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Investors have acquired and sold shares based upon share prices reflecting the understanding that the funds had no Indian tax exposure for portfolio securities sold after being held for the requisite long-term holding period.
The Bharatiya Janata Party's manifesto for the 2014 elections promised to end "tax terrorism", and in his campaign speeches Narendra Modi likened the taxman's role to the light touch of a honeybee harmlessly drawing nectar from a flower.
More than a year later, however, the "flowers" are writhing in pain because of multiple taxation-related stings, forcing the Modi government to spend an inordinate amount of time on damage control following a firestorm of protests from foreign investors.
Consider the controversy over retrospective applicability of minimum alternate tax (MAT) on foreign portfolio investors (FPIs).
The Finance Bill 2015 amended the MAT provisions to exclude capital gains earned by FPIs from the ambit of MAT from April 1, 2015, but the tax department's position has been that MAT applies to FPIs on all income (including capital gains) up to March 31, 2015 and to all income (other than capital gains) from April 1, 2015.
Tax experts, however, say the noise over this absurd tax demand could have been easily avoided because as per the law, there cannot be provision for capital gains tax on FPIs which are resident in tax-treaty regimes where capital gains tax is not levied.
Besides, MAT is supposed to apply to domestic companies which pay little or no tax because of the special incentives that the Income-Tax Act provides.
The controversy erupted when the tax department served notices on 68 foreign institutional investors (FII), demanding MAT dues.
The notices were served after the Authority for Advance Rulings in 2012 had directed Mauritius-based investor Castleton to pay MAT on its book profits when the company transferred shares from a Mauritius entity to one in Singapore.
What was surprising was that so much uncertainty over investments by FIIs was created even though the total value of the tax notices served eventually was just Rs 602 crore or Rs 6 billion.
The government got a committee headed by Law Commission Chairman A P Shah to look into this; but its report, submitted in July, was not made public because the Supreme Court was to hear a case that has a bearing on the matter filed by Castleton. As a result, uncertainty just increased.
It is welcome that the government tried to make its intentions clear last week - especially as risk concerns return to global markets.
There is a lesson from all this. The government must douse such fires more swiftly.
The tax department, meanwhile must be reined in.
An overzealous pursuit of such cases is counterproductive to the larger cause of tax administration.
It adds to the overall perception that India is arbitrary about taxes.
The water has already been muddied by innumerable previous instances of conflict, notably those involving Vodafone and Cairn.
In the MAT-FPI case, innumerable foreign investors had already got their prior tax returns audited by the tax department - without MAT ever being asserted.
Investors have acquired and sold shares based upon share prices reflecting the understanding that the funds had no Indian tax exposure for portfolio securities sold after being held for the requisite long-term holding period.
The harm to investor confidence - harm that is directly attributable to the sudden and unexpected MAT assertions - cannot be overstated.
Photograph: Reuters
