Minimum Alternate Tax (MAT) is not a novel concept. It has been in existence in India for at least for the last two decades. The reason for the imposition of MAT is pretty simple – Companies with significant incomes, which even go the extent of companies distributing dividends to shareholders, take advantage of incentives and deductions to show close to zero net profit thereby evading tax payments. The prime reason for this argument arising is because the companies project their Profit & Loss (P&L) statements according to Companies Act to their shareholders while they prepare the same according to the Income Tax Act while filing for tax.
In India, there have been two bases for MAT calculations – either 25% of the net income or 2% of the gross assets, whichever is larger. While there has been lot of revisions around the above two methods, the fact that the Income Tax officials have decided to slap notices to Foreign Portfolio Investors (FPIs, also known as Foreign Institutional Investors(FIIs)) to the tune of billions of dollars retrospectively has brought the specter back into prime focus (This is primarily because the I-T officials have misinterpreted the statement of the Finance Minister who said that MAT will not be levied on FPIs post April 2015; The I-T officials have misinterpreted this statement to slap notices to FPIs for transactions done on or before March 2015).
Before we analyze the impact of MAT on FII net flows, let us first understand the nitty-gritties of it. Right from its inception, there has been a lot of noise created regarding the need to define the word “company” as defined in section 115JB. As it currently stands, MAT is currently applicable to all domestic companies and any other company that has a permanent establishment (PE) in India. There is a lot of confusion over the latter part of the above sentence, especially with respect to whether it is right to tax companies which do business in India without a PE.
Secondly, it asks companies to pay a minimum amount of tax (to the tune of 18.5% of net income) irrespective of whether the company is posting profits or losses. This, especially, hits the loss making firms really hard. As loss making entities try to revamp their business and return to profitability, this tax burden will make it difficult to achieve even break-even as there will be a significant financial drain. This will be equally applicable to those companies posting profits but not sufficient enough to pay for MAT.
Thirdly, by asking companies to pay a minimum amount of tax, the I-T department is implicitly forcing companies to have high ratio of sales to gross assets and have high margins. In nearly-perfectly-competitive industries such as telecom, this may not be possible at all. This implicitly imposes a penalty on those companies which fail to have high levels of asset utilization.
In addition to the above three reasons, there are two other reasons which are of particular interest to the FIIs – The first is that, going forward, the companies can no longer expect credit for having discharged their tax liability for the previous year and the second is that, with each year being separate, the same process of tax (and MAT) computation and payment has to be carried on.
Despite the above mentioned downsides of MAT and the associated hue and cry about it from the FIIs, the aspect of MAT needs closer introspection. For instance, the implication of MAT is only in the short to medium term; in the long term, FIIs are still highly optimistic about the Indian market. This can be seen in the light of positive outlook for India by Moody’s or the upward revision of India’s economic growth forecasts by International Monetary Fund (IMF). Moreover, MAT is applicable only on capital gains on short term investments; the long run investments are still in safe hands. And while it is true that this will trigger a sense of panic among FIIs who seek clear and transparent policies, their fears will come down as the Finance Minister sheds more light on the applicability of MAT altogether.
From the above discussion, it becomes clear that the outflow of capital from FIIs is only a short-run phenomenon and that MAT does not affect the long-run prospects of India as an investment destination. It also becomes amply clear that MAT augurs well for all the companies as they implicitly force them to seek ways to better utilize the resources available at their disposal. By doing this, India positions itself well in the global economy as it strives to create an atmosphere to achieve better utilization of resources.