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Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

The end of the MAT controversy

It took a committee to decide what the government could have done earlier

It took the A.P. Shah committee to iron out a particularly knotty problem for the Narendra Modi government. For some time now, foreign institutional investors (FIIs) have faced tax demands under minimum alternative tax (MAT) when the tax was applicable on them only by stretching definitions and relying on confusing judicial verdicts issued by a tax tribunal.

The episode casts a poor light on a government that assumed power on the back of reformist credentials. So far, there have been precious few such reforms, and wriggling out of the MAT controversy took a committee to save the day for the government.

Understanding the background of MAT, a relic of India’s socialist age, is important for understanding the current controversy. MAT was first introduced in 1987, to handle the problem of tax avoidance by what were referred to as “zero-tax companies". These firms had healthy profits but paid no taxes by deftly using tax preferences—exemptions, concessions and the like. The measure—codified as section 115J of the Income Tax (I-T) Act, 1961—was made inoperative from the assessment year 1991-92. It was reintroduced in 1996 based again on the principle that zero-tax companies were not contributing anything to the exchequer. Since then, it has existed in one form or another on the I-T Act, 1961. The intent behind MAT has always been that there are companies that make profits but don’t pay reasonable taxes. It may have had legitimacy at one time in India’s history. It does not any more.

In the instant case—involving a clutch of FIIs—the problem started with tax authorities ignoring the distinction between foreign companies that are liable to pay MAT and FIIs—ones with no physical presence in India—who are not in the ambit of MAT provisions. There was ample leeway for the finance ministry to interpret and creatively apply provisions of the law. Between the start of the process sometime in October last year and the sending of notices to FIIs in March, neither the finance ministry nor the Central Board of Direct Taxes (CBDT) tried to check the drift. The 2015-16 budget changed the MAT provisions prospectively—from 2015-16—but by then the damage had been done: the previous cases, pursued rather vigorously, hurt India’s image as an investment destination.

The larger political economy issue is one of drift in this government. Two points are pertinent here.

One, in the period between October last year and March this year, the government did nothing to change course in spite of representations by FIIs. The problem was not one of differing judicial decisions issued by the Authority on Advance Rulings [notably in the Timken (2010) and Castleton (2012) cases that went into the question of physical presence of a company in India]. In the end, a committee had to take the decision for the government. The issue was one of government fearing that it would be perceived as being pro-business.

Two, increasingly, this government’s view on reforms is too short-sighted. In the year since it has come to power, the issue of liberalizing and attracting foreign direct investment (FDI) has been pushed to the backburner. There is a practical reason for it. With foreign investors pouring in hundreds of millions of dollars in start-ups and e-commerce companies, the government’s incentives for attracting investment reduced considerably. Why push for unpopular decisions when one is getting results without expending any political capital? This is an extremely short-sighted view of investment.

India has always had huge investment needs as it has historically been a capital-scarce country. In the present context, this need has been amplified greatly because of a domestic capital flow bottleneck—banks can’t lend because of high non-performing assets and stress in the system. The only way out is to make up with foreign capital inflows. The combination of obdurate bureaucracy and fearful political leaders, however, is more than sufficient to scare away even the hardiest investor having faith in India.

Why does the National Democratic Alliance government fear it’s being perceived as a pro-business government? Tell us at views@livemint.com

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