When Prime Minister Narendra Modi began his tenure at the helm of one of the world’s fastest growing economies, he made it a priority to attract foreign investors to continue India’s economic growth.  However, just one year after assuming office, Prime Minister Modi and his administration must confront the concerns of foreign investors, following the retroactive enforcement of the Minimum Alternative Tax (“MAT”) on foreign investors.

The MAT was established in 1988 and has served as a tax on book profits for domestic companies.  Foreign institutional investors (“FIIs”) began investing in the Indian market in 1993.  Though FIIs have been subjected to other taxes, it was widely believed that the MAT only applied to domestic entities.  In fact, the Authority for Advance Rulings, a tax body that issues determinations about foreign tax liability, concluded in 2010 that the MAT did not apply to companies without a permanent establishment in India.  This changed in 2012, when the same body contradicted its prior ruling, concluding for the first time that foreign investors were required to make MAT payments.

The issue lay dormant while the company against whom the ruling was issued sought an appeal.  Yet the MAT gained a renewed interest when the 2015 budget included an amendment that would exempt FII income from the MAT after April 1, 2015.  This amendment, in the view of tax authorities, necessarily implied that FIIs were responsible for MAT payments on book income earned prior to this date.  Hence, tax authorities issued close to 100 demands to FIIs in an effort to retroactively collect MAT payments that could amount to over $6 billion USD.

These notices caused concern among foreign investors, and resulted in FIIs pulling out close to 17,000 Crore ($3 billion USD) in the first two weeks of May.  While the long term economic impact of the MAT demand on India’s economy is unknown, credit rating agency Fitch has noted that it may cause foreign investors to “think twice” before investing in the future.  Though foreign investors are justifiably concerned about the tax demands, the Modi Administration’s response offers hope that future controversies of this nature can be avoided.

First, Revenue Secretary Shaktikanta Das reassured investors that FIIs from countries that have tax treaties with India may be exempt from the MAT.  Second, Finance Minister Arun Jaitley directly addressed foreign investors by authoring a column in the Financial Times, in order to assuage concerns over India’s tax policy.  Jaitley highlights the reforms adopted by the Modi Administration, such as clarifying rules on transfer pricing and introducing safe harbor provisions for investors.  Most notably, he distances the Modi administration from the Authority of Advance Rulings’ decisions, stating that this body was established prior to the current administration assuming office.

While much of the column may be viewed as a justification for the administration’s decision to respect the tax body’s decision to issue demand letters, Jaitley offered encouragement for investors by proposing the creation of a high level committee to explore solutions to provide tax certainty to investors.  This three-person committee officially formed in mid-May.  Chaired by former Chief Justice of the Delhi High Court A.P. Shah, the panel has scheduled meetings with various FIIs and industry associations in order to develop a comprehensive view of the MAT controversy.

The substantive impact of the panel remains to be seen, primarily because the MAT issue is still pending before the Supreme Court.  It is unclear how the panel’s recommendation will coexist with a subsequent Supreme Court ruling on the same issue.  Yet the manner in which the government has directly confronted the controversy and has provided FIIs the opportunity to present their positions to an independent panel provides hope that investors may experience greater transparency with regards to their tax liability in the future.

This post was written with contributions from Assam Padukone.