The finance ministry is set to drop a key proposal in the direct taxes code (DTC) to change the way companies work out their minimum alternate tax (MAT), helping them save crores of rupees in taxes.

The decision should not come as a surprise to industry. It opposed the new formula to charge MAT on gross assets of companies and not book profits, saying the move will hurt capital-intensive and loss-making companies. The government agreed for a review and will disclose its stand in the revised discussion paper on the code.

MAT is charged on companies that do not pay income tax because of exemptions. These companies enjoy more exemptions than their counterparts who pay corporate tax.

The draft code proposed a 2% MAT on gross assets of companies to garner more revenues. The idea was to levy MAT on presumptive income, encourage companies to use assets better and curb tax evasion. The new approach also meant discouraging companies from going on an asset creation binge.

A related proposal in the draft code was to scrap the facility that allows companies to carry forward MAT credit and set it off against their normal tax liability for 10 years. Today, MAT is like an advance tax paid by companies to the government that needs money to meet expenditure commitments. MAT will be the final tax, if the credit facility goes.

On the flip side, MAT on gross assets will hurt companies with a large asset base and relatively small earnings, besides loss-making companies.

One option is to exempt loss-making and capital-intensive infrastructure companies from MAT. However, selective exemptions will only distort the tax structure and defeat the goal of ushering in a neat tax system. The government should resist such pressures if it wants to end tax holidays.

The revised discussion paper on the code is likely to propose continuing with the current method of computing MAT. This means companies will pay MAT on book profits. That is only one side of the story. The devil, as they say, could be in the details. India Inc will have to look at the fine print before rushing to raise a toast.

For the government, dropping the codes formula will mean foregoing extra revenues of Rs 15,000-20,000 crore. This is not small change. It could, therefore, attach riders on MAT to garner revenues and end exemptions.

The intention of MAT, introduced a decade and a half ago, was to discourage companies from arranging their tax affairs in a manner that would result in huge book profits and a substantial dividend payout, but no tax liability.
At that time, the rate was fixed at 7.5% of book profits of a company.

It was raised to 10% in 2006-07, and 15% in 2009-10. The MAT rate was raised to 18% in this years Budget that saw a lowering of the corporate surcharge.

These two policy decisions were perhaps an indication of the impending overhaul in the direct taxes regime. What are the options before the government?

It can propose an increase in the MAT rate to bring it closer to the effective corporate tax rate of about 22.8%. Effective tax rate is the average tax rate for companies after exemptions have been claimed. It is lower than the statutory corporate tax rate of 33.99%. Ideally, the two should converge, and this will happen once the exemptions are removed.

A hike in the MAT rate will result in more cash outflow for companies, compelling them to postpone their investments. They may have to reckon with a higher rate as a trade-off for dropping the new formula. If the credit facility goes, two rates will be in force. But this will defeat the goal of a simple tax system. It makes sense to retain MAT credit.

As part of the comprehensive reforms package, the draft code also proposed a cut in the corporate tax rate to 25% from 30%. Is a 5% cut in the corporate tax possible if the new formula is dropped? Here again, the government has to take a call, given the revenue implications.

The country needs to lower its corporate tax rate if it has to compete with China and east Asian economies. This is eminently feasible if the government ends all tax exemptions.

Tax breaks are inefficient and iniquitous, and raise compliance and administrative costs. These giveaways were estimated to cost the government around Rs 80,000 crore last fiscal year. But the benefits arising from these exemptions are difficult to gauge.

Tax breaks were justified when corporate tax rates were very high. Not any more. The panoply of exemptions should be removed, and MAT can be abolished once this is done.