While the direct taxes code is still to be implemented, finance minister Pranab Mukherjee has gone ahead and implemented its proposal to impose minimum alternate tax (MAT) on developers of special economic zones (SEZs) as well as units operating in SEZs. How will this impact firms that develop and/or operate in SEZs?
Analysts led by Manoj Bahety at Edelweiss Securities Ltd have a lucid report on the issue. They explain that the impact may not be as large as feared because MAT will be applicable only when the effective tax rate at the company–level is lower than the MAT rate of 18.5%. Consider a firm that has three operating units, with one of them being either involved in SEZ development, or operating within the SEZ. Let’s also assume that each of the units has a pre-tax profit of Rs100 each. Leaving out the SEZ unit, the company would be liable to a corporation tax of Rs64.90 on the remaining two units (based on the corporation tax rate of 30% plus surcharge of 5% and education cess of 3%).
At the company-level, this works out to an effective tax rate of 21.6% (as a percentage of total profit of Rs300). Since this figure is higher than the MAT rate, profits earned in the SEZ unit will be tax-free.
But if the other two units were linked to SEZs, then the tax of Rs32.45 on the non-SEZ unit would result in an effective tax rate of only 10.8% (as a percentage of total profit of Rs300). In this case, the firm would have to pay an additional tax to bring the overall company-level tax rate to the MAT rate of 20% (18.5% plus surcharge of 5% plus cess of 3%).
The total tax liability on the overall profit of Rs300 works out to Rs60, which means the firm would have to cough up the difference of Rs27.55. To sum up, the impact will be higher for firms that derive a relatively high proportion of their profits from SEZs.
This additional tax can then be used as a MAT credit entitlement for the next 10 fiscals. If the firm’s effective tax rate rises above the MAT rate in the future, the credit entitlement can be used to offset the higher tax incidence. For firms that are able to avail of this benefit, the incidence of MAT on SEZ profit will, therefore, only lead to a cash flow impact. There will be no impact on the profit and loss statement since the MAT credit entitlement will be reflected in the balance sheet.
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