The compatibility and conduciveness of a taxation system plays an important lubricating role in the overall growth and direction of an economy.

The proposed direct tax code is a sincere attempt in this direction and should be lauded. The openness of the legislators in seeking public debate and feedback on the law is an even bigger gesture of a mindset change.

Keeping in mind the larger role expected to be played by a tax system in the economy, if Indian companies were to select some key proposals to provide feedback on the code proposals, the proposed minimum alternate tax (MAT) and the investment-based incentive regime would surely feature in that list. This article is an attempt in that direction.

MAT: the proposed levy

The discussion paper released with the code outlines the rationale for levying MAT on companies whose tax liability is extremely low due to tax incentives and tax evasion. It further provides that the shift in the MAT base from book profits to gross assets will encourage optimal utilization of the assets and, thereby, increase efficiency.

Also Read Ketan Dalal’s earlier columns

While there would be many concept papers, the genesis of an asset-based MAT levy in India, in the recent past, can be traced to a 2001 report of an advisory group constituted by the Planning Commission under the chairmanship of Parthasarathi Shome.

Illustration: Jayachandran / Mint

The code proposes a MAT levy of 2% (0.25% in the case of a banking company) of the gross assets of a company if such MAT exceeds the normal tax liability (i.e., 25% of taxable income). MAT shall be payable even if the company makes losses. Further, it is proposed that MAT will be a final liability and MAT credit against normal tax liability in subsequent years is sought to be discontinued.

The proposed MAT levy could seriously discourage investments in highly geared projects or projects with long gestation periods. The impact, particularly on infrastructure and capital-intensive projects, the stated priority sectors for the Indian economy, could be profound.

The commitment of promoter equity, as also project finance, can be seriously hindered, despite the attractiveness otherwise of the project. It also acts as a disincentive for investments in high-risk ventures, which could promote anti-competitive situations in those sectors with limited established players.

Treatment of liabilities

The comparison of the tax bases, that is, gross assets (for MAT purposes) with taxable profits (for normal tax computation), seems inconsistent. As such, the taxable profit is obviously after deducting interest, whereas the 2% on gross assets does not contemplate the deduction of liabilities. This itself is incongruent.

One would venture to say that in any case, it is unfair to not reduce liabilities. Also, MAT to be levied on all assets, that is, intangibles, investments and current assets, does not appear to be fair because even assuming MAT were to remain in the form of a levy on assets on the basis of asset deficiency, one is assuming that the asset deficiency relates to fixed assets.

If one were to apply some simple arithmetic, for a company with a debt-equity ratio of 2:1, the levy translates into a tax break-even of 6% of the net worth.

Thus, a company with 6% return on net worth (profit before tax/net worth) would only earn enough to discharge its tax liability. With more leveraging, the threshold worsens, with serious impact on a project’s internal rate of return, which forms the basis for capital and financing commitments.

A 2% MAT levy presupposes an inflection point for a company at a minimum return of 8% on gross assets, considering the corporate tax rate of 25% (one-fourth of the profits). This basis seems unfounded. In fact, a rough sample study of nearly 1,300 listed companies (source: CMIE Prowess, based on the FY08/FY09 data) seems to indicate that less than 50% earn a return of more than 8% on gross assets. Interestingly, nearly one-fourth of the companies in the sample earn a return of less than 2% of the gross assets.

Even genuinely loss-making companies will have to bear the burden of this levy (as an example, Air India).

While the objective is ostensibly to encourage optimal utilization of assets and thereby increase efficiency, this may actually result in companies facing tax liabilities despite not having earned any profits, resulting in capital erosion, including, in the public sector sphere.

Multiple impact

The multiple and cascading effect of MAT has various dimensions. Two of these are critical ones: the fact that MAT is a yearly levy and, therefore, the same asset bears tax year on year, in the nature of a wealth tax; second, it has a multi-tiered effect. This is explained below.

The proposed MAT levy covers all assets, including the investment assets of a company. This can result in a cascading effect of the levy for multi-tiered holding subsidiary structures, which does not seem to be the intention.

So, for instance, while the holding company is subject to MAT on its investment in a 100% subsidiary, the subsidiary is subject to levy on its own assets, leading to multiple levies, year on year, on the same asset.

A uniform 2% levy across all sectors (other than banking) could lead to disparity in taxation of companies, given the fact that return on assets would vary materially across sectors, say, in a capital-intensive sector vis-a-vis a services company. In fact, given the code’s stated objective of achieving equity in taxation, such consequences seem unintended.

Some suggestions

Given the fact that one of the reasons for MAT to exist is that there were several incentives, the removal of these incentives is itself a reason why MAT should not be there in the first place.

Even assuming it is there, clearly the levy should be only on fixed assets as reduced by the liabilities that have been undertaken in relation to such fixed assets. In any case, important sectoral considerations need to be recognized, such as those relating to financial services and infrastructure.

Incidentally, it appears that the MAT levy should not extend to shipping companies that have been, for reasons of global competitiveness, judicially granted the tonnage tax status; however, this needs to be expressly clarified since there could be some interpretation ambiguity.

The critical shift

Historically, tax incentives in India have played a very important role in channelling investments in priority sectors, contributing to healthy capital formation and the overall growth of the economy.

For people, this provides access to essential goods and indeed, services (such as, say, power) at affordable prices. In fact, this is the global experience, and in other Bric (Brazil, Russia, India, China) countries. While this has affected the exchequer, in the long run it has definitely stood to benefit with higher tax collections due to the secular growth resulting therefrom.

The code marks a critical shift from “profit-based incentives" to “investment-based incentives" for specified businesses in priority sectors such as infrastructure, healthcare, oil and gas, etc. The need to incentivize these priority sectors needs no emphasis and the code rightly recognizes this by providing for a separate regime.

The question is whether, given the specific business dynamics, the new regime would provide the necessary impetus to propel investments in these sectors, which is a priority objective for the economy.

Accelerated depreciation

If one were to analyse the new regime, it essentially allows the priority sectors to accelerate the depreciation claim for capital expenditure in the first year instead of the reducing balance (written-down value) basis, as allowed generally.

Thus, the incentive is at best a deferment of tax rather than an exemption.

Now, these sectors generally have a trend of long gestation periods. It is not uncommon for businesses to incur losses in the initial years and, hence, the ability to take advantage of the accelerated depreciation benefit would be limited. The code, on the other hand, seeks to ring-fence the accelerated depreciation claim to the priority business only.

The combined effect could, eventually, mean no tax benefit during the initial phase, when cash flows are needed the most.

The accelerated depreciation, even if fully absorbed in the priority business for tax purposes, would result in a deferred tax liability in the books of the company. This would, effectively, negate any tax benefit in earnings per share calculations or in the ability to repay investor monies, the two most critical parameters evaluated by an investor before any capital commitment.

Priority businesses

The incentive regime under the code, as currently proposed, does not seek to exempt the priority businesses from the asset-based MAT levy.

Clearly, it does not seem congruent to allow accelerated depreciation benefit on capital assets, on the one hand, and collect taxes on the same assets, on the other.

While there cannot be a quarrel on the reduction of incentives, provided that these are adequately grandfathered, it must equally be appreciated that the so-called capital-based incentives are really in the nature of accelerated depreciation and, hence, at least for the period for which the accelerated depreciation is available to the company, it does not appear to be rational to neutralize even such diluted incentive by the MAT levy.


The proposed asset-based MAT levy, introduced with the sincere objective of simplifying and reducing litigation and encouraging optimal utilization of resources, could have the unintended consequence of impairing capital formation in the economy. Also, the proposed incentive regime does not seem enough to achieve the objective of the code, as also the government, in propelling investments into the priority sectors.

The impact of these provisions on the global competitiveness of the Indian economy generally—and the priority sectors in particular—to attract investments needs to be weighed in adequately.

Even worse, the possibility of a capital flight from the country, instead of being deployed in the much-needed growth engines of the Indian economy, would need serious consideration. This, for sure, does not seem to be the intention of an otherwise dynamic tax code, and certainly merits a relook.

Ketan Dalal is executive director and Vishal Shah is associate director, PricewaterhouseCoopers. Your comments and feedback are welcome at