India Clarifies Defective Return Notices for Foreign Institutional Investors
Editor: Tracie Frost
The Central Board of Direct Taxes (CBDT) Thursday issued a clarification regarding defective return notices received by foreign portfolio investors (FPIs) and foreign institutional investors (FIIs) earlier this year. The clarification was welcome news to foreign investors.
From April to July the CBDT issued an estimated 500 defective return notices to FPIs/FIIs who had failed to attach balance sheets and income statements with their Indian income tax returns. The returns were to be corrected and refiled within 15 days. Many companies re-filed the returns only to have them returned again, raising the risk of having their returns declared invalid or not filed. This could have attracted penalties and interest.
The issue arose over the intersection of three articles of the tax code.
First, FPIs and FIIs earning India-source income such as interest and capital gains are required to file income tax returns in India even if they are not subject to (or do not owe) tax.
Second, an income statement prepared in accordance with Indian tax law is required.
Third, under Income Tax Act Section 139(9)(d), a return can be regarded as defective when regular books of account are maintained by the taxpayer but the return is not accompanied by copies of the “profit and loss account or income and expenditure account or any other similar account and balance sheet.”
These three provisions read together were interpreted to mean that when FPIs and FIIs file their Indian tax returns, they must compute book profit in accordance with Indian law, and they must attach their book accounts to their returns. Returns not prepared in this manner were deemed defective, and notices were issued.
The notices created an uproar with foreign institutional and portfolio investors. FIIs/FPIs generally earn income from investments in securities and operate largely from foreign destinations with no a place of business in India. Since they do not have any place of business in India, they are not required to maintain books of accounts in India. Further, FPIs/FIIs do not maintain separate accounts for Indian investments, so it is not possible to compute book profit.
In order to overcome this difficulty, the Central Board of Direct Taxation issued a notice clarifying that returns will not be treated as defective in cases where the FIIs/FPIs meet the following criteria:
- They are registered with the Security and Exchange Board of India (SEBI);
- They have no permanent establishment in India;
- If they have business income, they have attached to the return a statement indicating the amounts of turnover, gross receipts, gross profit, expenses, and net profit and the basis on which such amounts have been computed.
The notice states that returns filed with an SEBI registration number for assessment year 2015-16 are now being processed in the central processing center in Bengaluru. Some tax practitioners have suggested that the income tax forms themselves must be amended to disclose whether the FPI has a place of business in India.
This decision is being hailed as proof that India is becoming a mature tax jurisdiction. Certainly, this is a case where the Central Board of Direct Taxation got it right; however, many international tax issues still remain.
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