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Monday, Mar 10, 2008
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The amendments to MAT
The Finance Bill, 2008 proposes to put an end to controversies surrounding treatment of deferred tax, tax on distributed profits, interest, etc, by resolving the issues in favour of Revenue.
Sunil D. Shah
The Minimum Alternate Tax (MAT) has had a chequered history. It was first introduced in the form of Section 80VVA by the Finance Act, 1983 which was omitted by the Finance Act, 1987. The Finance Act, 1987 introduced MAT in the form of a tax on book profits in Section 115J.
The tax remained in force for three years and was withdrawn by the Finance Act, 1990. MAT was again introduced with the insertion of Section 115JA by the Finance (No. 2) Act, 1996. And Section 115JA was replaced by Section 115JB by the Finance Act, 2000.
The current MAT provisions basically provide for levy of tax at a minimum rate of 10 per cent (plus surcharge, cess, etc.) on the book profits. For this purpose, the book profits are profits shown in the company’s statutory profit and loss (P&L) account. There are certain adjustments required to be made to the profits shown in the P&L account in arriving at the book profits. These adjustments are specified in the Explanation to Section 115JB(2). The Supreme Court, in the Apollo Tyres Ltd vs CIT (255 ITR 273) case, has held that apart from the specified adjustments, no other adjustment is permissible to the profit as shown in the P&L account.
A few of the adjustments as specified in clauses (a), (b) and (c) of the Explanation in respect of amounts to be added back to the profits as per the P&L account read as follows:
“(a) the amount of income paid or payable, and the provision therefor; or
(b) the amounts carried to any reserves, by whatever name called, other than a reserve specified under Section 33AC; or
(c) the amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities; or……..”
Several controversies have arisen on the interpretation of the above clauses. These controversies include the treatment of deferred tax, tax on distributed profits, interest, etc.
The Finance Bill, 2008 proposes to put an end to these controversies and resolve the issues in favour of the Revenue as follows:
The amount of deferred tax and the provision therefor will be added back to the book profits.
Tax on distributed profits under Section 115O will be treated as part of income-tax.
Interest charged under the Income-Tax Act will be treated as part of income-tax.
Surcharge, education cess and secondary and higher education cess will be treated as part of income-tax.
The Explanatory Memorandum states that the intention behind the add-backs in the book profit calculation under MAT is that items which appear below the line in the P&L account should not be deducted in arriving at the book profit for MAT purposes.
The Explanatory Memorandum states that “below the line items” such as deferred tax, dividend distribution tax (DDT) had not been previously specifically provided for because these were believed to be included in “income-tax” in clause (a).
The amendments have been made with retrospective effect from the assessment year 2001-02 when Section 115JB was enacted.
To provide the context to the amendments, the issues involved are discussed below:Deferred tax
Accounting Standard 22 issued by the Institute of Chartered Accountants of India (ICAI) provides that tax expense comprising current tax and deferred tax should be included in the determination of net profit or loss. The Standard also provides that deferred tax should be recognised for all timing differences.
The Income-tax Appellate Tribunal (ITAT), in CIT vs Balarampur Chini Mills Ltd (297 ITR AT 15 Kolkata), had occasion to consider whether a deferred tax charge debited to the P&L account is to be added back under Explanation (a) as income-tax in computing the book profit for MAT purposes.
The Tribunal held that deferred tax charge is a provision for the tax effect of the difference between the taxable income and accounting income and is not a provision for income-tax paid or payable. Deferred tax assets and liabilities are to be distinguished from current tax assets and liabilities.
The Tribunal also found that deferred tax is not in the nature of reserve under clause (b) of the Explanation because it is an expense of the period in which it is charged and cannot be transferred to the P&L account or used for issue of bonus shares or declaration of dividend.
The Tribunal also held that deferred tax is not an unascertained liability under clause (c) of the Explanation as deferred tax charges are measured scientifically and as per strict guidelines of the ICAI and accepted globally.
The Tribunal also observed that any withdrawal from the deferred tax provision would be taxable under the proviso to Explanation 1.
Consequently, the Tribunal held that the deferred tax charge is not to be added back in computing the book profit.
This issue was also considered by the Tribunal in the Maharaja Shree Umaid Mills Ltd vs ACIT (17 SOT 72) case. Although this concerned an order of rectification, the Tribunal held that a deferred tax liability is neither income-tax paid or payable nor a provision. It is an ascertained liability. The Tribunal consequently held that for the purpose of MAT the net profit does not need to be increased by the amount of deferred tax liability.
Recently, the Supreme Court, in J. K. Industries Ltd vs Union of India (297 ITR 176), had occasion to consider deferred tax in the context of Accounting Standard 22. Although the judgment was not rendered in the context of MAT, some of the findings may be relevant for MAT as well.
The Supreme Court held that AS 22 is right in stipulating that tax effect of timing differences should be included in the tax expense in the statement of P&L account and deferred tax liability/deferred tax asset in the balance-sheet.
The court saw no inconsistency between liability as understood in the conventional sense and deferred tax liability.
The court observed that the inclusion of deferred tax in tax expense is necessary if one has to go by the paradigm shift from historical costs accounting to fair value principles. The findings of the Supreme Court may support an inference that deferred tax is part of income-tax.
The controversy has now been set at rest by the amendment which specifically inserts clause (h) to add back the deferred tax.
There is no amendment corresponding to clause (h) dealing with how a deferred tax credit in the P&L account should be dealt with. Consistent with the intention behind the amendment, it would be reasonable to argue that any deferred tax credit should not form part of book profits.Tax on distributed profits
Another issue which arose is whether tax on distributed profits is part of income-tax and to be added back under clause (a) of the Explanation.
The Tribunal, in CIT vs Balarampur Chini Mills Ltd (297 ITR AT 15 Kolkata), held that tax on distributed profit could not be covered under the above clause as there are fundamental differences between income-tax and tax on distributed profits, since income-tax is payable on income whereas tax on dividend is paid at the time of distribution of profit, that is, at the time of application of the income on which income-tax has already been paid.
The Tribunal also held that tax on distributed profit is similar to FBT since both are payable at the time of incurring certain expenditure.
Circular No. 8 dated August 9, 2005 (at Question No. 103), clarifies that FBT is deductible in computing the book profit. The Tribunal held that the clarification in the Circular was applicable to tax on distributed profits as well and, therefore, such tax was not to be added back in the computation of book profits.
A contrary view was taken in the CIT vs Dhanalakshmi Paper Mills Ltd (290 ITR AT 27 Chennai) case where the Tribunal held that under Section 115-O the burden of paying income-tax was shifted from the individual shareholders to the company. The Tribunal concluded that tax on distribution of profit retains the character of tax on income. This controversy has now been set at rest by the retrospective amendment.
Interest on income-tax
As a general principle, interest on income tax is considered as inextricably connected with the tax and, therefore, not deductible in computing taxable income, as held by the Supreme Court in Bharat Commerce and Industries Ltd vs CIT (230 ITR 733). However, for the purpose of MAT under the erstwhile Section 115J, it was held in the CIT vs Fertilisers and Chemicals Travancore Ltd (261 ITR 484 (Kerala) case that Explanation (a) mentions only income-tax and does not include interest. Consequently, interest on income-tax cannot be added back for MAT purposes. This judgment was followed by the Tribunal under Section 115JA in the Insilco Ltd vs JCIT (85 TTJ 538 Delhi) case.
The amendment now neutralises the above decisions and provides that interest on income-tax will be considered as part of income-tax and will consequently need to be added back for MAT purposes.
Surcharge, education cess
Surcharge has normally been considered as part of income-tax as held by the Supreme Court in the CIT vs K. Srinivasan (83 ITR 346) case. To avoid any controversy on this issue for MAT purposes, it has been provided that income-tax will include surcharge which will consequently be added bank for MAT purposes. Since education cess and secondary and higher education cess are both in the nature of additional surcharge, it has been provided that these will also be treated as part of income-tax.
As indicated above, the amendments are retrospective from the assessment year 2001-02, when Section 115JB was enacted. Matters in litigation may thus be affected by the amendments. The amendments will not affect years prior to the assessment year 2001-2002 when Section 115J or Section 115JA, as the case may be, were operative.
Fortunately, wealth-tax has been spared from the amending provisions. In the case of CIT vs Echjay Forgings P. Ltd (251 ITR 15 Bombay), it was held that wealth-tax is not covered by clause (a) of the Explanation and consequently is not to be added back to the profit for the MAT computation. As there is no amendment concerning wealth-tax, companies can still rely on this judgement and claim that wealth-tax is not to be added back.
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