In the biggest-ever tax demand slapped on them, nearly 100 foreign funds have been asked to cough up an estimated US $5-6 billion for 'untaxed gains' made by them in the domestic markets over the past years.

The number of affected investors can rise substantially as assessments are still in progress and notices could be served in many more cases, taking the overall tax demand from them to well over US $10 billion, sources said.

Spooked by these "retrospective" notices and assessment orders, the foreign investors have begun lobbying intensely with the policy makers and regulators, while stating that the move goes against the government's stated position of providing a 'non-adversarial and stable tax regime'.

Till March 31, close to 100 foreign institutional investors (FIIs) got notices from the Tax Department for a controversial Minimum Alternate Tax (MAT) of 20 per cent, while they are now being followed up with Assessment Orders.

The FIIs have, however, decided to challenge the tax demands, stating that MAT cannot be levied on FIIs or FPIs as they do not earn any 'business income' in the country and their income is defined as 'capital gains' under the I-T Act.

These FIIs, many of whom have now converted themselves into Foreign Portfolio Investors (FPIs), include entities from the US and Europe, besides those operating through Singapore, Hong Kong and Mauritius.

Among others, the issue has been raised by FIIs with Finance Minister Arun Jaitley, Minister of State for Finance Jayant Sinha, capital markets regulator Securities and Exchange Board of India (Sebi), the Central Board of Direct Taxes and the top Finance Ministry officials, while they are now planning to approach Prime Minister Narendra Modi to intervene in the matter.

When contacted, a top official said that the government was looking into the matter to allay any 'genuine concern' such investors might have, but added that no assurance could be given yet to nullify the notices.

There are an estimated 8,000 FPIs registered in the country and they have emerged as a mainstay of the domestic markets over the years with an overall outstanding net investment of US $226 billion (over Rs 11 lakh crore).

This includes over Rs 8 lakh crore in stocks and Rs 3 lakh crore in debt markets. In the 2014-15 financial year itself, FPIs made a net investment of Rs 2.7 lakh crore into the country's markets.

Interestingly, this is the first time since 1993, when FIIs were allowed to invest in the Indian markets, that such investors have been asked to pay MAT.

Amid concerns that investor sentiment can take a bigger hit as similar demands may be slapped on foreign companies, many international bodies have red-flagged the latest move of the Tax Department, saying "this may act as strong deterrent for foreign investment in India".

These organisations include European Fund and Asset Management Association (EFAMA), Asia Securities Industry and Financial Markets Association (ASIFMA) and ICI Global, while many foreign funds have also individually raised the issue.

MAT is generally applicable to domestic and foreign companies having a 'place of business in India' that are required to draw up a balance sheet and a profit and loss account for their business income.

However, the Tax Department began issuing tax notices to FIIs as well late-2014.

To clarify the situation, Jaitley in the Union Budget 2015-16 proposed to amend the relevant sections so as to specifically "provide that income from transactions in securities (other than short term capital gains arising on transactions on which securities transaction tax is not chargeable) arising to an FII, shall be excluded from the chargeability of MAT..."

However, these "amendments will take effect from April, 1, 2016 and will, accordingly, apply in relation to the assessment year 2016-17 and subsequent assessment years".

It is this 'prospective' nature of the clarificatory amendment that has led to the Tax Department continuing with its notices and assessment orders for MAT demand from the FIIs for the past years.

The country's tax laws allow such notices and assessments to be issued for up to seven previous years.

Experts, however, said that such tax demands would also override benefits enjoyed by foreign entities under the country's bilateral tax treaties with Mauritius and Singapore - two jurisdictions that account for a major chunk of overseas inflows.

"The current action by the tax authorities practically results in overriding the favourable capital gains tax provisions in India's treaties with countries such as Mauritius and Singapore," said Sudhir Kapadia, National Tax Leader at EY, said.

The situation has created "avoidable uncertainty" in taxation of an important source of foreign investment in the Indian economy, he added.

Ketan Dalal, Senior Tax Partner at PwC, also said that the uncertainty over MAT is hurting investor sentiment and was creating "the image of a tax regime where unpleasant surprises seem to be the norm".

