Why FIIs will keep a wary eye on Jaitley

Because the most important budget announcement may be one that isn't made

The usual hopes for an STT reduction or tweaks to the short term capital gains tax,  may or may not be met  as the budget is read out. The markets are unlikely to be greatly moved by these steps either way. But there is one development that the market may not be so blasé about. 

Those in the know have suggested that tax authorities are waiting to pounce on the tax returns of hundreds of foreign portfolio investors. And the axe will fall if there is no clarification in the budget over the application of Minimum Alternative Tax or MAT to foreign portfolio investors. 

MAT is applicable to large domestic corporates who do not pay any taxes because of various incentive schemes. The authorities are now seeking to apply the same to foreign portfolio investors who are structured as corporate entities. 

Notices in this regard have been sent out and foreign investors have been asked to clarify why MAT should not be imposed. The tax authorities have apparently conveyed to investors that MAT would apply if there is no clarification to the contrary in the budget. 

This would mean that foreign portfolio investors’ effective tax rate goes up from zero per cent for long-term capital gains to 20 per cent under MAT.

The application of Minimum Alternative Tax could cost as much as a hundred crores for a large foreign portfolio investor. With thousands of them in the mix, the tax liability is likely to be considerable. 

The basis of this application is flimsy, contended Rajesh Gandhi, Partner-Tax at Deloitte Haskins & Sells. 

"Primarily, they are relying on a recent decision pertaining to Castleton Investments, according to which MAT can be levied on foreign corporate entities. However, this is an advance ruling and not binding on other taxpayers. It might, at the most, have some persuasive value. In September 2014, the Delhi tribunal, in the case of Bank of Tokyo Mitsubishi, had observed MAT was only payable by companies required to maintain books of accounts under Indian law," he had told Business Standard earlier. 

The government has every right to impose taxes if it deems them appropriate. But such taxes should be based on a clear position in law rather than the kind of ambiguity that tax experts are alleging. 

If you thought foreign investors' reaction to GAAR was bad; MAT has all the signs of being far, far worse.