Corporate Tax Rate Cuts Will Set Off A Positive Chain Reaction
Corporate tax rate cuts in India were long overdue. Now the critics can legitimately ask why the Modi-led BJP government waited for five long years to undertake this exercise. But there is a valid defence. The BJP, when formed government in 2014, inherited not just the legacy of policy paralysis and widespread corruption but also the burden of reining in fiscal deficit of the union government, which plays a key role in how global rating agencies rate India’s sovereign bonds and how foreign investors place money in any economy. The first crucial step was to abide by the prudent norms with respect to fiscal deficit and the then Finance Minister ushered in reforms to gradually bring the deficit down to a sustainable level. It worked. This was, however, sensibly accompanied by a phased cut in corporate tax rates and in 2018 the tax rate was brought down to 25 percent for companies with annual turnover of upto INR 250 crore. The successor to Mr. Jaitley, Mrs. Sitharaman, made the 25 percent tax rate applicable to companies with turnover of upto INR 400 crore. That said, the latest cuts announced this month cannot be termed as the first step towards rationalization of corporate tax rates in India.
What does the September announcement say?
By pragmatically interpreting the global slowdown that has gripped India within its sphere, the Finance Ministry embarked on an ambitious plan to inject liquidity in the market by letting companies save more on tax so that these savings can be deployed to expansions and other such investments. By amending the Income Tax Act 1961 with the help of an ordinance, the ministry in a single stroke boosted the spirits of Indian corporates. This included giving an option to domestic companies to pay corporate tax at the rate of 22 percent, which mean an effective tax rate to 25.17 percent when surcharge and cess are added. Indeed, the government was aware of slow activity in the manufacturing sector and hence, a tax rate of 15 percent has been announced for those companies that are set up after 1 October 2019, with a condition that they start production before 31 March 2023 and do not avail exemptions or incentives. This measure means an effective tax rate of 17.01 percent for new manufacturing companies, a step that is set to keep the office of the Registrar of Companies (RoC) busy in coming days. Minimum Alternate Tax (MAT) will not be applicable to all the mentioned entities.
In the same notification, the ministry gave big relief to foreign portfolio investors by rolling back the enhanced surcharge on capital gains arising out of sale of securities as introduced in the Finance (No. 2) Act, 2019. In the same breath, Indian investors including individuals, Hindu-undivided families (HUF) and AOPs have been relieved of the enhanced surcharge applicable on capital gains arising out of sale of equity shares of a company or unit of equity-oriented fund or of business trust that is liable for STT. In what can be seen as a game-changer, the ministry has also laid down new expansive norms for corporate social responsibility (CSR) spending by companies. From now on, the CSR funds can be used to aid the incubators funded by government or PSUs and contributions can be made to such institutions as the IITs, ICAR, ICMR and DRDO. The scope of CSR spending has been expanded in a sense that funds are utilised for the promotion of science, technology, medicine and engineering, thereby contributing to the attainment of Sustainable Development Goals (SDGs) set by the United Nations General Assembly.
Why corporate tax rates matter?
That India as an economy has one of the highest corporate tax rates in the world is a much-documented fact. To put things in perspective, global average corporate tax rate is 23.79 percent, while the average tax rate in Asia is 21.09 percent. By bringing effective tax rate for domestic companies down to 25.17 percent, the government has achieved multiple goals in a single act. The question is how? We all know that the world has become a near-single market today owing to globalisation and substantial reduction in tariffs on goods and services. Even an amateur can tell that high taxation of Indian companies made them uncompetitive in the global market, more so when countries like China are known to dump their goods in international market even by incurring losses or by keeping the margin as thin as possible. Secondly, any tax on profit curtails the company’s ability to spend on research and expansions, thereby taking away the chances to compete with those that invest their surplus on technological advancement. Private investment that has been stagnant for years is set to see an uptick, more so when the tax rate for new manufacturing companies has been brought down to 15 percent.
It is yet to be seen whether domestic companies utilize the savings after the rate cut in giving consumers relief in prices of goods and services or investing in expansion and / or product and market research. The benefits arising out of both these alternatives are more or less same as demand and consumption are set to pick up in medium to long term since expansions will result in employment generation and increased spending capacity of individuals. Another element that hasn’t been much discussed in the media after the tax cut announcement is the expansion of scope of CSR funds utilization. That startups are the new engines of growth and incubators need funds to help these startups in their initial phases when access to capital is limited is a much accepted fact. Companies can now give a portion of their CSR fund to these incubators provided that they are funded by central or state government. In order to bring down some of the outlays of the government to such vital institutions as IITs and DRDO, companies have been allowed to hand over CSR funds to these institutions, thereby increasing funding avenues and helping create a future pool of competent engineers, besides furthering research in defence.
Should revenue loss of INR 1,45,000 crore worry us?
First things first. This is only an estimate. Secondly, when one factors in the increased dividend that the government is set to receive from public sector undertakings owing to increase in their net profit after tax cuts, the revenue shortfall may appear overestimated. At the same time, collection of dividend distribution tax (DDT) will see an uptick after big corporate players shell out more dividends to their shareholders on the back of increased net profits. The record jump in the stock market after the tax cuts were announced are indicative of the fact that investors are anticipating a much faster economic recovery. Should this happen, the gap created by revenue loss, if any, due to the corporate tax cuts will be filled by improved collection in goods and sales tax (GST), and with increased competitiveness, and hence, profitability of export-oriented domestic companies. In fact, the cuts in corporate tax rates are timely and can be termed as a structural reform, rather than a tactical one, to bring the economy back on the track of higher GDP growth. Revival of India’s export sector, job creation and an atmosphere of improved private investment at a time when credit availability is under pressure are the goals that triggered the move. One can expect economy to recover in the coming days.
By Sunil Gupta
(The author is a Chartered Accountant)
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