Much will depend on how the surplus in the hands of companies resulting from tax cuts is apportioned among them and equally importantly, how it is spent
In a flurry of announcements made on September 20, 2019 (also described in media circles as a third Union Budget in less than three months), Finance Minister Nirmala Sitharaman handed out a bonanza to the Indian corporate sector.
The most pleasing announcement pertains to the steep reduction in the rate of corporate tax for new entities incorporated from October 1, 2019 in the manufacturing sector, that start production before March 31, 2023 from the existing 25 per cent to 15 per cent. After subsuming surcharge and cess, the effective incidence of tax will be lowered from the existing 29.15 per cent to 17.01 per cent — a drop of 12 per cent. Such companies won’t have to pay Minimum Alternate Tax (MAT) that is levied on book profit of firms which have no taxable profit, courtesy exemptions and incentives.
This is a bolt from the blue as in the road-map laid down in the Budget speech for 2015-16, the then Finance Minister, Arun Jaitley, had proposed reduction in the corporate tax to 25 per cent (at present, the benefit of this rate is available only to start-ups and firms having an annual turnover lower than Rs 400 crore even as companies with a turnover higher than this threshold pay 30 per cent). There was absolutely no hint whatsoever about the rate being reduced to any level less than 25 per cent even for start-ups. Sitharaman has broken this barrier.
The second announcement relates to an equally significant reduction in the tax rate on existing companies from 30 per cent to 22 per cent. However, this is subject to the firm surrendering all incentives they are availing under the existing dispensation (once exercised, the firm is not allowed to change the option subsequently). With surcharge and cess, the effective tax will work out to 25.17 per cent down from the existing 34.9 per cent — a drop of almost 10 per cent. These firms will also be exempt from MAT.
Existing small and medium enterprises (SMEs) with a turnover of less than Rs 400 crore, currently pay tax at the rate of 25 per cent. They too will have the option to switch to 22 per cent. Inclusive of surcharge and cess, the effective tax incidence will fall from 29.15 per cent to 25.17 per cent. The crucial point to note here is that under the new regime, existing big companies will pay tax at the same rate of 25.17 per cent as SMEs. The companies who decide to continue with the existing dispensation of tax at the rate of 30 per cent with a view to fully utilise the incentives and exemptions that go with it, will also get covered under the new 22 per cent tax regime, starting from the sunset date of those incentives. For the period they remain under the subsisting regime, they will be liable to pay MAT but at a reduced rate of 15 per cent down from existing 18.5 per cent.
There couldn’t be a more attractive package for someone keen to undertake fresh investment in India — be it a domestic investor or a foreign company with an Indian partner. The effective tax rate applicable in such cases at the rate of 17.01 per cent being the lowest among all major countries (US 21 per cent, Organisation for Economic Co-operation and Development average 21.4 per cent, China 25 per cent), makes India the most attractive destination. This may even prompt companies wanting to relocate from China in the light of the worsening trade relations between Washington DC and Beijing, to look at India as a top priority.
For existing investment, the offer is compelling. Around 2,50,000 companies out of 8,40,000 that filed tax returns for 2017-18 had paid tax at an effective rate of 25 per cent or higher. Out of the top 21 companies listed on the Bombay Stock Exchange, the effective tax rate for 10 is in excess of 25 per cent (remaining 11 pay less in view of the domineering effect of exemptions and incentives). These companies will stand to gain by switching over to the 22 per cent tax regime. However, much will depend on the treatment of MAT credit accumulated in the books of the companies concerned.
Though companies are keen that even after a switchover, they must be allowed to set off MAT credit against future tax liability, the ordinance is silent on this. If the Government replies in the negative, then the option of immediate switchover loses its sheen. Then, the firms would prefer to wait for a couple of years till such time the accumulated MAT credit in the books is fully adjusted (this is permitted under the existing scheme of things). While, one has to wait and see how the legal brains in the establishment would react to this, prima facie the Government may not be inclined to permit this balancing. This is because the new 22 per cent tax (plain vanilla) regime has to be free from the past baggage that included a plethora of exemptions, incentive, MAT et al. Further considering that under the new regime, no MAT is levied, then to allow an adjustment of the accumulated MAT credit will be incongruous.
The decisions have been taken in the backdrop of a significant deceleration in the Gross Domestic Product (GDP) growth and a dismal job scenario. These are intended to reverse the trend and put the economy on a high growth trajectory by boosting private investment and aggregate demand. Will things pan out in the manner intended? Much will depend on how the surplus in the hands of companies resulting from tax cuts (about Rs 145,000 crore annually being the equivalent of revenue loss to the Government) is apportioned among them and equally importantly, how it is spent. Broadly, two strands come out quite clearly.
Considering the steeper drop in effective incidence of tax on bigger companies (turnover Rs 400 crore) from the existing 34.9 per cent to 25.17 per cent, they will get a bigger slice of the bonanza as against SMEs for whom effective tax is lowered from 29.15 per cent to 25.17 per cent. Given the priority all along assigned by the Narendra Modi Government to the latter, there was a strong case for reducing the tax for them to 15 per cent on par with that applicable to new investment (if, earlier SMEs were on par with new units, why should the parity not be maintained now?)
SMEs have a share of about 29 per cent in the GDP but account for 40 per cent of the total employment. Therefore, leaving more money in the hands of these enterprises will be more advantageous, especially when it comes to creating jobs and boosting demand in the country. But reducing the tax rate alone won’t help, more so when a large number of them are incurring losses and facing closure. They need support by way of credit, timely payment and release of Goods and Services Tax (GST) refunds.
The other crucial aspect is how big companies spend the surplus. Ideally, this should be invested in creation of a new capacity or increasing utilisation of the existing capacity, as this will give a fillip to growth and employment. They may also pay back loans to banks, which will enable the latter to increase credit availability for a wider impact. They should go for distribution of dividend only as a last resort.
To conclude, the near overhauling of the corporate tax structure, with a focus on making it “competitive” and “simple” is a great leap forward. It has lifted the sentiment and laid the foundation for increasing investment, growth and employment. But, this should be complemented by measures to plug loopholes in tax collection, increase farmers’ income and boost infrastructure development to ensure that the growth is inclusive and sustainable.
(The writer is a New Delhi-based policy analyst)
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