MAT trips pharma companies in Sikkim

The increase in excise duties on medicines from 5% to 6% would add to costs, but tax credit on inputs would lessen the burden of the pharma companiesMark to Market | Ravi Ananthanarayanan         Pharmaceutical companies would tend to have termed the budget a normal one. The increase in excise duties on medicines from 5% to 6% would add to costs, but tax credit on inputs would lessen the burden. Excise as a percentage of sales has come down over the years and is at just 1.5% in 2010-11, nearly half its level in 2006-07.

The budget also extended the 200% weighted income tax exemption on research and development expenditure for five years, giving long term certainty on this exemption. This will benefit domestic drug firms who spend significant sums on research and most companies focusing on the US generic market for formulations would fall in that category.

R&D expenditure as a percentage of total revenues was 1.9% in 2010-11 for listed pharmaceutical companies. This may seem small but is higher for companies such as Dr Reddy’s Laboratories Ltd (9.5% of revenues) and Cadila Healthcare Ltd (8.5% of revenues), based on data from Capitaline.

While the budget would have largely preserved the status quo, except for some inflation in input costs, an amendment to the minimum alternate tax laws took the wind out of the sails of some companies. The government has imposed MAT on all companies, in the past few years, even those eligible for tax exemptions.

But partnership firms escaped the MAT net. The budget proposes to end that concession, making it applicable to all taxable entities, with very few exceptions. Companies who had set up partnership firms with a significant operating size in states like Sikkim, where area-based tax exemptions are available, have been hit hard.

Cadila holds a 96% share in a Sikkim-based partnership firm, and its share of profit in the firm amounted to Rs. 412 crore in 2010-11 or about 49% of its consolidated profit before tax. At a MAT rate of 18.5%, if this measure had been in place in 2010-11, it would have led to a 9% reduction in PBT in 2010-11.

Similarly, Sun Pharmaceuticals Ltd owns a 97.5% share in a Sikkim-based partnership firm, and its share in the profit of this firm in 2010-11 amounted Rs. 1079 crore, or 53% of its consolidated profit before tax. MAT would have led to about a 10% reduction in its profit before tax.

The impact of this measure is thus significant, but it is not catastrophic. The MAT paid out today will be recouped in later years and it is a timing effect. That is, companies will pay MAT now, but when they exit the tax holiday and have to pay normal income tax, they will get credit for MAT paid.

The immediate effect will be to see earnings drop, which is why share prices have fallen. But for long-term investors, who will consider earnings over a longer period, this should not drastically alter their outlook on these companies.


source:/Mint