What’s MAT and why is it rattling markets?

What is MAT?

The concept of Minimum alternate Tax, MAT, was originally introduced, about two decades ago, in order to tax companies, which while making high profits and declaring dividends, did not have significant tax liabilities. The reason for low or nil tax payout was the skilful use of exemptions, deductions and incentives, by the companies concerned.

These companies managed to avoid taxes by making use of the loopholes provided by the Income Tax Act itself. This was not a case of evasion. They followed all the rules and regulations and yet came up with situation where they faced little or no tax liability.

Staring at revenue shortages, the government introduced MAT to mop up revenues from such companies. Thus, even though their income may be eligible for legitimate shelter from the existing provisions of the Act, the new MAT mandated that this be excluded in the calculations for taxation purposes. This was made possible by introducing the concept of ‘book profits’. By this law, the government intended that all cash rich companies would also be taxpaying companies. MAT was applicable to all companies which were required to maintain ‘books of account’. Hitherto the common wisdom has been that MAT applied only to those companies which have a ‘place of business’ or a ‘permanent establishment’ in India, or if they were required to draw up their accounts as per the Companies Act. The government has nullified this status by issuing notices on Foreign Portfolio Investments, or FPI’s.

Currently, MAT is calculated at 20% of ‘book profits’, and advance tax provisions are applicable. Budget 2015 amended the act to specifically exclude such gains from the ambit of the tax from the current financial year onwards.

Why the blues

The present imbroglio concerns the levying of the tax on FPI’s. Trouble began when recently the Advance Ruling authority declared that MAT applied to FPI’s too. The Income Tax department then sent notices to Foreign Portfolio Investors on the ground that MAT applied to capital gains as well. All these notices related to earlier years. FPI’s have complained, legitimately in the eyes of many analysts, that this constitutes a retrospective application of tax. Exactly the kind of taxation, that the Modi government swore it would avoid.

Further, the FPI’s argue that they are not mandated to maintain ‘books’ under the Income tax law and hence are not subject to the tax. By definition, these entities do not make any money in India other than Capital Gains. But the Department has remained unimpressed. Since then, the matter has gone to higher courts.

The Finance Minister Mr. Jaitley declared publicly that up to Rs. 40,000 crores could be at stake, though notices have been sent for only about Rs, 600 crores so far. The politician in him stood out when he said, “I can build the entire irrigation system of India with these forty thousand crores.”

How has the market reacted

The reaction of markets has been abrupt and hostile, as FPI’s started to sell off securities. The current correction started off with a MAT related sell-off, but is now looking larger than just the MAT issue. MAT was in any case, a trigger that began the current sell-off, which is impacting not just the equity market, but also the currency.

Seeking to redress the situation a rattled central government has issued a series of ‘clarifications’. The Government said the entities based in countries with which India has double Taxation Avoidance Agreement (DTAA) would be exempt under the provisions of those agreements. Minister of State for Finance, Jayant Sinha also clarified that the whole matter would be closed within a month.

How does it affect the economy

That the government is on the back foot on the issue is clear. What worries is the lack of policy clarity from the top. Last July, Mr. Jaitley in his reply to the debate on the national budget for the current fiscal, told the Lok Sabha, “One thing we have made very clear: No retrospective tax creating fresh liabilities will be imposed.”

What has set off alarm bells ringing is his follow on statement.”The sovereign right of the government to undertake any retrospective legislation is unquestionable,” the finance minister had said during the course of his two-hour-long budget speech. “However, this power has to be exercised with extreme caution and judiciousness, keeping in mind the impact of each such measure on the economy and the overall investment climate,” he added. “This government will not ordinarily bring about any change retrospectively which creates a fresh liability.” (Business Standard, July 18).

However, his stance of April 2015 seems at variance with his robust assertions of eight months ago. Today investors are more worried about the stability of the tax regime even more than intrinsic merits of the proposal. This perceived lack of stability has provoked the great volatility in the markets.

Perceptions and confidence

“Investors are worried because the tax notices may lead to many litigations, which may be a long-drawn affair and may lead to a lot of uncertainty. The issue is not whether it is legitimate or not, the reason investors are worried is because of the uncertainty,” says Nirmal Jain, chairman of stockbroker IIFL group.

Another point raised by the FPI’s is that they are already obligated to pay taxes on their incomes in their own tax jurisdictions. Hence the imposition of MAT would lead to an absolute loss.

Investor confidence is a fragile thing – it takes a lot to build it, and just one slip to make it crumble again. FPIs who were anguished with the previous regime for their penchant for retrospective legislation, and who took comfort from the current regime’s assertions against such policy moves, are now anxiously waiting to see how the Finance Ministry resolves the issue, which it has promised to do in a month. The Government has a tight rope to walk, in restoring FPI confidence on the one hand, without seeming to “cave in to FPI pressure” and give more ammunition to a resurgent Opposition.

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