Financial Daily from THE HINDU group of publications
Friday, Mar 19, 2004
Corporate - Taxation
MAT strengthens India Inc.
The scrutiny intensified significantly in 1999 when major Indian companies began listing American depositary shares on the NASDAQ and the New York Stock Exchange (NYSE). Unsurprisingly, accountants, analysts and lawyers found little that could be shown as evidence of aggressive accounting and overstated profits. First, Indian companies understood the purpose and nuances of US' generally accepted accounting principles (GAAP) and had adopted GAAP quite enthusiastically. Second, they had begun to derive the significant benefits from India's minimum alternative tax (MAT).
MAT was implemented in 1996. It possesses significantly important properties that have strengthened India Inc. It infuses realism and sanity into corporate earnings. It provides strong economic disincentives to companies that may want to overstate incomes. MAT makes it difficult for companies to get away with inflated earnings. In the main, it provides the right incentives to report earnings without any deception.
The case for retaining and reinforcing MAT has become stronger now. First, India Inc. has steadily grown in stature from a dwarf to an emerging global force. The Reserve Bank of India (RBI) has recognised this steady progression and has rewarded India Inc. by allowing companies to borrow up to $500 million through the automatic approval channel. The previous limit was a minuscule $50 million. MAT would play a vital role in demonstrating the true earnings potential and the repayment capability of India Inc.
Second, the RBI has permitted India Inc. to raise external commercial borrowings for overseas direct investment in joint ventures or wholly owned subsidiaries through mergers and acquisitions. MAT would guide global banks and shareholders of target companies in their attempts to separate weak balance-sheets from strong balance-sheets. MAT would make the completion of the due diligence process easy.
Third, Indian investors including pension and mutual funds would soon be able to invest in the India depositary receipts of global corporations. They would most certainly compare India Inc. with global corporations before making significant investments. MAT would guide them in this process. They would discover that India Inc. reports its incomes with little deception because of MAT. MAT has institutionalised the truthful reporting of economic performance by India Inc., and has become an ally of banks, auditors, debt-holders and shareholders.
Top dog deceives
Global corporate analysts seldom attempt comparisons between America Inc. and India Inc. When they do, their objective is to show how vastly superior America Inc. is to India Inc. The stereotypical view is that India Inc. is a tiny cluster of primitive, semi-formed companies set in a flawed democracy and guided by poorly-designed institutions. By contrast, America Inc. is the global galaxy of big, perfectly-formed companies guided by well-informed institutions such as the US Congress, the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB) and GAAP defined by FASB.
But WorldCom and Enron once the revered top dogs of America Inc. comprehensively deceived their shareholders by overstating earnings. They deceived their debt-holders by overstating earnings. Both shareholders and debt-holders now know that overstated earnings have comprehensively ruined their wealth. It is no consolation that the senior executives of these companies have been subjected to investigation and prosecution for conspiring to overstate earnings in violation of GAAP and other accounting standards.
An avalanche of financial restatements and earnings revisions is expected in 2004. Wall Street analysts expect more American companies to clean up overstated earnings and past messes. There have been more than 75 instances this year where American companies have chosen to either restate their earnings or have been instructed to clarify and substantiate published accounting statements. Last year, more than 300 companies restated their earnings.
All of them had adopted overly aggressive accounting policies and methods. They had booked future revenues in current period earnings and postponed recognition of costs. They enthusiastically overstated profits but did not pay taxes. For example, Enron reported hundreds of millions of dollars in profits to shareholders. Yet, it reported to the US Internal Revenue Service that it had $3 billion in cumulative losses. Such deceit is impossible in India. India's MAT would have discouraged Enron and WorldCom from stretching the truth.
Underdog stands tall
Poor institutional framework is often seen as the major contributory factor to India Inc.'s poor image. In particular, financial statements of Indian companies are regarded often with deep suspicion and sometimes with total disdain. In the eyes and minds of analysts at the global accounting and auditing firms, legal firms, investment banks, pension funds and investment banks, India Inc. adopts poor standards or no standards at all in practices related to revenue and expense recognition. Indian companies, goes their argument and assertion, overstate incomes and understate expenses.
But there has been no interesting and big case of overstated incomes and understated expenses in India. There has been no `Parmalat' in India even though the payoffs from deceitful accounting could be putatively high in a primitive economy characterised by poorly-structured institutions.
The pressure on India Inc. to show healthy profits and continuous growth in earnings is considerable and it is difficult to argue that it is any less vigorous than it is on American and European companies. Perhaps, the pressure on Indian companies is more than it is elsewhere. But healthy and profitable companies have reported their earnings with as much trueness and fairness as possible since any overstatement may have increased their tax liability under MAT. The not-so-healthy and the not-so-profitable companies too have reported their earnings without deceit. If they had overstated their earnings, they would have had to find the cash to support their tax liability under MAT.
India Inc. has pursued efficiency and profits without depending on dubious accounting props and devices. It has improved its operations and strategies and has used competition among firms as a spur to better economic performance. It has responded to the new microeconomic environment without being pushed into experimenting with accounting fiddles. India Inc.'s operations and strategy rank in 1998 was 50. It was 37 in 2001, a significant improvement by 13 places, the biggest jump in the world.
India Inc.'s capital asset productivity, profitability from operations, value delivered to customers and corporate tax paid to the exchequer rose significantly in a period when America Inc. chose to post attractive earnings by the early recognition of revenues and by the postponement or capitalisation of costs.
Government has been a significant beneficiary of the rising productivity and profitability of India Inc. Corporate taxes, as a fraction of capital employed, rose by 40 per cent. Corporate taxes, as a fraction of net sales, rose by more than 5 per cent. By contrast, these ratios declined in the US. It is surprising that Wall Street and the US Congress chose to ignore the falling ratios, which belonged to the losers that overstated earnings.
By contrast, the rising ratios belong to the earnest and the winners. MAT has made winners out of India's underdogs. It has contributed significantly to the reliability of India Inc.'s accounting statements and disclosures.
It is surprising that a simple institutional device such as MAT could be more effective than the SEC, NASDAQ, the NYSE and the FASB collectively. What is more, MAT comes without the bureaucracy, the committees and the costs.
(G. Ramachandran is a financial analyst. C. Ramesh is a chartered accountant. Feedback may be sent to email@example.com)
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