Foreign institutional investors (FIIs) will not face a minimum alternate tax (MAT) in India thanks to a government U-turn.

Three years ago, a ruling by a quasi-judicial body, the Authority for Advance Ruling, stated that as the income tax law does not make a distinction between Indian and foreign companies, MAT was applicable to the latter as well. It was on this basis that tax authorities made retrospective demands on foreign investors.

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The government appointed a high-level panel headed by Justice AP Shah, which concluded that an FII without a permanent establishment or place of business in India will not be liable to pay MAT. The panel also recommended amending section 115JB in the Income Tax Act to do away with retrospective taxation on FIIs, which the government has indicated it will consider in the next session of Parliament. The Central Board of Direct Taxes (CBDT) also issued a circular on September 2 advising field authorities to take into account the panel’s recommendations and “keep in abeyance, for the time being, the pending assessment proceedings in the cases of FIIs” and not to pursue recovery of outstanding demands.

The government’s decision is largely motivated by the adverse impact MAT has had on investor sentiment. Although the proximate cause was stock market turmoil in China, FIIs sold as much as $2.59bn worth of shares in the equity market in August. Their bearish mood has persisted with sales of $417m up to September 4, according to the National Securities Depository.

India’s finance minister has clarified that the CBDT circular concerns only FIIs and not MAT on foreign companies bringing in FDI. The Shah panel stated that MAT should not apply to foreign companies that do not have a presence in the country. The Supreme Court’s decision on the petition by Mauritius-based Castleton Investments that has been pending since 2013 is eagerly awaited in this regard.