AREA OF RESEARCH: INDIA’S FOREIGN INSTITUTIONAL

INVESTORS TAX REGIME

ABSTRACT
Foreign Institutional Investors (FIIs) have always remained influential players in India's
investment market. However, India's tax regime in respect of FIIs has constantly undergone
turbulent phases. To start with, the controversy pertained to classification of FII income under
the income heads of business income versus capital gains, which classification was critical
considering its tax chargeability and tax rate implications under India's direct tax laws. While it
appears to be clear by the 2008 ruling in LG Asian Plus Ltd. v. ACIT, uncertainties for FIIs in
the context of non-resident taxation in India followed.

The first limb of this uncertainty is found in the proposed General Anti-Avoidance Rules
(GAAR) which seeks to implement the 'commercial substance' test if the Indian tax authorities
believe that the transaction was undertaken only to avoid taxes or lacked commercial substance.
This is proposed to apply notwithstanding that the transaction was routed through a tax friendly
jurisdiction, and as per India's tax treaty with such jurisdiction, no tax liability arises in India.
While effectuating of GAAR has been pushed back to 2016, the retrospective amendments of
2012 undertaken in India's Income Tax Act, 1961, pursuant to the Vodafone ruling by India's
apex court, has brought FII taxation under radar. The amendment, which adopted the 'look
through' approach against the 'look at' approach, may expose investors/P-Note Holders behind
the FIIs to taxation in India, notwithstanding that the FII may be located in jurisdiction like
Mauritius, with whom India has a favorable tax treaty. Also, as no time limit is prescribed for
retrospective application of the amendment, the whip will keep hanging on FII investments time
immemorial.

Expert committees have been set up to scrutinize and settle these tax controversies and to create
conducive tax environment for foreign investors in India, which is of utmost significance both,
from an investment and economic standpoint. However, with the foregoing retrospective
amendment in effect, it is to be seen how Indian authorities pacify FIIs from drawing out their
investments from India amidst the tax qualms and mitigate the uncertainties and associated risks.
This article discusses India's FII tax regime in light of the foregoing controversies, the prevailing
uncertainties and challenges, their impact on FII investments in India, and India's consequent
exposure to potential actions under bilateral investment treaties.