MAT is a tax I have never properly understood. First, governments come under pressure and give tax preferences to some constituencies. Governments come and go but these preferences remain forever. Time and again, economists have pointed out that there are costs involved in giving preferential tax treatment to some particular sector, some particular activity. According to a World Bank paper, there are at least four types of costs- revenue costs; resource allocation costs; enforcement and compliance costs and costs associated with the lack of transparency. Instead of giving such preferences that benefit the selected few, governments can easily reduce the rates that benefit everybody. But, in that case, the taxation system becomes transparent and it is doubtful if governments really want a transparent tax system.

Like so many complex aspects of modern taxation, the concept of a Minimum Alternate Tax (MAT), also originated in the United States. There the system was initially targeted towards wealthy individuals. In 1969 the then Secretary of the Treasury Joseph Barr testified before Congress that 155 individuals had incomes above $200,000 but had no liability under income tax. The resulting uproar led Congress to enact the so-called "add-on"minimum tax, that later got transformed into the Alternative Minimum Tax.

As compared to the USA, the Indian tax system is perhaps full of bigger holes. There was a mild effort at pruning some of the tax preferences by Mr. Yashwant Sinha in the early 2000s. In his budget speech for 2000-2001, the Minister stated:

"With almost every sector of the economy expecting a special treatment, our Income-tax Act has become a vast compilation of exemptions. Income is income and should be taxed. There should be no permanent exemptions. With this in view, I want to make a beginning towards rationalising the existing system of concessions and exemptions …"

Important constituencies however ensured that either the sunset clauses introduced keep getting extended or that the tax preferences in some other forms came back. Despite numerous committee reports testifying to the contrary, tax preferences continue. The Kelkar committee in its 2002 report observed that ‘exemption Raj' had replaced the so-called ‘licensing Raj' of the pre-reform period. The figure of tax expenditure that is contained in the tax-foregone statement attached to the budget documents since 2006 shows that overall revenue foregone accounts has not declined over the years.

To contain the damage to the revenue to some extent since 1997 we introduced our own version of a MAT. As compared to the USA, in India, till recently the MAT was confined only to companies. However, the budget 2013 has introduced the concept of AMT that is now applicable even to individuals and other non-corporate businesses.

The current controversy relating to MAT is however relating to another field - the taxation of foreign investors. Ever since the opening up of the Indian economy since the 90's, the foreign investors, particularly the foreign portfolio investors are a pampered lot. Much of the foreign investment in India is of the portfolio variety rather than of the more durable FDI. Portfolio investment is volatile and here investors look for quick returns and scoot the country at the slightest provocation. Managing this hot money becomes a nightmare both for the government and the RBI. A sizeable chunk of the FII investment in India is again through participatory notes, a mechanism that RBI is not at all comfortable with. Recent attempts to control the PNs have led to another bout of sell off by the FIIs forcing the government to shelve the move (See 'The P(robematic)-Note')

As for taxation, at the beginning of the reforms process, when FIIs were allowed to invest in the Indian shares and securities, a special tax regime was actually legislated, giving such investors a preferential regime in the form of reduced rate of taxation relating to all the three forms of returns- dividends, interest and capital gains. Over the years however, there have been multiple changes in the taxation regime particularly in the area of dividends and capital gains and the general rate of tax on these streams of income has also been brought down with the result that these provisions have become more or less redundant. However, foreign investors bring with them the practice of international tax planning through double tax treaties involving complex interplay between domestic tax and such treaties. It is here that the politicians are either unable to fathom or unwilling to take action. Despite the fact that most foreign companies invest in India through preferential jurisdictions thereby reducing their effective tax rate, the government of India keeps on maintaining a differential headline tax rate between domestic and foreign companies. Thus, on paper, India is a rare country where the headline rate of tax on foreign companies is higher than the rate for domestic companies. On the face of it, this is discriminatory against the foreign investors. In actual practice, foreign companies pay much less tax and often times, it is the domestic investors that face actual discrimination. The movements against multinationals like Starbucks and others in other parts of the world have shown how the current international tax system is patently unfair to domestic investors.

Coming back to MAT, the origin of the concept in India can be seen in section 80VVA that was introduced way back in 1983. Since, the deductions from total income are contained in chapter VIA, that chapter contained this section that tried to restrict the deductions and there was no distinction between a domestic company and a foreign company. Any company availing of the chapter VIA deductions was subject to the restrictions. However, this system did not work properly and was replaced with section 115J in 1987. As narrated by the Justice AP Shah Committee tracing the history of MAT in India, the then Minister in his budget speech specifically mentioned:

"(…) [A] domestic widely held company will pay tax of at least 15% of its book profit."

So, going by the legislative intent, it seems that the intention at that time was to restrict the operation of the provision to Indian companies alone. Section 115J was subsequently made inoperative in 1990 following rationalization of the tax structure.

The problem of zero tax companies however continued due to the tax preferences and in 1996,the government reintroduced MAT in the form of section 115JA and now companies whose total income under the Income Tax Act was less than 30% of the book profits under the Companies Act were required to pay tax on 30% of their book profits. However, there were various exclusions even for the calculation of the book profit under the Companies Act. The scheme of taxation of the zero tax companies was therefore further changed in 2000 and section 115JB was introduced and now the comparison was to be done between the tax payable under the Income Tax Act with a fixed percentage of book profits under the Companies Act prepared in accordance with Schedule VI. The rate got progressively increased from 7.5% to the current 18.5%. The tax paid under MAT@ 7.5% was originally not available for credit. However, when the rate got increased, the MAT paid can now be carried forward and set off to ten years against the tax payable under the normal provisions of the Act.

It may be noted at this stage that through an amendment in 2006, it was specifically provided that long term capital gains exempt under section 10(38) would have to be taken into account for the purpose of computation of book profits of a company.

Section 115JB(1) as it stands today mentions that the provisions apply to an assessee, being a company. Therefore a plain literal meaning of the words may mean that the provisions apply to any company including a foreign company. 115JB(2) however provides how the profit and loss account should be prepared. Life Insurance companies are also specifically excluded from the ambit of MAT. Thus the argument that the provisions apply to all companies may not be correct.

An important question that arises in the context of MAT is whether foreign companies come within its ambit. As noted by the Justice Shah Committee report, the question first arose before the AAR in 1998 in [P.No14] (2002-TII-56-ARA-INTL) and the AAR at that time held that the MAT provisions are applicable to all companies including the foreign ones. The AAR observed that a foreign company with an established place of business in India was required to prepare accounts in accordance with provisions of the Companies Act and this attracted the charge under the then existing section 115JA. The Mumbai Tribunal in the case of Dresdner Bank (2006-TII-20-ITAT-MUM-INTL) also followed this ruling.

Then came the ruling in the Timken case where the AAR distinguished the case from P-14 since in this case the foreign company did not have any place of business. This same ratio was followed by the AAR in Praxair (2010-TII-26-ARA-INTL). The department apparently did not challenge these rulings.

Then came the ZD case (2012-TII-16-ARA-INTL) where there was a share sale that would be exempt from capital gains u/s 10(38). However considering the amendment in section 10(38) that stated that MAT would apply even in the case of exempt capital gains, the assessee sought a ruling from AAR. The AAR this time observed that a company is a company of whatever hue and that the difficulties in preparing accounts in terms of schedule VI of the Companies Act did not mean that the provisions of MAT in section 115JB should be whittled down. The AAR held that if by the interpretative process, it was to be held that section 115JB applied only to domestic companies, then as a corollary, it was to be held that section 10(38) would also apply only to domestic companies and there was no reason to adopt such a restrictive interpretation.

This was followed by the famous Castleton case (2012-TII-36-ARA-INTL). Here the AAR held that the provisions of section 115JB would apply even in the case of a foreign company that did not have a physical presence in India. The ruling was challenged before the Supreme Court that in turn has kept the issue pending.

It may be noted that in none of the cases litigated so far any FII was directly involved. However, the view propounded by the AAR in Castleton that MAT applies in case of foreign companies even if these did not have a physical presence in India would mean that FIIs that operate in India without a physical presence would be subject to MAT.

FIIs do not want to pay any tax. Of course, they will not say so. There is a term used for this. It is called ‘certainty'. But certainty has to be of one variety- no tax; otherwise there is no certainty. Naturally therefore, these forces lobbied hard and the government, ever worried about the investment situation, actually did them a favour by clearly specifying in the budget 2015 that FIIs/FPIs would not be subject to MAT. However, the government gave a prospective operation to the amendment. This meant that for earlier years, the MAT provisions could be applicable to FIIs.

However, it is also a fact that despite some decisions to the contrary, no one had actually heard the Revenue demanding MAT from foreign companies. It is only after the prospective amendment in 2015 that the tax department issued notices to FIIs asking for MAT demand. There was a huge furore. Caught on the back-foot, the government then appointed the justice Shah committee to study the whole issue and give its recommendation in this regard.

The recently released report of the committee has accepted the arguments that the provisions of MAT can apply only to those companies that are required to comply with section 591-594 of the Companies Act. The Committee took the view that filing of accounts by foreign companies is not attracted if there is no place of business of such companies in India. The Committee also pointed out that the machinery provision of section 115JB (2) would fail in case of foreign company not having a place of business in India. Besides, the FIIs have been given a special regime of taxation in section 115AD of the Act and if MAT were to apply and tax was to be levied @18.5% under MAT, the special provisions providing for a lower rate of taxation would become meaningless. The Committee also considered the effect of the DTAAs that in many cases give preferential treatment and these will again be meaningless. It may be noted that in between CBDT had also clarified through a instruction that those FIIs that are eligible for preferential treaty treatment through Mauritius and the like would not be covered by MAT. Adopting a purposive approach to interpretation, the Committee therefore took the view that FIIs would not be subject to MAT and that the amendment brought in by the Finance Bill, 2015 should be considered clarificatory and given retrospective effect. To put matters at rest the committee suggested that an amendment might be made in section 115JB to clarify the inapplicability of MAT to FII/FPI or CBDT might issue a circular in this behalf.

The Committee also took pains to stress that its report was restricted to FIIs and that it had refrained from giving any opinion about other foreign companies. It may be noted that the Castleton case involved a foreign company that did not have a place of business in India. Therefore the logic given by the Committee should apply to that case as well and the government having accepted the recommendation of the Committee, it is likely that the Supreme Court will finally decide the SLP in favour of the taxpayer in the case.

Although the committee's report does not specifically mention other foreign companies, it seems that the legislative intent mentioned in the report should equally apply to other foreign companies. It is possible to argue that even in case of other foreign companies; there will be impossibility of performance in the sense that foreign companies may not place their India accounts in their AGMs.

Besides, there is a change in language in the Finance Act as passed and the Finance Bill as originally introduced. The Minister's speech specifically refers to FII, as does the Memorandum. The Finance Bill actually proposed insertion of the following clause (iid) in the explanation to section 115JB:

" the amount of income from capital gains arising on transactions in securities (other than short term capital gains arising on transactions on which securities transaction tax is not chargeable), accruing or arising to an assessee being a Foreign Institutional Investor which has invested in such securities in accordance with the regulations made under the Securities and Exchange Board of India Act, 1992, if any such amount is credited to the profit and loss account;"

However, the Finance Act, 2015 as has been passed has the following provision:

(iid) the amount of income accruing or arising to an assessee, being a foreign company , from,—

(A) the capital gains arising on transactions in securities; or

(B) the interest, royalty or fees for technical services chargeable to tax at the rate or rates specified in Chapter XII,

if such income is credited to the profit and loss account and the income-tax payable thereon in accordance with the provisions of this Act, other than the provisions of this Chapter, is at a rate less than the rate specified in sub-section (1).

Thus the ambit of the provision has been extended. It now covers not only capital gains but also interest, FTS etc. The relaxed provision would apply to all foreign companies and not merely to FIIs. The most likely outcome therefore will be that foreign companies even with place of business in India would be out of MAT. It is a plausible outcome. However, this would be one more instance of reverse discrimination against domestic companies. Thus domestic companies having income from exempt capital gains would pay MAT as against foreign companies that will pay no MAT.

As for Justice Shah Committee report, the only complaint that I have is relating to the part that gives the FII inflow figure in India over a period of time to show the importance of such investments. By implication, the inference is that income from such investments should not be taxed or the practice that such incomes were not taxed under MAT should continue. But, if investment is the only criterion for taxation, then what offence has been committed by domestic investors that they should be discriminated against? After all the bedrock of investment in India is still domestic investment. True the FIIs have invested in India. But, that is certainly not for charity and they have reaped handsome gains from these investments.

The way this episode has played out shows that at a policy level, too much importance is given to the stock market indices. There is panic whenever the Sensex falls precipitately. And the Sensex is much too much dependent on the FIIs. So, the investors behind these entities that nobody knows may end up dictating the policy for the government. The venerable Deepak Parekh has also flagged the ill effects of such overdependence on FII investment. Speaking at a function organized by the ISB he observed:

"There is too much dependence on foreign Institutional Investors (FIIs), and I think we have exported our capital markets abroad. We have to do something to change this pattern."

[Source: It's time we stop over-dependence on ‘fickle FIIs': Deepak Parekh [http://www.dnaindia.com/money/report-it-s-time-we-stop-over-dependence-on-fickle-fiis-deepak-parekh-2033498] Sunday, 9 November 2014.] Mr. Parekh pertinently asked:

"Who is really benefitting from our well regulated equity markets? It is not the Indians, it is not our institutions, it is not our labour, it is not our retirees, but the FIIs"

The root cause of the problem therefore lies in our system of continued tax preferences. Apart from anything else, these create most of the litigations that India has come to be associated with. The Finance Minister has announced in the 2015 budget his intention to cut the headline corporate tax rate in 3 years to 25%. This is a laudable objective. However, this requires a drastic pruning of all our exemptions and deductions. A comprehensive study needs to be carried out to ascertain the cost benefit analysis of these provisions. Similarly, the tax treaties that we have entered into also end up giving tax preferences to the multinationals. The BEPS project at least has been able to bring this out. If as a result of all these efforts, we are able to curtail the various tax preferences, we will not only not need any MAT but we will also avoid a lot of litigation. That however seems like a very distant dream.