Restructured as limited partnership, companies can reduce their tax outgo.
With the Direct Taxes Code (DTC) expected to become a law effective only April 1, 2012, the government appears to have heeded to the request from industry to provide almost an 18-months window to allow tax payers to relook at their business models, restructure them and be better prepared.
This presents itself an opportunity to do some out-of-box thinking and challenge established band wagon. One such area is planning for Minimum Alternate Tax (MAT) and Dividend Distribution Tax (DDT).
While the overall corporate tax rate is proposed to be brought down from 33.22% to 30%, MAT is being marginally increased to 20% (from the existing 19.93%) on book profits. Additionally, developers of Special Economic Zones (SEZs) and units located therein are also being brought under MAT.
While MAT is creditable against taxes payable under normal provisions as and when it becomes applicable, it has significant cash flow impact especially for the small and medium enterprises. MAT is therefore an advance tax with no interest accruing!
MAT was initially introduced in 1996 to bring “zero-tax companies” that had an arbitrage as a result of higher rates of tax depreciation to the tax bracket. Initially, at an effective tax rate of 12%, MAT was reduced to 7.5% in 2001.
After that, MAT has only gone upwards since then — 11.22% in 2006-07 to 19.93% for the year 2010-11, thereby impacting cash flows of companies.
Initially, the DTC had proposed to levy MAT based on “asset base” at the rate of 2%. In light of widespread discontentment, the revised discussion paper addressed the issue through a pragmatic approach of keeping it in line with the current method of levying with reference to “book profits”. This has now been enshrined in DTC.
The clawback period of MAT credit is proposed to be extended to 15 years from the existing 10 years. However, an issue that is still unclear is the availability of credit in respect of MAT paid under the current law. Although there are no transition provisions in this respect, it appears that the carry forward benefit should be available.
Similarly, while the cascading effect of DDT is proposed to be done away with, other provisions with respect to DDT are proposed to be continued (rate down from 16.61% to 15%).
It is a well know fact that getting foreign tax credit in an overseas jurisdiction for DDT paid by the underlying Indian company is a huge challenge. Now, branch-profits taxes are also proposed to bring non-residents taxation on par with residents.
Interestingly, only companies are liable to MAT and DDT. The ‘flow through’ taxation of Limited Liability Partnerships (LLP) are proposed to be continued.
This means that as an LLP, the net cash in the hands of shareholders, say for example in case of a SEZ unit/developer which otherwise enjoys the tax exemption benefit, would be the full profits while as a corporate, it could be only 69.57% (a savings of close to 30%), a significant cash savings which is worth consideration by tax payers. See table.
Even where taxes are payable under the normal provisions, it may still be worth-while to explore a LLP structure to mitigate impact of DDT (savings of close to 10%).
With flexibility in set-up and exit, liability being limited (similar to a company) and the credit of being internationally acclaimed, it appears that the government is now indirectly promoting more LLP form of structures. It is expected that Reserve Bank of India will soon come out with clarifications regarding foreign direct investment into LLPs.
With respect to outbound investments, the exchange control regulations broadly treats firms registered under the Indian Partnership Act, 1932 on par with companies. These provisions need to only be extended to LLPs registered under the Limited Liability Partnership Act, 2008.
At any point in time, for corporate, funding or any other non-tax reasons, a LLP could be converted into a limited company through a tax-neutral re-organisation. Curiously, such re-organisation is now proposed to be covered under amalgamations and business re-organisations in the DTC.
In view of the changes proposed in the DTC, it is important for all tax payers to immediately undertake a comprehensive review of its impact on their effective tax rate and optimise their overall tax burden by fully integrating tax considerations with business decision making.
Posted by M.K. SREEDHAR , A Tax Man at MOF | 09 Sep, 2010
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