For India Inc, the storm has passed but grey clouds remain

Toeing the FM’s timetable of tabling the revised Direct Tax Code (DTC) in the monsoon session of Parliament, the Central Board of Direct Taxes (CBDT) has released a discussion paper outlining the manner in which it proposes to deal with certain key issues identified in the initial draft of the DTC (draft DTC).

The draft DTC covers 11 areas of concern raised by the taxpayers vis-a-vis the previous draft code. This article covers one of the key areas, viz. minimum alternate tax (MAT).

Introduction of a gross assets based Tax (GAT) instead of the prevalent book profits-based MAT in the draft DTC had caused a lot of heartburn for India Inc.

As per the draft DTC, a corporate taxpayer was expected to pay the higher of (i) tax computed as per the normal tax provisions, or (ii) GAT at the rate of 0.25% of the gross assets for banking companies and 2% of the gross assets for others.

The draft DTC proceeded on the assumption that an investor would typically have a target return on assets (ROA). It would therefore not be unfair to use the same basis, i.e. the value of assets, for levy of tax either.

Another professed objective of the GAT was that it would encourage corporate taxpayers to utilise their assets efficiently, and avoid investments in unproductive assets.

These proposals had been cause of concern for corporate taxpayers. The CBDT has, graciously enough, admitted the possible collateral concerns that could arise from an “as-is” implementation of the GAT. Some of these are:

• That GAT applied, without exception, even to loss making companies;
• That ROA, as an investment criterion, is typically applied on the long-term average assets employed in a business. The GAT, on the other hand, imposed an annual tax on assets owned, notwithstanding that such assets might not have been “employed”, such as, WIP, that is as yet unproductive;
• That GAT favored companies that either did not need to own assets (for eg, service companies) or companies that chose to outsource;
• With no exemption from GAT during the gestation period, sectors like infrastructure would have had to consider income-tax as a set-up cost, adversely impacting the time taken and the costs involved in achieving financial closure.  The irony for infrastructure stood-out as it effectively nullified the investment-linked tax incentives conferred under other provisions of the DTC;
• The GAT had a cascading impact for multiple tiers of subsidiaries, as the value of investment in a subsidiary would be included in the gross asset base for the parent company;
• It applied to Shipping companies and Special Economic Zones (SEZs), which are currently exempt from application of MAT;
• There was no provision for credit of GAT. 

Recognising these shortcomings, the discussion paper proposes to revert to the tried and tested methodology of levying a book-profit based MAT. This is certainly a welcome change and will boost investor confidence. The discussion paper, however, still leaves certain questions unanswered. First and foremost, it does not speak of the rate at which the MAT would be levied. Considering the widespread expectation that tax rates would generally be moderated under the DTC, it would be helpful to know the rate proposed for MAT. It is also, at this stage, uncertain if MAT would be extended to hitherto uncovered sectors such as special economic zones and shipping companies that are taxed under the tonnage tax scheme. Crucially, while the discussion paper identifies the lack of credit mechanism as one of the issues concerning GAT, it fails to shed any light on the manner in which credit, if any, for MAT paid may be granted.

Another aspect that needs to be addressed relates to reforms being proposed in the accounting realm. With India likely to migrate to IFRS in a phased manner, starting 2011, wherein the income statement could include recognition of unrealised income/ unrealised losses on account of change in the fair value of assets, it remains to be seen whether the new regime would make allowances for such unrealised income/ loss.

It is would be interesting to see how these aspects pan out in the DTC bill, to be tabled in the Parliament. However, considering the intention of reverting to the existing regime, the government is likely to continue the current regime as it is, in which case it would be a great relief to the taxpayers.

The writer is tax partner, Ernst & Young. Views are personal.