Over the last few weeks, the press has been rife with the recent clarification given by the CBDT. In fact, CBDT had recently clarified that companies that shift to the new 22% tax formula will not get the MAT credit. That had created a sense of panic among a lot of large corporates. Here is why!
Why MAT credit matters
Minimum alternate tax was introduced more than 20 years back but the rate of MAT had consistently increased from 30% of tax liability to over 65%. Effective 2017, Indian companies were permitted to carry forward their MAT credits for a period 15 years during which they could write off the same against profits. As per a study by ETIG, the total MAT credits pending in books of Indian companies were to the tune of Rs.75,000 crore. The worry was that all these MAT credits would be lost. If you look at the MAT credit companies it includes companies like RIL, Power Grid, NTPC etc which have MAT credits of over Rs.8000 crore reach. MAT credit is not a problem for companies where the tax liability is more than the MAT paid. It is a challenge for companies with heavy capital investment where the actual tax liability is less than the MAT rate of 18.5% and hence results in MAT credit. The concern was that all these companies would prefer to delay signing on to the new tax formula. Without these names, the new tax formula would be a virtual non-starter.
That is not how it will work
The good news is that MAT credits are unlikely to be lost. The effective tax rate is 34.94% (30% tax + 12% surcharge + 4% cess). Under the new formula, this effective rate will work out to just 25.17%. That is a clear benefit of 9.77%. Firstly, for companies that are already paying higher than 25.17% and do not have too much of allowances or MAT credits to worry about, the choice is clear. Move to the new tax formula and save 9.77% tax. But, what happens to the companies with existing MAT credits that are available to be absorbed over the next 15 years.
Look at the L&T Finance model
What the shift means is that once you shift to the new tax formula, you only get tax shields on your MAT credit to the extent of 25.17% due to the lower tax incidence. That is where the L&T Finance model comes in handy. What L&T Finance has done is that they have taken their deferred MAT available and written it down by 9.77% (difference in the tax rates). With this done, they are shifting to the new tax formula effective the fiscal year 2019-20. In fact, the reason for the sharp fall in the profits of L&T Finance in the September quarter is due to this deferred tax write down. So companies with profits can use this formula to reduce their current tax outflow and also shift to a rate of tax that is substantially lower at 25.17%! ©