Minimum Alternate Tax

Einstein once said “The hardest thing to understand in the world is the income tax.”

The statement rings true as tax laws are quite complicated and require a great deal of time and effort to understand them. Recently, the union government’s decision to go ahead with an amendment to the Income-Tax Act and waive minimum alternate tax (MAT) liability on capital gains made by foreign portfolio investors (FPI) is being welcomed by the corporates. Let’s try to understand MAT and various changes made to the income tax act.

In the past, a large number of companies showed book profits on their profit and loss accounts and at the same time distributed huge dividends. However, these companies didn’t pay any tax to the government as they reported either nil or negative income under provisions of the Income-Tax Act.

Companies that show book profits and declare dividends to their shareholders but do not pay any taxes are popularly known as ‘zero tax’ companies.

The Indian Income-Tax Act allows for a large number of exemptions from total income. Besides exemptions, there are several deductions permitted from the gross total income. Further, depreciation allowable under the Income-Tax Act, is not the same as required under the Companies Act. The latter provides a lower rate viz-a-viz the I-T Act which computes a higher rate of depreciation. Minimum Alternate Tax (MAT) came into existence in 1996 with the intention of making companies pay at least some tax. That is because some were paying little or no tax, as they were enjoying tax exemptions, but at the same time were making profits and even paying plentiful dividends to the shareholders.

The list companies on which MAT is levied in India includes several corporations such as Dabur, Godrej Consumer, power utilities like NTPC, Power Grid Corporation and infrastructure developers such as Adani Ports. The core business of these companies enjoys certain tax exemptions and yet report accounting profits. And so, the government levies MAT.

So how does the MAT affect FII’s?

FII’S are supposed to pay capital gain tax on the money which they invest in the Indian stock market. However charging MAT on the income earned by them weakens the investor sentiments. The income earned by sale purchase of securities is exempt from taxes but the MAT demands taxes to be paid on booked profits.

MAT to be waived for FIIs

Union government waived minimum alternate tax on capital gains made by foreign institutional investors on September 2, 2015. The decision is in line with the electoral promise made by BJP to end “tax terror”. The announcement and the subsequent instructions issued to the tax department to keep in abeyance, till the appropriate amendment is carried out and not to proceed with the recovery of outstanding demands in such a case is big relief for FIIs. In these times of heightened uncertainty in the global financial markets, when risk appetite of investors is especially low, the government’s initiative would serve to restore some of the lost faith of investors in India as an investment destination that doesn’t resort to retrospective taxation. The tax department has been in too many disputes with global companies such as Vodafone and Cairn, some of which has dragged India into international arbitration. It has been said that India’s image as an investment destination has suffered as a result.

Future scope

The same way as the government has taken a position on and dispelled the uncertainty around MAT, it must make its mind around another outstanding issue, concerning participatory notes (P-notes).India’s indecision on this matter is affecting FII’s. P-notes are offshore derivative instruments that institutional investors use to park their funds in equity markets without disclosing their identity to Indian authorities. The government has said that it won’t immediately act on it after share market reacted sharply to news on it. But sooner or later, it has to decide what has to be done, given that action against black money was a big election promise. The MAT experience shows that sooner is always better than later.

-Shubham Gupta