Saturday, February 26, 2011

The bullish case for MTNL has carried an excellent series on the deterioration of BSNL(unapproved capex plans, litigious tenders, no VRS etc). But there is hardly any coverage about the impending demise of another erstwhile PSU gem-MTNL. Considering that external shareholders hold 25%(GOI 56%, LIC 18%), you would expect some good coverage on this stock. But there's hardly any analyst interest in the stock-when there is enough here to fill a Bollywood potboiler.

A bearish case can be built as follows:-
  1. Risk of losing major customers:- With 47% call units coming from 8% access lines, MTNL is  particularly vulnerable to losing market share if other operators aggressively target our largest subscribers. A similar defection is happening in the Mumbai Power sector between RPower and Tata Power. To its credit though, MTNL has identified high usage “commercially important persons” and is making all efforts to strengthen  relationship with these subscribers. But will this be too little too late?
  2. BSNL issue:- As MTNL mildly puts it(Page 8 of 20-F), We have significant amounts due from related parties and our inability to collect them or change the terms of our arrangements with our elated parties could adversely affect our revenues and profitability. As I blogged earlier, the dispute with BSNL exceeds its total Mcap. And this is only the surface
  3. Pension issue:- The DOT had agreed that pensionary benefits to the Government employees absorbed in MTNL and who have opted for either the Government Scheme of pension or for prorated pension scheme shall be paid by the Government. But this amount is simmering(and not accounted for)
  4. Weak controls(all pervasive):- Controls are weak in major areas like reconciliation of subscriber deposits, accounting for related party transactions and information technology controls.
The stock is beaten down to such low levels that a favourable resolution of any/all of the below issues can send the share price zooming for a while. The pension issue itself is worth Rs 1900 crores and can materially boost performance of the stock-irrespective of operational aspects. A careful tracking of the ligation progress could yield rich dividends

MTNL pending litigation Note 23 F-46 20F 2009-10 filed Oct-10 with SEC

Thursday, February 24, 2011

Why retrospective tax amendments are beneficial in the long run?

As a future chartered accountant(with an interest in taxation), I'm probably biting the hand that feeds many of my co-professionals. But the rationale for retrospective tax amendments should be understood before complaining about it(like the ICAI has done in its Pre Budget Memorandum here).

Like any human activity(and more so typical of a social science like law), tax law is imperfect. In this rapidly changing economic/technological environment, even the best trained policy makers cannot anticipate all the consequences of their laws. This gives rise to unintended consequences as the below examples show;-

  1. In the early 1990's, GE Shipping(of the Sheths) made a virtue of issuing rights shares at par, often at a substantial discount to market value. The conventional explanations of rights issue discount, ownership base not changing etc do not account for it. ProfSidharth Sinha(IIM-A Prof) postulated a probable explanation that for creating tax deductible reserves under Section 33AC of the IT Act 1961(linked to par value of share capital), GE Shipping issued rights issue at par to maximize the par value(depressing share premium to zero!). This fine example of transaction structuring was a perfectly legal way to minimize taxes(even if if went against financial markets canons)
  2. India's tax treaties with Marutitius, Cyprus and other tax havens lead to the incongruousness of Indian assets being transferred without capital gains being paid to India(via source rule). The tax authorities then tried to characterize the  sale of shares as being 'substantially the sale of underlying assets'
In perfectly legal cases like (1), courts may frown upon the morals but no court will uphold the tax demands. But in case (2) where the taxman can build a plausibly arguable case, he may win the battle in court as the present Vodafone tax tussle shows.

Also, as the Statement of Revenue foregone shows, smaller firms pay more tax reflecting that they are not 'optimizing tax as conventionally thought. It is the big fish who pay less tax. So even from an equity standpoint, retrospective amendments level the playing field for big and small players. 

 Moral:- As a famed jurist said, when people play with fire(transaction structuring without an economic rationale save tax saving), they should not complain when they get burned. So if people devise strategies which bend the letter of the law, they should not complain when the spirit is applied via retrospective amendments.