SKP Tax Alert
15 December 2015 | Volume 8 Issue 23
CBDT addresses the issue of defect notices to foreign companies, only for FIIs/FPIs 

  • Over the past two years, many foreign companies, especially Foreign Institutional Investors (FIIs)/Foreign Portfolio Investors (FPIs), have been receiving notices from the income tax authorities stating that the tax returns filed by them were ‘defective’ in nature. The ‘defect’ as stated by the tax authorities was that these companies were not filing the details of their balance sheet and profit and loss account in their tax return forms.
  • The tax authorities accordingly asked these companies to rectify the defect within 15 days of receiving the notice. The law holds that if a defective return is not rectified within the prescribed time, the tax return filed could be treated as invalid.
  • Generally, all foreign companies (including FIIs/FPIs) have been taking a position that since they do not have any presence/permanent establishment (PE) in India, they are not required to maintain books of account in India. Accordingly, these companies are not required to file details of their balance sheet and profit and loss account in their Indian tax returns. Since the tax return form prescribed under the Indian tax law does not differentiate between domestic Indian companies and foreign companies which do not have any presence/PE in India, these companies would simply fill these fields as ‘nil’. Accordingly, on receipt of the defect notices, these companies were re-filing their tax returns without carrying out any changes and were also filing a letter with the tax authorities explaining the reasons for not filling these fields in their tax returns.
  • However, the tax authorities were taking a view that every company filing the tax return form should compulsorily provide the details of their balance sheet and profit and loss account in their tax return forms. Accordingly, if any company was filling these fields as ‘nil’ it was considered a ‘defective’ tax return. And the tax authorities repeatedly reissued such notices to these foreign companies, in certain cases upto five times.
  • The frequency with which these notices were being issued to the foreign companies (especially FIIs/FPIs) had taken the international investor community by surprise. In fact, certain FIIs/FPIs thought that one of the reasons for issuing these notices was to try and levy Minimum Alternate Tax (MAT) of approximately 20% on their book’s profits even though they may be subject to a lower tax on their income under normal income tax provisions.
  • In the meantime, the Indian government amended the Indian tax law to clarify its intention that all foreign companies which do not have a presence/PE in India and earn income in the form of capital gains, interest, royalty, fees for technical services, etc. would not be liable to MAT. Furthermore, the government also accepted the recommendations of the A. P. Shah Committee which stated that FIIs/FPIs were exempt from the levy of MAT. However, the issue of pending defect notices still remained unresolved.
  • It appears that in order to address this controversy, the Central Board of Direct Taxes (CBDT) on 10 December 2015 issued a clarification on this issue for defect notices issued to FIIs/FPIs.
CBDT’s clarification
  • CBDT has clarified that the tax returns filed by FIIs/FPIs will not be treated as defective even if the balance sheet and profit and loss account are not filled, provided the concerned FII/FPI:
  1. is registered with the Securities Exchange Board of India (SEBI)
  2. has no PE/place of business in India
  3. has provided the basic information required in case of any business income in India.
  • The CBDT has stated that wherever FIIs/FPIs have provided their SEBI registration numbers in their tax returns for the assessment year 2015-16 without filling details of their balance sheet and profit and loss account, the same will be processed without being treated as defective if the conditions mentioned above are satisfied.
  • Furthermore,  FIIs and FPIs who continue to receive defect notices for previous assessment years have been asked to provide the above information in their online response on the e-filing portal of the Income Tax department.
SKP's comments
  • This is a positive step on part of the CBDT to put to rest the controversy of issuing defect notices to FIIs/FPIs who do not have any presence or PE in India. This should not only bring down the amount of time and effort of the FIIs/FPIs in replying to these notices but  will also be welcomed by the institutional investor community.
  • However, the CBDT should consider issuing similar clarifications for foreign companies (i.e. companies other than FIIs/FPIs) who earn capital gains, royalties, interest, fees for technical services from India but do not have any PE in India. This would be possible as these companies  already state in their tax return forms that they neither have a PE in India nor are their books of account maintained under the Indian Companies Act. Such a step would be welcomed across the industry and would result in overall investor confidence in the Indian tax system.
  • Alternatively, the CBDT could consider notifying a separate form for such foreign companies (including FIIs/FPIs) which will not only capture the required information but will also save these companies from the hassle of filing responses to multiple notices.

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