New tax code to help Reliance Industries, few others

In six weeks, the finance ministry is likely to introduce the new tax code (DTC), which it may try to get enacted.

If passed in its original form, the DTC will change the very definition of minimum alternate tax (MAT).

Instead of taxing income, or profits — which is what any income tax regulation ought to do — it seeks to tax gross fixed assets (GFA).

Instead of the existing rule that 15% of book profits (profit before tax in most cases) will be treated as tax, the new tax code wants to impose a 2.5% tax on GFA.

DNA undertook a simple exercise to find out the implications of this highly controversial move.

It must be pointed out that our analysis is based on annual report disclosures, in which taxes actually paid are on the basis of the set of figures presented to the income tax authorities. Both the sets of figures need not be the same.

We analyse the impact DTC could have on the top 150 profit-making companies in India. (See table for a sample of the top ten). What is discovered was highly intriguing, and does call for further study.

First, prima facie, the new tax collections would appear to favour finance companies (see the difference column).

However, that could be misleading, as banks are not likely to enjoy significant depreciation cover or benefit from many tax shelter opportunities. That is why, even in fiscal 2009, they paid taxes that were higher than those computed under the old MAT scheme.

The only exception would appear to be IDBI, which paid lower taxes than even those applicable under the MAT. The DTC could change all that for IDBI.

Second, watch the companies highlighted. They are those which paid taxes lower than what would have been paid under the old MAT.

If the DTC comes into effect, they could be savagely hit. Some of these companies are (according to our computation) Reliance Industries, Bharti Airtel, NTPC, Reliance Communications and (as mentioned above) IDBI.

This can be quite intriguing, because the general perception is that finance bills generally tend to favour Reliance Industries (RIL).
A widely held belief on Dalal Street is that no finance bill is ever introduced in India if it is about to harm RIL in any way.

This belief was akin to a blind faith with most marketmen when founder-chairman Dhirubhai Ambani was alive. But, even today, it is whispered as a sacred mantra. There is something about RIL that seemingly makes all policymakers create rules that benefit, or at least not hurt, the company.

So is the DTC likely to change the perception by making RIL pay a lot more? Prima facie it would appear to be the case. But then, there are many good reasons to believe 2010-11 will see RIL generate profits that will be substantially higher than in the past.

First, consider how, just last week, RIL announced an increase of over Rs 1,000 crore in its quarterly profit. And this, agree many analysts, is just for starters. The number is bound to grow several fold in the near future.

Then pay heed to RIL’s own admission in December 2009. It stated that it had become the country’s largest natural gas producer with over 50 million standard cubic meters per day (mscmd), and had thus surpassed ONGC’s 49.6 mscmd output.

Third, consider the statement made by RIL’s challenger, RNRL, in January this year, before India’s courts. RNRL wants RIL to provide it gas at $2.34 per mscmd (as part of the agreement between the two Ambani brothers), while the government (and RIL) wants this price to be $4.20). In its submissions, RNRL said RIL would be making an additional profit of Rs 30,000 crore just from the difference between the Government determined price of $4.20 and the agreed price of $2.34. RNRL’s statements could be wild allegations, but they, too, underscore the fact that profits from gas (and oil) could be mind-boggling.

Fourth, RIL is no longer a yarn company, but a petrochemical giant, and should be compared with ONGC.

ONGC should benefit from the new tax code even going by last year’s profits (See table). ONGC did not plan its tax shelters carefully and ended up paying more than double what it would  have under the old MAT. If the proposed DTC were to be applicable, and if ONGC plans its tax strategy well, it could also be a big beneficiary.

There is, therefore, good reason to believe RIL’s profits will be equal to, if not higher than ONGC’s. That is why we have penciled in the potential of a Rs 30,000 crore profit before tax for financial year 2011 from Rs 15,637 crore in the last financial year (2009).

Lastly, do remember that ONGC’s profits from oil come even after selling it to the government at a ridiculous price of $51.9 per barrel (against the current market price of over $80).

RIL does not sell its oil to the government at this subsidy price. Nor do Essar and Videocon, both of whom are private oil producers and are thus allowed to sell their oil produce at market prices.

Unfortunately, it is not possible to compute the amount of money RIL or Essar make from oil extracted in India.

This is because both are refiners, and only the sale price of refined oil is given in their annual reports, not that of crude oil which is merely a ‘throughput’.

But indicative figures are available from the balance sheet of Videocon Industries, which (along with Essar and RIL), was one of the three beneficiaries of ONGC’s richest oilfields in the pre-NELP days during 1994).

During the year ended March 2009, Videocon (which does not have a refinery) sold 5.3 lakh tonnes of crude oil for Rs 1,800 crore. This means Videocon could earn a price of $101 per barrel (one tonne of crude roughly equals 7.3 barrels). Thus, considering ONGC lost $52 per barrel, Videocon could have profited by at  least $50 a barrel from just its oil business.

Reliance could have earned even more. First, because it got more oilfields than Videocon did in the pre-NELP days. Second, because it value-adds this crude and sells it as refined products at market rates.

Either way, RIL wins, irrespective of whether the DTC is passed or not. The only things that will happen is that DTC will allow it to pay lower taxes than the old MAT did.

In other words, the new tax code may not hurt RIL at all.