Amidst an atmosphere of gloom and doom [triggered by growth plunging to a low of less than 5% during the current year and muted projections in regard to growth during the next year], it is necessary to closely scrutinize tax proposals in the Union Budget for 2020-21 [presented by the Finance Minister, Nirmala Sitharaman on February 1, 2020] to assess whether or not these will generate the much needed growth impulses.
The 4 major factors impinging on growth are (i) private consumption; (ii) investment; (iii) export; (iv) spending by the state. Modi – government has kept up the tempo of expenditure by way of building infrastructure on an unprecedented scale and massive spending on welfare schemes. As regards export, given the depressed growth and international trading environment, there is little that it can do in terms of using this lever for boosting growth.
Therefore, much of the focus has necessarily to be on the first two levers i.e. private consumption and investment. The big question is whether the tax proposals by Nirmala Sitharaman will help in giving the much needed boost to the demand. First, let us look at the changes proposed in personal income tax [PIT].
Under the subsisting dispensation, a person earning up to Rs 500,000/- per annum doesn’t pay any tax. A person earning > Rs 500,000/- but < Rs 1000,000/- pays tax @ 20% whereas, someone earning more than Rs 1000,000/- pays @ 30%. Accompanying these tax rates are a plethora of exemptions and deductions viz. Section 80C [annual investment, expenses, life insurance premium etc up to Rs 150,000], Section 80D [health insurance premiums], Section 24 [interest on home loans], Section 80CCD [including extra NPS contribution up to Rs 50,000/- a year], Section 80E [education loan interest] and Section 16 [standard deduction on salary income], Section 10 [house rent allowance and leave travel concession].
This budget even while retaining ‘no tax’ for annual income less than Rs 500,000 , on income > 500,000, it has mooted a differentiated structure with 5 slabs against 2 under the existing scheme of things. The proposed slabs and corresponding rates are: Rs 500,001 – 750,000: @10%; Rs 750,001- 10,00,000: @15%; Rs 10,00,001- 12,50,000: @ 20%; Rs 12,50,001- 15,00,000: @ 25%; above Rs 15,00,000: @ 30%. For a person availing of significantly lower tax rates under the new scheme will have to forego most exemptions and deductions. In other words, the assesses can either continue with existing scheme or go for the new regime. No cherry pick is permitted.
For a person availing of most tax breaks, switch-over to the new scheme won’t yield any savings; in fact, there could even be loss depending on the income profile and deductions/exemptions availed off. For instance, a person having annual income of Rs 15,00,000 and availing tax breaks aggregating Rs 3,75,000 [Section 80C:1,50,000; Section 80D: 25,000; Section 24: 2,00,000] or net income Rs 11,25,000 will have to pay Rs 156,000 as tax. In case however, he opts for the new scheme i.e. taxable income remaining at Rs 15,00,000 but lower rates, his tax liability will be Rs 1,95,000. This being Rs 39,000 higher, he would be better off continuing with the old scheme.
But, the reality on ground zero is that majority of the assesses are unable to avail of the tax breaks. This is because persons in the early stages of their family life have high expenditure commitment and hence need more cash in hand leaving little surplus to invest which is necessary for availing off deductions. Then, there are persons at fag end say age 55 years plus who are under no compulsion to save [he has already built a house or nearly completed education of children]. Such persons who are unwilling to invest and hence, unable to avail off exemptions and deductions – due to economic circumstances facing them – would be better off under the new scheme.
In the above example [annual income Rs 15,00,000], the tax liability of such person under the old regime would be Rs 2,73,000 which is Rs 78,000 higher than under the new scheme [Rs 1,95,000]. Without doubt, he/she will be inclined to go for the latter. That apart, the FM’s proposals empowers assesses to take their own decisions instead of being constrained by available tax breaks. Someone wanting to have more cash in hand can opt for the new scheme whereas another person keen to save more can continue with old regime.
According to an internal exercise by the finance ministry, the proposal will entail loss of Rs 40,000 crore to the exchequer which means that much extra cash in the hand of tax payers which they can spend thereby giving boost to the demand and in turn, growth.
Another proposal expected to leave more cash in the hands of those earning less than Rs 10,00,000 per annum relates to the manner of levying dividend distribution tax [DDT]. At present, a company is required to deduct tax [known as DDT] @20% [including surcharge and education cess, this comes to 20.35%] from the surplus/profit set aside for distribution of dividend to shareholders. The budget proposes to substitute this by taxing dividend in the hands of recipients [read: shareholders].
This substitution means that retail investors whose earnings are in the Rs 500,001 – 750,000 and Rs 750,001- 10,00,000 slabs will stand to gain as they will pay tax on dividend @ 10% and 15% respectively as against 20% charged currently. This will also be a booster to foreign portfolio investors [FPIs] who will be able to able to claim offset for the tax paid on dividend received here in their respective jurisdictions [this is not possible under the subsisting dispensation].
Implementation of this proposal will entail an annual loss of Rs 25,000 crore to the exchequer. This much extra money in the hands of investors will also help augment purchasing power.
Coming to corporate tax, on September 20, 2019, Sitharaman had announced steep reduction in the rate of corporate tax for ‘new entities’ incorporated from October 1, 2019 in manufacturing sector and start production by March 31, 2023 from existing 25% to 15%. Such companies won’t have to pay minimum alternate tax [MAT] [levied on book profit of firms which have no taxable profit courtesy, exemptions and incentives].
Further, the tax rate on ‘existing companies’ was reduced from 30% to 22% [for small and medium enterprises (SMEs) having annual turnover < Rs 400 crore, this was reduced from the already preferential 25% to 22%] sans exemptions and deductions. These firms are also exempt from MAT. For companies who decide to continue with the old regime viz. tax @30% with tax breaks [to fully exhaust those tax breaks], MAT was reduced from existing 18.5% to 15% down.
In the budget for 2020-21, she has extended the benefit of 15% rate to ‘new’ power companies. Besides, ‘cooperatives’ are also eligible for 22% rate sans exemptions and deductions.
The steep reduction in tax rate [for new enterprises, at 15% this is lower than other major countries viz. US: 21%, OECD average: 21.4%, China: 25%; even for existing firms @22%, this is comparable] is a major structural reform aimed at making firms more competitive and leaving more resources with them for increasing investment and boosting growth. The FM has also given a choice enabling them to choose either the old regime [higher tax rate with exemptions] or new regime [lower tax rate sans exemptions].
The budget proposals [September 2019 and now] entail mammoth giveaway of about Rs 150,000 crore per annum. This will help in spurring investment demand. However, given that at present, demand is subdued and surplus capacity exists in several sectors [major investment by way of setting up new projects can come only after existing capacities are fully utilized], its impact on growth in the short-term may not be much.
Unless private demand improves significantly, companies might be inclined to retain the tax cut bonanza instead of investing. It would have been better if the government had put more money in the pocket of individuals by giving extra relief in PIT [say, by applying 10% tax to income in Rs 500,001 – 10,00,000 range] as the need for resurrecting growth now is far more pressing.
To conclude, tax proposals in 2020-21 budget are in the right direction. However, a lot more needs to be done in terms of further ‘reducing’ and ‘simplifying’ the PIT. In regard to corporate tax, the government should aim at 15% rate applicable ‘uniformly’ to enterprises in ‘all sectors’, ‘new’ or ‘existing’ [sans exemptions].