What’s the hubbub about Minimum Alternate Tax (MAT)?

The levy of MAT on foreign companies became a contentious issue and led to an outflow of foreign capital from India. The tax dispute has hammered the Indian stock markets and dented the business-friendly image portrayed by our Prime Minister Narendra Modi. Why is MAT so important for Indian government and why has a special committee been formed to look into the issue.

MAT is a method of making companies pay minimum amount of tax. Normally, a company is liable to pay income tax in accordance with the provisions of the Income-Tax Act, but the profit and loss account of the company is prepared as per the provisions of the Companies Act. Companies were showing book profits on their profit and loss account and at the same time distributed dividends but were not paying any tax, thanks to the exemptions, deductions and other incentives (in the form of liberal rates of depreciation, sector and region specific exemptions) available under the Income-Tax Act. In order to bring such companies under the Income-Tax net, section 115JB was introduced and all companies had to pay a minimum alternate tax of 18.5%.

Recently, too much brouhaha started over MAT with the I-T department sending notices to FPIs asking them to pay MAT for the financial year 2011-12. This led the FPIs, slapped with the notices, to challenge the applicability of MAT to capital gains arising from trading in stocks and bonds.

It all started with a dispute between Castleton Investment Ltd and the revenue authorities. The Authority for Advance Rulings (AAR) had, in 2010, ruled that MAT did not apply to foreign companies that had no presence in the form of a permanent establishment in India. But in 2012, AAR came up with judgment in favor of revenue department and held that MAT provisions scope was wide to cover all companies including foreign companies. Hence, AAR directed Castleton to pay MAT in India on their book profits when it transferred shares from a Mauritius entity to a Singapore entity. Though the ruling went unnoticed till earlier this year but India’s tax laws allow the I-T department to reopen tax assessments going back six years.

The FPIs claim that MAT provisions should not apply to them since they do not have any place of business in India and so are not required to maintain account books in India. The biggest challenge for FPIs lies in the fact that most of them have already distributed the funds to the investors and it’s practically impossible to recover the funds in order to honour MAT liability.

While the tax department has already sent notices to the tune of Rs 6,500-7,000 crore to FPIs for their past capital gains, the government has been trying to pacify the jittery investors, who turned net sellers for the first time since April 2014. In his budget speech, FM Arun Jaitley exempted capital gains accruing to FPIs from levy of MAT effective from 1st April, 2015 but with no relief from liability arising in previous years. MAT would vanish once corporate tax exemptions are eliminated and corporate tax rate reduced to 25% from 30%. Once all exemptions go, there will be no difference between the book profit and the taxable profit, so MAT itself becomes irrelevant.

During January to May, investments by Foreign Portfolio Investors (FPIs) totaled Rs 83,122 crore in 2015 compared to Rs 91,923 crore in 2014 for the corresponding period. A month-on-month analysis also shows a similar trend of foreign fund flows. The below graph depicts monthly trend of investments from FPIs for the year 2015. We can see a significant fall in the investments made by FPIs from Rs 33,700 crore in January to Rs 15,300 crore in April and finally turning net sellers in the month of May with Rs 14,300 crore flowing out of the country.

The tax demand shocked some investors who had been expecting a more transparent tax regime from the new government. The uncertainty created by MAT led foreign investors to sell Indian shares and bonds, and made the stock market go for a toss.

To resolve tax tussles and evaluate MAT row that has vexed foreign investors, a high-level committee has been set up by the government. The committee is headed by Justice Shah which includes chartered accountant Girish Shah and former chief economic advisor Ashok Lahiri. With experts from outside the government, the committee can take a more holistic and independent view. The panel has commenced its work and invited recommendations from different stakeholders to submit a report as quickly as possible.

Though a committee has been formed to look into the controversial issue, the Supreme Court may decide the issue based on the law and not take into account the findings of the committee. The lack of clarity in applicability of MAT provisions could have an inimical effect on the flow of foreign investment in the country.

With the lack of certainty over the growth numbers for the fiscal year 2015, weak corporate earnings and prediction of less than normal monsoon; investor sentiment is turning negative and taking a toll on the markets. In addition to this, the fear of rising crude prices and expectation of an interest rate hike by the Fed in the later part of the year has prompted investors to turn bearish.

Therefore, to meet the goals of restoring investor confidence and growth, the government needs to provide more clarity on the issue and not resort to tax terrorism. This can be done by bringing in a more transparent, predictable and stable tax regime. A complete revamp of the tax code is required; instead of applying bad laws indiscriminately.