Corporate India – tax all @15%

A major factor affecting the competitiveness of Indian industries and India’s ability to attract foreign investment for long has been the high rate of corporate tax. In 2018-19, the rate of tax on domestic companies was 30%; including surcharge and cess, the effective incidence worked out to 34.9%. Given that the corporate tax rate in other countries viz. US (21%), OECD average (21.4%), China (25%), Vietnam (20%), Thailand (20%), Singapore (17%) etc, was much lower, this made India a sort of outlier when seen from the perspective of a potential investor looking for investment opportunities.

Though, the Income Tax (IT) law provides for a spate of exemptions and incentives which facilitates reduction in the tax liability, the effective incidence continues to be significantly higher at 27.8% on companies on an average (2018-19). Besides, these exemptions/incentives creates room for discretion which gives rise to corrupt practices and is completely out of sync with the ease of doing business – another most crucial factor impinging on investment prospects.

With a view to correct this anomaly, the then finance minister (FM), Arun Jaitely had announced in his budget speech for 2015-16, a road-map for phased reduction in the corporate tax over a period of 5 years (eventually settling at 25%) and concomitant elimination of exemptions and incentives. However, this road-map was adhered to only partially.  The 25% rate was brought in only for start-ups/new enterprises and firms having annual turnover < Rs 400 crore. The large firms having turnover > Rs 400 crore continued to attract 30% rate along with exemptions/incentives.

In a dramatic announcement on September 20, 2019, the incumbent FM Nirmala Sitharaman handed out a steep reduction in the tax for new entities in the manufacturing sector (incorporated from October 1, 2019 and starting production by March 31, 2023) from existing 25% to 15%. Including surcharge and cess, the effective rate went down from 29.15% to 17.01%. It is anomalous as to why firms having annual turnover < Rs 400 crore who under Jaitely were made eligible for 25% rate on par  with start-ups, were not considered for the same treatment. What then, is the rate applicable to them?

For all existing companies irrespective of the turnover, the FM reduced the tax rate from 30% to 22%. From this, one can surmise that firms having turnover < Rs 400 crore (earlier eligible for 25% rate) will now have to pay @22%. The preferential treatment of small companies thus stands withdrawn. With surcharge and cess, the effective rate for all existing firms is 25.17% (down from 34.9% for large companies and 29.15% for firms with turnover < Rs 400 crore).

However, the companies have been given a choice to either stay with the existing dispensation [read: 30% tax with exemptions and deductions] or opt for the lower 22% rate wherein they won’t get exemptions and deductions. The firms who continue with status quo have also got some relief by way of reduction in minimum alternate tax [MAT] from existing 18.5% to 15% (MAT is levied on book profits of a firm which has no taxable profit).

There couldn’t be a more attractive package for someone keen to undertake fresh investment in India. The effective tax rate applicable to new firms in the manufacturing sector @17.01% being the lowest (in fact, only Singapore at 17% comes closer to it], makes India the most attractive destination. This may even prompt multinational corporations (MNCs) wanting to relocate from China (which is facing heat from the world over in view of its dubious role in the Covid – 19 crisis) to look at India on top priority.

It is ironical that Covid – 19 crisis has engulfed the world at a time when India has brought about a revolutionary change in the corporate tax regime for new investment. This is bound to delay the plans of potential investors. In view of this, the government has decided to relax the time lines for start of production (at present, this is March 31, 2023) for a new undertaking to become eligible for the 15% rate. This is a welcome move in sync with the unfolding scenario.

For existing companies, the effective rate at 25.17% is lower than the effective tax incidence of 27.8% on companies on an average under the existing dispensation (this is arrived after adjusting for exemptions and incentives) and substantially lower for some companies who pay @34.9% due to their inability to avail of exemptions/incentives. However, even at 25.17%, this is still significantly higher than what enterprises in other countries (except China where the tax rate at 25% is more or less comparable).

At a time when all companies are facing intense competitive pressure, there is scope for making the tax architecture more ‘attractive’ and ‘simple’. Three areas need special focus.

First, the small enterprises definitely deserve better. There is a strong case for lowering the tax rate for these companies from 22% to 15% i.e. at par with new manufacturing enterprises. This will be in sync with the erstwhile dispensation put in place by Jaitely which has been abandoned by his successor.

Second, the objective of making taxation simple won’t be achieved unless the exemptions and incentives are completely erased from the rule book. True, the FM has offered companies a leeway to move towards a simple regime. But, given the fact that the promised effective tax at 25.17% under it is not sufficiently lower [when compared to an average of 27.8% under existing dispensation, this is a drop of 2.6% ; in fact, 11 companies listed in Sensex pay less than 25.17% in view of the domineering effect of exemptions and incentives], they have no compelling incentive to switch over.

If, existing companies are also charged @15% i.e. the same as for new enterprises (implying an effective rate of 17.01%), this will be decisively lower than the tax paid even by a firm which takes maximum advantage of exemptions/incentives under the existing dispensation (say, any of the aforementioned 11 companies in Sensex). It will give them a categorical signal to go for the new lowest tax and simple regime.

A ‘uniform’ rate of 15% applicable to all companies will also put an end to all sorts of attempts by entities to place themselves in a category where the tax outgo is the least (for instance, an existing firm attempts to start or carve an on-going activity under a ‘new’ enterprise only to take advantage of 15% rate). It will also put India in the most advantageous position with regard to attracting foreign capital.

Against these positives, seemingly, the only negative of going for a uniform tax @15% for all companies is the revenue loss. According to an estimate, the loss is estimated to be about Rs 250,000 crore (this is based on the earnings during 2018-19). But, it should be possible to more than offset it by the big boost to investment (including investment by the MNCs) and resultant acceleration in economic activity leading to manifold increase in tax collection. We also need to consider the impact of a simple tax regime (sans exemptions/incentives) on increase in compliance and enhanced collection.

This will also greatly minimize tax litigation which arise largely due to subjective interpretations of a plethora of exemptions and deductions in tax legislation (currently tax demand worth about Rs 500,000 crore are locked up in disputes over corporate tax which the Central government is trying to settle under ‘Vivad se Vishwas’ scheme). The precious time of the government and judiciary could be better utilized for attending to more important matters.

To conclude, the steep cut in the rate of corporate tax for new enterprises  and significant reduction in tax rate even for existing firms (sans exemptions/incentives) notified last year was a great leap forward in overhauling the tax structure and making it simpler. The government should take the next logical step of introducing a ‘uniform’ tax @15% applicable to all enterprises new or existing but without any exemptions or deductions. This will lay the foundation for increasing investment and growth on a sustainable basis.

The government should also accelerate the process of removing other bottlenecks such as high cost of capital, relatively poor infrastructure, cumbersome legal system, rigid labor laws/low productivity, high cost of power and real estate, continuing difficult business environment (despite efforts to improve). Without good progress on these fronts, it may not be possible to exploit the full potential of tax reforms.