and even Individuals; there is something called “AMT” but we haven’t seen a ruling that applies this to capital gains yet.

It’s not over – there will be a lot of push and pull from every side, but this adds another horrible layer of misunderstanding. We wouldn’t be surprised to see such tax aggression followed by investors just refusing to invest. Yes, India does have a point; but does it really need to say that something is tax free when it isn’t?


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