In a flurry of announcements made on September 20, 2019 [also described in media circles as a third budget in less than three months], the finance minister, Nirmala Sitharaman handed out a bonanza to the Indian corporate sector.
The most pleasing announcement pertains to 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%. After subsuming surcharge and cess, the effective incidence of tax will be lowered from existing 29.15% to 17.01% – a drop of 12%. 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].
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 Jaitely, had proposed reduction in the corporate tax to 25% [at present, benefit of this rate is available only to start ups and firms having annual turnover less than Rs 400 crore even as companies with turnover higher than this threshold pay @30%]. There was absolutely no hint about the rate being reduced to any level less than 25% even for start-up. Sitharaman has broken this barrier.
The second announcement relates to an equally significant reduction in the tax rate on existing companies from 30% to 22%. 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% down from existing 34.9% – a drop of almost 10%. These firms will also be exempt from MAT.
The existing small and medium enterprises [SMEs] having turnover less than Rs 400 crore currently pay tax @25%. They too will have the option to switch to 22%. Inclusive of surcharge and cess, the effective tax incidence will fall from 29.15% to 25.17%. 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% as SMEs.
The companies who decide to continue with the existing dispensation viz. tax @30% with a view to fully utilize the incentives and exemptions that go with it will also get covered under the new 22% tax regime starting from the sun-set 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% down from existing 18.5%.
There couldn’t be a more attractive package for someone keen to undertake fresh investment in India – be it domestic investor or foreign company jointly with an Indian partner. The effective tax rate applicable in such cases @17.01% being the lowest among all major countries viz. US [21%], OECD average [21.4%], China [25%], makes India the most attractive destination. This may even prompt companies wanting to relocate from China [courtesy, worsening trade relations between US and China] to look at India on top priority.
For existing investment, the offer is compelling. 250,000 companies out of 840,000 that filed tax returns for 2017-18 had paid tax at an effective rate of 25% or higher. Out of top 21 companies listed in Sensex, the effective tax rate for 10 is in excess of 25% [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% tax regime. However, much will depend on the treatment of MAT credit accumulated in the books of concerned companies.
Even as the companies are keen that even after switch over, they will be allowed to set-off MAT credit against future tax liability, the ordinance is silent on this. If, the government replies/decides in the negative then, the option of immediate switch-over 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 set-off. This is because the new 22% 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 set-off of the accumulated MAT credit will be incongruous.
The decisions have been taken in the backdrop of significant deceleration in GDP growth [during quarter ending June 30, 2019, this was at six year low of 5%] and 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 as per official estimate] is apportioned among them and equally importantly, how it is spent. Even as the situation may vary from company-to-company [depending on the balance sheet size, effective tax incidence etc], broadly speaking two distinct strands come out quite clearly.
Considering the steeper drop in effective incidence of tax on bigger companies [turnover >Rs 400 crore] from existing 34.9% to 25.17% they will get a bigger slice of the bonanza as against SMEs on whom effective tax is lowered from 29.15% to 25.17%. Given the priority all along assigned by Modi – government to the latter, there was a strong case for reducing the tax for them to 15% at par with that applicable to new investment [if, earlier SMEs were at par with new units, why should the parity not be maintained now].
SMEs have a share of about 29% in GDP but account for 40% of 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 [both are major constraints on growth]. But, reducing tax rate alone won’t help more so when, a large number of them are making losses and facing closure. They need support by way of more credit, timely payment for their supplies [including by PSUs] and release of GST refund.
The other crucial aspect is how big companies spend the surplus. Ideally, this should be invested in creation of new capacity or increasing utilization 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 latter increase credit availability for wider impact. However, they should refrain from reckless distribution of dividend which only means pile of cash with shareholders and won’t be of much help even in creating widespread demand.
To conclude, the near overhauling of corporate tax structure with focus on making it ‘competitive’ and ‘simple’ is a great leap forward. It has unambiguously 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, maintain the pace of investment in infrastructure, rejuvenate agriculture and increase farmers’ income to ensure that the growth is inclusive and sustainable.