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On The Mat - Views on News from Equitymaster
 
 
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  • Jan 13, 1997

    On The Mat

    Suddenly, this concept of the Minimum Alternative Tax is being criticized even by people from within the government. The Prime Minister, concerned about the changed political environment and alarmed by the threat (real or imagined) of bleeding money-bags volunteering to fund another election as long as the winning government promises to abolish this minimum tax nonsense, has already gone on record saying that this MAT stuff is being reviewed. The Finance Minister (who just a few months ago quite rightly said that what happens to the Sensex does not bother him) looks like he may be having sleepless nights. Colleagues in the Cabinet and bureaucracy are publicly calling MAT a mistake.

    The stock market is delighted by these confessions and, in anticipation of the withdrawal of MAT, Dalal Street has come to life. A 450 point gain (16%) in less than a month is witness to the simmering fire in the belly of the Bull. But maybe we should hold our horses a bit and see if what is being surrendered is for short term benefits at the cost of long term gains.

    Let's examine three issues: (1) Is corporate Indian paying too much income tax, (2) Why did the stock market not like MAT? (3) Is the government now bailing out the market by being nice to corporate India and unfair to others who have suffered under other changed government policies?

    INDIA IS A TAX HAVEN.

    Despite claims of high taxation on corporate India, the fact is that Indian corporates are amongst the lowest payers of income-tax in the world. Although there are many corporates who pay over 40% rates of tax on their income, if one looked at a sample of the larger 200 companies covered in the Quantum Stock Market Yearbook, the reality is that the average rate of effective taxation on income is less than 20% - and it has been at these levels for over 4 years. A talk with entrepreneurs and bankers around the world suggests that Indian corporates are getting away cheap on the income tax front. In the United States, the average rate of taxation on income for small or large companies is over 30%. In Europe it is over 40%. In Philippines it is over 30%. In Singapore 30%. But the taxation rate is lower in Hongkong at 20%. Keep in mind, though, that Hongkong sells itself as a low-tax trading country rather a manufacturing country. And it is anyone's guess what will happen after China walks in on July 1, 1997. The conclusion, here, is that the effective tax rate in India on incomes earned by corporates is about the lowest in the world.

    CONSUMERS PAY INDIRECT TAXES, NOT THE CORPORATES.

    I have often heard many of the Indian industrialists complain that they pay truckloads of money to the exchequer in the form of excise duty, sales tax, and provident fund payments. Well, although these corporations may be writing the cheques to the government, the honest truth is that the money is actually paid for by you and me - the consumers. When I buy a car, the excise duty is built into the price. I pay it to the company who, in turn, may have already paid it to the government. What is true for cars is true for all products. And what is true for excise duty is also true for sales tax, import duties, or provident fund payments.

    Sometimes when there is an increase in the excise duty on yarn or the import duty on steel, this is passed on to the consumer by raising the selling price of the product - either immediately or in phases. And, when this price is upped for the consumer, he or she may continue to buy those products or they may stop buying those products - temporarily or permanently. Ultimately, a good manager and a company which has a good product to sell will collect its dues from Mr. Consumer. The corporates price their products in a way that reflect all their costs - including all these taxes they pay on behalf of you and me. So the next time you hear a corporate boasting about how much they contribute to the exchequer by way of excise duties keep in mind the bullshit factor and remember that the consumer actually paid those taxes.

    CONSUMERS MAKE ASSUMPTIONS WHEN THEY BUY PRODUCTS.

    Every day we consumers of products have choices which we exercise: to buy or not to buy a product and when to buy - today or tomorrow. And our decisions are based on need and expectations. If I want to buy a flat, I need to worry about whether the price of that property will go up or down in the future and how urgently do I want to be an owner of property. Or do I need to buy the Maruti Esteem today or should I buy a car tomorrow when increased competition could result in lower prices. And we consumers also make assumptions on which we base our decisions. I may assume that this country is going throughout a massive cleansing process and in 1997 some politicians or builders or criminals will actually go to jail and that could result in declining property prices. Or I may believe that telecommunications is going to make work so much easier that no one needs to be in Nariman Point and people could just dump their property there and move out of Bombay to Bangalore, Madras, or Pune. All of which could result in lower property prices in Bombay. These are all assumptions and scenarios that we build to help us make decisions.

    INVESTORS WHO FLOCKED TO DALAL STREET FOR MOST OF 1996 MADE WRONG ASSUMPTIONS WHEN THEY BOUGHT SHARES - SO WHY ARE THEY COMPLAINING?

    At one level, I would argue that shares are another product or another commodity. If an investor did not factor the impact of a possibility of higher taxes in his estimates of future earnings, then he gets punished by the lower share price when taxes are actually imposed and Dalal Street nose-dives into a tailspin. Most of the research analysts and investors who made forecasts on expected future profits of companies, assumed that taxes would remain at these ridiculous low levels of 0% for the larger corporates. Well, their assumptions were wrong and they should be made to pay a price for it in the form of lower share prices - that is why Dalal Street does not like MAT. So if the stock market is down, tough luck investors - make better assumptions next time.

    In fact, investors and the marketmen know better than to grumble about MAT. After all, many investors and analysts grumble that it was this investment allowance reserve and all the myriad of tax breaks that the government gives corporates that resulted in large groups investing in inefficient assets. In the 1980's and early 1990's it was fashionable for large corporates to invest in cement, petrochemicals, and steel plants only because the tax breaks linked to these investments justified this asset-building mania. These tax breaks were actually responsible for the inefficient investments that led to this diversification binge by the Grasims and Indian Rayons of the world. And the market is punishing these diversified conglomerates by placing lower P/E ratios on their share prices. Or even punishing companies like Reliance which may be focused in one business but reinvest for the sake of reinvesting - to get tax breaks and not boost return on capital. By introducing this MAT system, Indian corporates will now no longer invest only for the tax break because they have to pay some minimum tax anyway. They will invest increasingly because there is a return on capital that can be justified. Dalal Street should be cheering this MAT move, not condemning it and the only reason it is being condemned is because no one expected it as a government directive - it was not factored into most people's assumptions.

    RESCUE ME, TOO!

    And, if the government rescues the investors of 1996 by knocking down MAT, maybe they should start rescuing the long line of people who are also suffering because they made wrong assumptions. For example, I bought a computer 12 months ago taking a view that import tariffs would not fall. Well, they did and today the computer is worth 30% less. In 1996 500,000 computers were bought and assuming an average fall of Rs 20,000 per computer bought that amounts to a loss of Rs 1,000 crores! Will the government reimburse us?

    Or what about the guys who bought the Ambassador cars all these years. They probably never expected to see the day when they could buy an Opel or Ford or Esteem. They made wrong assumptions and are now left owning a pretty worthless piece of heavy metal. Or the people who bought cement in 1980 at Rs 180/bag...Or the people who bought property in Nariman Point at Rs 35,000 per square foot...the list is endless.

    LOWER THE COST OF CAPITAL, RAISE THE TAX.

    What Indian corporates need is actually lower costs of capital in terms of the rates of interest and the availability of money. They should be free to borrow at international rates (with no guarantees by the government) and let each project be scrutinized on its return on capital basis rather than some tax break given by the government. These sort of decisions would do great things for the economy - by making sure that projects make economic sense on a stand-alone basis. And they will also do great things for the market as access to lower cost of international funds will result in a lowering of domestic lending and deposit rates and allow money to flow back to equities.

    So, Mr. Prime Minister, Mr. Finance Minister, and everyone else with the power to do something: maybe it is wise to keep some sort of minimum taxation policy and - if you really want to help the economy and please Dalal Street - the thing to do is lower interest rates and not subsidize wrong assumptions made by consumers or investors. That will floor the market and take the Index higher.

     

     

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