ANALYSIS BEYOND CONSENSUS

... the new ABC of research

MAT on SEZ - P&L neutral; cash flow negative February 28, 2011

Manoj Bahety, CFA (manoj.bahety@edelcap.com) + 91-22-6623 3362

Sandeep Gupta (sandeep.gupta@edelcap.com) + 91-22-4063 5474

Nitin Mangal (nitin.mangal@edelcap.com) + 91-22-4063 5475

Budget 2011 announced the levy of MAT on SEZ developers and units operating under SEZ, clouding sentiments on account of
the expected increase in tax burden. However, in our view the implication may not be true for many companies as they may
still continue to be outside MAT at the entity level or even in some cases where it is applicable, the impact may be restricted to
only cash flow and not P&L.

MAT applicable only when tax of overall company is lower than 18.5% of book profit

Under the amended provisions of Section 115JB of the Income Tax Act, a company is required to pay MAT on its book profit if
income tax payable on the total income is less than 18.5% of book profit.

The income tax payable for the applicability of MAT, however, needs to be looked from the overall company perspective and
not from the perspective of its individual business units. So, in a case where a company has three business units, of which one
is a SEZ developer/ unit operating under SEZ, we need to look at the aggregate profit of all three units to decide whether the
company will fall under MAT.

Hence, in case of companies which have SEZ units along with normal tax paying business units, wherein overall tax paid is
already higher than 18.5% of book profit, there will not be any incremental cash flow or P&L impact on account of MAT on SEZ
units.

Incremental MAT will be restricted to the difference between current tax rate and MAT rate

For companies wherein current tax paid is lower than 18.5%, the incremental MAT outflow will be only to the extent of the
difference between MAT rate and current tax rate. For example, if a company is already paying tax @ 10% of book profit, the
maximum impact due to MAT applicability on SEZ units will be around 8.5% (refer annexure I for details).

MAT permitted to be carried forward to be set off against future taxes

A company falling under the ambit of MAT is allowed to carry forward MAT credit for a period of 10 years following the year in
which MAT has been paid.

MAT credit = MAT – normal income tax

Salient features of MAT credit are:

„ Amount of MAT credit will be equal to the excess of MAT over normal income tax for the year in which MAT is paid.

„ No interest is allowable on such credit.

„ MAT credit can be carried forward for set-off for 10 succeeding years from the year in which MAT credit becomes
allowable.

„ The amount of MAT credit can be set-off only in the year in which the company is liable to pay tax as per normal
provisions of the Act.

„ The amount of set-off will be to the extent of normal income tax over the amount of MAT for that year.

Hence, MAT credit can be set-off only in the years when the normal income tax is higher than MAT and the set-off is restricted

Analysis beyond Consensus (ABC) is our initiative to provide a differentiated perspective to our clients on various non-routine and intricate issues. This unit
of research works independent of the sector/stock research team and views expressed in this report may vary with that of respective sector/stock analyst.

Edelweiss Securities Limited

1
Analysis Beyond Consensus

MAT credit to be recognised as an asset; hence, may not have P&L implications

As per the guidance note issued by ICAI, India Inc., can recognise “MAT credit” as an asset
under loans and advances. The corresponding credit will be to P&L, which will neutralise the
incremental impact of increase in MAT rates on reported earnings.

However, the under-mentioned conditions are required to be met to recognise MAT credit:

„ There is convincing evidence that the company will pay normal income tax during the
specified period (next 10 years).

„ There will be sufficient future taxable income to absorb MAT credit.

Hence, in cases where MAT is due to some tax exemption and the remaining period of tax
exemption is less than 10 years, the increase in MAT rates should not have any impact on
reported earnings. However, cash flow will be negatively impacted on account of higher cash
taxes (refer Annexure II for details).

Edelweiss Securities Limited

2
 MAT on SEZ

Annexure I

MAT impact when company has multiple business units of which one or more is a
SEZ developer/ operating in SEZ

A company has three business units, of which unit 1 is a SEZ unit

(INR mn)
Case 1 Case 2
PBT PBT
Business Unit 1 - SEZ 2,500 7,000
Business Unit 2 2,000 2,000
Business Unit 3 4,500 4,500
Total 9,000 13,500

Tax calculation
Total PBT 9,000 13,500
Less Profit out of SEZ unit 2,500 7,000
Taxable PBT 6,500 6,500
Tax @32.4% 2,106 2,106
PAT 6,894 11,394
Effective tax rate (%) 23.4 15.6

Incremental MAT impact

Cash flow (MAT^ - normal tax) Nil 594
P&L (Refer annexure 2) Nil Nil
Note:^ MAT = total income *20% (Effective MAT rate including surcharge and education cess)

Edelweiss Securities Limited

3
Analysis Beyond Consensus

Annexure II

Post budget impact on reported profits of SEZ developer/ unit operating under SEZ

A company has a book profit of INR 1,000 mn and operates in SEZ and was earlier exempted
from tax. Post budget, the company will be liable to pay taxes under MAT

(INR mn)
Particulars Pre budget Post Budget
Book profit 1,000 1,000
Provision for tax 0 0
MAT tax 0 200
Less : MAT credit entitlement 0 200
PAT 1,000 1,000
Tax cash outflow 0 200
Note: * chargeable @20% including surcharge and education cess
Note: For simplicity, we have assumed book profit and reported profit to be the same

“MAT credit entitlement” will be recognised under loans and advances in the balance sheet.

As can be seen above, the impact of increase in MAT will be P&L neutral. The cash outflow
will, however, be higher.

Edelweiss Securities Limited

4
 MAT on SEZ
th
Edelweiss Securities Limited, 14 Floor, Express Towers, Nariman Point, Mumbai – 400 021,
Board: (91-22) 2286 4400, Email: research@edelcap.com

Vikas Khemani Head Institutional Equities vikas.khemani@edelcap.com +91 22 2286 4206

Nischal Maheshwari Head Research nischal.maheshwari@edelcap.com +91 22 6623 3411

Recent research

Date Title

17-Jan-11 ABC Compendium – Annual Report Analysis

27-Dec-10 IL&FS Transportation Networks – Annual Report Analysis

23-Dec-10 HCL Technologies – Annual Report Analysis

22-Dec-10 C&C Constructions – Annual Report Analysis

08-Dec-10 IRB Infrastructure Developers – Annual Report Analysis

30-Nov-10 IVRCL Infrastructure – Annual Report Analysis

25-Nov-10 Bharat Forge – Annual Report Analysis

22-Nov-10 Welspun Corp – Annual Report Analysis

10-Nov-10 United Spirits – Annual Report Analysis

27-Oct-10 Unitech – Annual Report Analysis

20-Oct-10 Educomp Solutions – Annual Report Analysis

12-Oct-10 DLF – Annual Report Analysis

05-Oct-10 Bharti Airtel – Annual Report Analysis

04-Oct-10 Aban Offshore - Annual Report Analysis

30-Sep-10 Suzlon Energy – Annual Report Analysis

24-Sep-10 Tracing RIL’s treasury share sale proceeds

20-Sep-10 Hindalco Industries – Annual Report Analysis

Access the entire repository of Edelweiss Research on www.edelresearch.com

This document has been prepared by Edelweiss Securities Limited (Edelweiss). Edelweiss, its holding company and associate companies are a full service, integrated
investment banking, portfolio management and brokerage group. Our research analysts and sales persons provide important input into our investment banking
activities. This document does not constitute an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any
transaction. The information contained herein is from publicly available data or other sources believed to be reliable, but we do not represent that it is accurate or
complete and it should not be relied on as such. Edelweiss or any of its affiliates/ group companies shall not be in any way responsible for any loss or damage that
may arise to any person from any inadvertent error in the information contained in this report. This document is provided for assistance only and is not intended to
be and must not alone be taken as the basis for an investment decision. The user assumes the entire risk of any use made of this information. Each recipient of this
document should make such investigation as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in
this document (including the merits and risks involved), and should consult his own advisors to determine the merits and risks of such investment. The investment
discussed or views expressed may not be suitable for all investors. We and our affiliates, group companies, officers, directors, and employees may: (a) from time to
time, have long or short positions in, and buy or sell the securities thereof, of company (ies) mentioned herein or (b) be engaged in any other transaction involving
such securities and earn brokerage or other compensation or act as advisor or lender/borrower to such company (ies) or have other potential conflict of interest with
respect to any recommendation and related information and opinions. This information is strictly confidential and is being furnished to you solely for your
information. This information should not be reproduced or redistributed or passed on directly or indirectly in any form to any other person or published, copied, in
whole or in part, for any purpose. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in
any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject
Edelweiss and affiliates/ group companies to any registration or licensing requirements within such jurisdiction. The distribution of this document in certain
jurisdictions may be restricted by law, and persons in whose possession this document comes, should inform themselves about and observe, any such restrictions.
The information given in this document is as of the date of this report and there can be no assurance that future results or events will be consistent with this
information. This information is subject to change without any prior notice. Edelweiss reserves the right to make modifications and alterations to this statement as
may be required from time to time. However, Edelweiss is under no obligation to update or keep the information current. Nevertheless, Edelweiss is committed to
providing independent and transparent recommendation to its client and would be happy to provide any information in response to specific client queries. Neither
Edelweiss nor any of its affiliates, group companies, directors, employees, agents or representatives shall be liable for any damages whether direct, indirect, special
or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information. Past performance is not necessarily a
guide to future performance. The disclosures of interest statements incorporated in this document are provided solely to enhance the transparency and should not be
treated as endorsement of the views expressed in the report. Edelweiss Securities Limited generally prohibits its analysts, persons reporting to analysts and their
family members from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover. The analyst for this report certifies
that all of the views expressed in this report accurately reflect his or her personal views about the subject company or companies and its or their securities, and no
part of his or her compensation was, is or will be, directly or indirectly related to specific recommendations or views expressed in this report.

Copyright 2009 Edelweiss Research (Edelweiss Securities Ltd). All rights reserved
Edelweiss Securities Limited