The relief of foreign institutional investors that they will not face a minimum alternate tax (MAT) in India has proved short-lived. According to a panel headed by Justice AP Shah – whose recommendations to roll back the tax have been accepted by prime minister Narendra Modi’s government – a foreign institutional investor that does not have a permanent establishment or place of business in India will not be liable to pay MAT.

India’s Central Board of Direct Taxation also issued a circular advising its field authorities to take into account the panel’s recommendations. But these tax authorities have raised queries from about five foreign institutional investors as to whether they have a permanent establishment in India.

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The ground for confusion is that there is no clear definition as to what constitutes a permanent establishment. Tax authorities consider that any foreign entity has a place of business in India if it has a dependent agent who executes trades or contracts on its behalf in the country. Foreign institutional investors typically have agreements with custodians or brokers, and their fear is that tax authorities would construe that as a permanent establishment.

Tax experts on the other hand argue that in tax treaties, brokers or independent agents would not be regarded as permanent establishments if they are acting in the ordinary course of business. The government must clarify this matter at the earliest opportunity, rather than leave it to the interpretation of tax authorities at the field level. Any lingering confusion on this matter is bound to adversely affect foreign investor sentiment just when the government is signalling that it is open to ending once and for all its high-profile tax disputes with telecommunications firm Vodafone.

The tax has had its effect on the bourses, although there are other factors that have also impacted investor behaviour, such as stock market turmoil in China. As much as $2.6bn-worth of shares were sold in the equity market in August, with this bearish mood persisting in September and early November, according to the National Securities Depository.

Writing in the daily newspaper Indian Express, Ajay Shah has argued that “the legal risk associated with taxation and arbitrary actions of the tax authorities have created a climate of fear… After the crisis over minimum alternate tax on foreign portfolio investors had subsided, it was reported that income tax authorities were trying to establish whether [foreign portfolio investors] have [permanent establishments] in India in order to open a new battle front”.