Did the Income Tax Dept(ITD) BPR project help PwC become India's best tax team?

In Dec-10, PwC was named(for the 2nd year in a row) India's best tax firm. This award(by a reputed journal) reflects the strength of the Indian practice-which anecdotal evidence also brings out. While the quality of the people and processes is beyond dispute, the question is whether PwC India received an unfair advantage because its international parent PwC executed the BPR project for the ITD from 2006 onwards(as mentioned in this press release).

When BPR is carried out,the consultant understands the existing process in depth and then suggests changes. This insight into the workings of the Departments is very helpful at appellate level and can be obtained by

1. Recruiting former IRS officers/Superintendents into PwC
2. Designing the systems itself

While all firms can adopt strategy (1), only PwC was given the chance of (2). This information is certainly of competitive advantage. Though I suppose confidentiality provisions would have been maintained, the issue arises of the proprietary of allowing a tax firm affiliate to understand and redesign the IT Dept systems. 

Takeaway;- Did the ITD invite the wolf  inside its henhouse? This question may take some years to answer but till then, the personnel who worked on that BPR project will be in high demand

The bullish case for MTNL

Rediff.com 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.

Still;-
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

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. Prof. Sidharth 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. 

Lavasa's 'vision' problem-arrogance or reality?

As the SPV for India's first planned city(2nd if you count Sahara's Amby valley which is more residential oriented), Hindustan Construction Company(HCC)'s 65% subsidiary Lavasa has ambitious plans. But their risk factor No 18(page 21 of prospectus available here) is something new to me.

The breadth of our vision may serve to distract management who may be unable to achieve or maintain an essential level of expertise in each segment of our business due to too many competing segmental interests. If our management is unable to achieve or maintain a necessary level of expertise or if we do not realize synergies across our business segments, our results of operations would be adversely impacted. Further, given the diverse nature of our business segments, we may be unable to recruit and retain adequately qualified professionals who may instead opt for companies with narrower strategies, which may hamper the growth of our business operations(emphasis added)

I have respect for the immense vision of Lavasa. After all, building a mainly commercially oriented city, with the hope that every square feet of commercial space will induce 2 square feet, does need courage and vision given the relatively remote location. Still, this does seem like the management wants to fill boilerplate or more worryingly, they anticipate the problem of distraction. That begs the question-if HCC cannot do it, who can?

Is it fair to restrict cross selling for MFIs but not for banks?

Whenever a crisis needs to be analyzed, CA Y.H Malegam invariably plays a role. The microfinance crisis in A.P was no exception, and his committee submitted the report yesterday to the RBI. This report on 'Issues and concerns in the Micro Finance Sector' made the case for restricting other income of MFI as follows

We have observed that some MFIs operate not merely as providers of credit but also provide other services to the borrowers and others.  These services include acting as insurance agents, acting as agents for the suppliers of mobile phones and telecom services, acting as agents for the sale of household products, providing agricultural advisory services etc. While these service can profitably be provided by MFIs along with the supply of credit, there is a risk that given the vulnerable nature of the borrower and his/her inadequate negotiating power, an element of compulsion may creep in unless the provision of these services is regulated.  It is, therefore, necessary that the regulator limit the nature of services which can be provided, as also the income which can be generated from such services, the latter as a percentage of the total income of the MFIs.

This situation is not really different for banks, specially the new private sector ones where a branch manager may often get cross selling targets. The banks often coerce customers for extra services like

• Taking education loan insurance from that bank's affiliate only(done by SBI)
• Pushing for investing in MF's from proceeds of matured Fixed deposits etc.

• Further, banks do levy an insurance administration charge(which the Malegam panel has criticized for MFIs stating that We have also noticed that some MFIs levy an insurance administration charge. We see no reason why such a charge should be levied.  MFIs should recover only the actual cost of insurance.

The RBI does mandate forming separate subsidiaries, arms length dealings etc but does not restrict the total income from such services in any way. Given that the MFI clients do need these services, is it fair to restrict MFIs but not banks.
Takeaway: If the stream of bank scandals/frauds keep growing, can we expect a similar proposal from RBI for banks? Probably not given the clout of the 'Indian Banks Association' but then these are uncertain times.

Jupiter Bioscience Ltd_something rotten in the preferential allotment?

While reading the 2009-10 annual report of this company, there was a series of legalese about promoter related share transactions( legalizing earlier allotment, issuing preferential warrants etc). The complicated disclosures did not help in unraveling the chain of events but this is what I figured out

• Company allotted 27.5 lakh shares @ Rs 146/share(total Rs 40 crore worth shares) in Apr-May'07
• It then realized that the increased promoter holding would result in an mandatory open offer to other shareholders(as required by SEBI)
• It then asked the Karnataka HC to cancel part of the shares-but the order 'inadvertently' cancelled the entire allotment
• Because of this, the promoter holding dipped to 18% creating "block in the minds of the Investors at
  large on account of the nature of the Industry."
• They then allotted fresh shares to promoters and others from Oct'08-Oct'09 without taking prior approval from BSE
• When the fact of non approval was realized, the market price had corrected and the minimum price as per SEBI regulations was Rs 90. 
• While the promoter was willing to accept the new shares(of Oct'08) at the old price, the company magnanimously lowered the price to Rs 90 stating that, "Considering the case being fair and just on the part of the Company towards its promoter, who and his family strived hard for the last 25 years to bring the Company upto this level..."
• To be fair, Rs 40 crore of the promoter was idling for nearly 3 years on which neither dividends nor interest could be paid. But considering that the mistake was due to the company itself, also that the promoter should not be subscribing shares for quickly selling them, the compensation rationale is doubtful

. The transactions are explained in an opaque manner(another corporate governance red flag)

Time to short MTNL? 3661 crores additional liability may wipeout Mcap of 3316 crores.

The scandal prone telecom sector has seen most telco stocks fall. MTNL being mainly a fixed line operator(a declining business) with heavy pension liabilities, the stock price has fallen to Rs 51 and thats why I thought of it as a 'contra buy'. Both the notes to accounts & audit report for 2009-10(available at www.valuenotes.com) merely said that Note No.16(a) & (b) regarding the amounts recoverable from DOT/ BSNL are subject to reconciliation and confirmation and in view of various pending disputes regarding each others claims we are unable to comment on the impact of the same on the profitability of the company.

But then I stumbled upon the C&AG audit report on Central Public Sector undertakings covering the 2009-10 reporting year.  And that was a shocker. Summarizing Page 11 & positions as per the audited accounts;-
MNTL- BSNL owes us Rs 1580.11 crores net
BSNL-MNTL owes us Rs 2080.99 crores(net).
There's a difference of 3661.1 crore between these 2 positions. And this does not find a mention in the audit report(to be fair-the auditor does not have access to BSNL's accounts and so must state the bland excuse "we are unable to comment"..


Since 2005-06, C&AG has been trying to get the Govt(DoT) to resolve this dispute between its two PSU's. But the management has not taken any initiative. Given the IPO plans of BSNL(on hold for now), this festering issue is bound to come out and heads will roll. But when will that be? God alone knows.This unfortunate episode highlights the agency problem at PSU's-there is no 'skin in the game' and inaction is not punished. By any token, 5 years is too long a time.


Takeaway: -Why should we care about disputes between 2 Govt cos? MTNL is listed and a F&O stock.If the press highlights this, short sellers could have a bonaza till the Govt clarifies. And given the weak systems of MTNL(as mentioned in its audit reports), it is likelier that its figure is incorrect.