Switchover To New Corporate Tax Rates: MAT Conditions Apply

Last fortnight’s Ordinance announcing an across-the-board reduction in corporate tax rates was cheered and dubbed as an economic stimulus to address the downturn woes. The new basic rate of 22 percent applicable to all Indian companies and a new rate of 15 percent for newly-incorporated manufacturing Indian companies will apply with conditions.

In this article, we decipher the fine print to ascertain what such an exercise shall entail and highlight with illustrations how taxpayer decisions will play out before opting for the reduced tax rate.

Section 11BAA, a new provision inserted in the Income Tax Act, in legal terminology, carries a non-obstante clause to declare that an ‘Indian company shall have the option of 22 percent rate subject to compliance with the enumerated conditions’. It is settled law that exclusionary provisions are construed strictly. Thus, in general, scrupulous observance shall be a condition precedent for eligibility to claim a lower tax rate. This takes us to an appreciation of each of these conditions.

Forsaking Present And Future Benefits

The first condition is no deduction can be claimed under enumerated provisions from the year the option for the lower tax rate is exercised.

These provisions are summarised below:

An immediate consequence for a taxpayer choosing to ‘opt-in’ for the lower rate is that, not just for the future but also for the current financial year, the benefits available under these provisions will have to be foregone.

For illustration, Section 35(1)(i) and Section 35(1)(iv) which incentivise expenditure on scientific research, Section 35CCA deduction to promote rural development programmes shall continue to be available even under the lower corporate tax rate regime.

Each Indian company will rework the extent of benefits currently available and required to be forsaken by undertaking a cost-benefit analysis to determine whether the new corporate tax is beneficial in the current year, or in future, in which case, it shall defer the benefit or perhaps, its better to maintain status-quo under the earlier regime.

Let us take a couple of basic illustrations to highlight this point.

Illustration 1: There is an entity C1 which is in the third year of operations as an SEZ unit. C1 is entitled to a 100-percent exemption for the current year and two more FYs. This means no corporate tax is payable and instead it must pay MAT at the current effective rate of 17.47 percent. Thus for the current and next two FYs, even though it pays MAT, it is better off without choosing the new corporate rate structure. For FY 6 to 10, C1 will be subject to ordinary corporate tax only on 50 percent of its export profits or MAT, whichever is more. Thus even during these years, it will have to assess whether it is better off with ordinary corporate tax/MAT or the lower corporate tax rates, depending upon the quantum of tax basis these choices.

Illustration 2: A company C2 has invested in new plant and machinery in power generation business in this financial year. This will result in an additional depreciation for C2 which may reduce the overall tax liability to less than 25.17 percent and thus there may not be a reason to choose the lower tax rate in the present FY.

Such examples can be extrapolated galore, depending upon the fact situation of the entity in consideration. The underlying task is simple i.e. consider the entitlements available under the ordinary provisions and determine the effective tax incidence with that under the lower corporate tax rates to assess which situation is favourable to the taxpayer.

Forgoing Carry-Forward Of Past Entitlements And MAT Credit Controversy

A second important condition surrounds the availability of losses carried forward from earlier years which are attributable to aforesaid incentives.

The Ordinance stipulates that certain losses carried forward by the entity would not be permitted, and they are also required to be forgone should a taxpayer opt-in for the new rate. It is noteworthy that all of the carry-forward loss is not restricted; it is only the losses “attributable to any of the deductions” enumerated in the earlier section which are restricted.

There is an attendant feature, relating to the availability of MAT credits, which has led to considerable debate.

For this one needs to appreciate the concept of Minimum Alternate Tax or MAT as it is popularly called. It is a tax on book profits, as opposed to a tax on ordinary taxable profits of a corporate entity. It was introduced to deal with cases of such entities that had book-profit (on which dividend was declared) but which ended up not paying income tax owing to tax-planning by taking refuge under the adjustments permitted by the tax law. Such entities are obliged to pay tax (i.e. MAT) on their book profits, even if there are no taxable profits. One salient feature of the MAT mechanism is that the MAT paid in a financial year is, subject to limits, available as credit and permitted to be set-off in subsequent financial years. In other words, if MAT has been paid for a financial year in the past and tax is payable as per normal provisions for a subsequent FY, the MAT paid in the previous financial years can be utilised (subject to the statutory stipulations) to off-set the corporate tax liability. Thus, cash is not required to be paid for the entire corporate tax and is payable only to the extent set-off is not available. In other words, the MAT paid in a financial year can be an asset of the entity as it becomes its entitlement under the law.

The Press Note accompanying the Ordinance states that the new corporate tax rate of 22 percent shall not be subject to MAT, meaning a MAT exemption on an ongoing basis.

The Ordinance amends the MAT provisions (Section 115JB(5A)) to effectuate this objective.

A first look at it revealed that no change has been carried out to the provision (Section 115JAA) which provides for MAT credit resulting in a view that such credit is nonetheless available, which is diametrically opposite to the view canvassed by the government in a clarification issued on Oct. 2.

That view being - that when the MAT provision itself does not apply, the question of taking MAT credit does not arise.

Here are two possible interpretations and what we believe would be implications of the Oct. 2nd clarification.

• A holistic reading of the scheme instituted by the Ordinance can be interpreted to mean that given non-application of MAT provisions, accrued-MAT should lapse. In other words, the choice of opting for a lower corporate tax rate implies forgoing MAT credit as a trade-off.
• A literal and strict interpretation of the Income Tax Act, which is also the manner in which fiscal laws are generally construed, would mean that in the absence of any specific restriction on the utilisation of the MAT credit, it will continue to be available even if one opts for the lower corporate tax rate. This is supported by the argument that the concessional rates apply from the current year and only the MAT paid, if any, for the current year should be denied credit.

What Can Companies Do?
Ingenious taxpayers may consider invoking the casus omissus principle to contend that the missing clarity in the legislation should ensue to their benefit. Nevertheless, they would have to counter the recent exposition of the legal position in the Supreme Court’s decision in the Dilip Kumar case which puts the burden on the taxpayer to establish that it falls within the four corners of a beneficial fiscal provision. It will indeed be an interesting legal challenge.

In practical terms, the implication of the view (that no MAT credit is available) will mean that companies with significant unutilised MAT credit may choose to not opt for the lower rate. It would compute its liability at the present effective rate of 34.94 percent (for companies with turnover in excess of Rs 400 crore) versus an effective MAT rate of 17.47 percent and the difference between them will be the eligible MAT credit. For companies liable for an effective tax rate of 29.12 percent under the old rates (where the turnover does not exceed Rs 400 crore) as well, a similar comparison will be required with an effective MAT rate of 17.47 percent, the credit will only be 11.65 percent.

New Mechanism To Compute Depreciation?

The third condition appended to the lower corporate rate option is that the depreciation must be ‘determined in such manner as may be prescribed’. The legal standard in which the expression ‘as may be prescribed’ is construed is that specific rules are notified by the government to effectuate the legislative stipulation.

However, the reading of this provision is peculiar. It does not state that depreciation ‘rates’ would be prescribed and instead only hints at a different computation mechanism. One will have to wait for the notification of such rules to assess their exact impact on the depreciation figures, but one can surely hope that the notified mechanism would not be such that what the lower tax rate gives would be taken away by the depreciation computation.

Summary

In our earlier column, we have already highlighted that the Ordinance extends a choice to the entities and is thus quite differently-placed from other amendments to the tax laws which are generally compulsory in nature. Given that the tax rates instituted in the Ordinance are liberal, staking claim to them should have been a natural choice for business.

However, the peculiarities of business positions and extent of available present and future entitlements may be such that managements and boards may have to reflect deeper before opting for these rates immediately.

It is a different case altogether than such considerations would not apply to new domestic manufacturing companies which would not be tied down by any past consideration from opting for the attractive 15 percent tax rate.

The Ordinance thus ensures that there are no worse-offs and extends attractive business options without disturbing those which are already-incentivised due to other provisions of the tax law.

Mukesh Butani and Tarun Jain are Partners at BMR Legal.

The views expressed here are those of the authors and do not necessarily represent the views of BloombergQuint or its editorial team.