The attractiveness of India as an investment destination is at stake with the government targeting foreign institutional investors (FIIs) in its latest attempt to increase tax revenues. Finance Minister Arun Jaitley confirmed on Tuesday that he plans to raise as much as Rs 40,000 crore ($6.4 billion) by issuing tax demands against FIIs. Global fund managers could join jittery shareholders of Cairn Energy and Vodafone in wondering if India is the right place to invest after all.

Jaitley revealed on NDTV for the first time the size of his planned claim over minimum alternative tax (MAT). He said FIIs had lost a case in 2012 against the levy of 20% MAT on the capital gains they made.

"FIIs went to a tribunal, which is called Authority for Advance Rulings. The tribunal has decided against them,” the minister pointed out.

Jaitley said his government could use the funds to pay for higher public spending in areas such as irrigation. “I can change the face of India's irrigation with that Rs 40,000 crore," he said.

The NDA government has abolished MAT from April 1, 2015, but the demands are for an earlier period and the FIIs reportedly wanted it to be waived.

“To which I responded and said 'we are reasonable, so for the future I have waived it. But, the tax demand after winning the case, if I waive off, we will be like a tax haven ... how would be I answerable to Parliament that after the case I just waived Rs 40,000 crore,” Jaitley said on NDTV.

Tax experts estimate that notices have already been sent to about 100 of the 6,000 foreign funds registered in India.

The minister’s remarks prompted dismay among senior figures at international investment funds and banks.

“There is a lot more concern now, this thing could be incredibly messy,” said the Mumbai-based head of one global financial institution, who spoke to Financial Times on condition of anonymity. “Investors think this could come with a very serious dent on the markets.”

According to FT, the argument over MAT is the latest in a long line of tax disputes involving global businesses in India that have dented the country’s reputation as an investment destination and seen the government’s approach criticized as “tax terrorism”.

Jaitley’s comments could imply that he will target funds who invest through either Mauritius and Singapore, both of which have bilateral treaties that protect investors from short-term capital gains tax.

“If that number ($6.4 billon) assumes this is the total tax leviable, this suggests they are now looking to override the treaties,” Sudhir Kapadia, head of tax at consultants Ernst & Young India told FT. “This would make the FIIs really worried, it would be very damaging.”

“This will compel all these guys to appeal, and this will open a floodgate of litigation,” he added.

This doesn’t appear to bother Jaitley, who said that, unlike the previous UPA administration, no retrospective tax law has been brought in in the past year and “not a single new notice has been issued. My only problem is with regards to legacy issues that I inherited from the previous government”.

But his tax demands on FIIs will only add to the earlier multi-billion dollar tax demands on Cairn Energy and Vodafone that make India look like a tough place to do business, where rules are often open to interpretation.

- Karan Singh

To Learn More:

Government to press ahead with Rs 40,000 crore tax demand on FIIs: Arun Jaitley (Times of India)

India on collision course with investors over $6.4bn tax target (by James Crabtree, Financial Times)

We are fair but not a tax haven: Finance Minister Arun Jaitley (by Amish Devgan, Zee Business)

Narendra Modi must tame the turbulent tax system in India (Financial Times)