The finance minister announced recently that direct tax collections for April-December 2016 grew by 12% over the same period last year. The net direct tax collections up to December are at R5.53 lakh crore, 65.3% of budget estimate of direct taxes, R8.47 lakh crore, for 2016-17.
In terms of gross revenue, the growth rate under corporate income tax (CIT) is lower, at 10.7%, while that under personal income tax (PIT), including STT, is 21.7%. Adjusting for refunds, the net growth in CIT collections is 4.4% and in PIT collections is 24.6%. Refunds of R1.26 lakh crore have been issued during April-December 2016, 30.5% higher than refunds during the same period last year, a good performance indeed.
As India moves towards a less-cash economy with an expected increase in tax buoyancy, the time is opportune for the FM to reduce the corporate tax rate in one stroke to 25%, the targeted corporate income tax rate announced by him in Budget 2015. This will kick start growth and employment in the corporate sector. Its positive impact will be felt fully in FY19, the timing of the next general elections!
While the statutory CIT rate for all companies is 33.84% (including surcharge and education cess, excluding Dividend Distribution Tax), in FY14 and FY15, the effective tax rate (ETR) was only 24.67% (23.22% in FY14) and around 26%, respectively. Deductions and incentives make up the 9% difference between the statutory rate and the ETR. Removing all deductions and incentives, CIT can be reduced by 9% though a reduction of only 5% is announced by FY19.
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During FY15, more than half of the companies in India (52.67%) contributed less than half a percent (0.49%) to CIT, reflecting an ETR of zero and less-than-zero percent (indicating losses). Another 5% of companies had ETR between 0-20%, contributing 13.24% of CIT. About 58% of companies contributed a disproportionately lower amount of CIT of 13.73% in relation to their profits of about 36.50%. About 23% of companies had an ETR between 30-33%, contributing the substantial part of CIT (46.46%). Only about 9% of companies accounting for 13.89% of CIT, had an ETR approximately equal to the statutory rate of 33.84%. This shows that CIT across companies is unevenly distributed, primarily due to various tax preferences.
ETR for companies with PBT of over R500 crore was low, at 22.88%, in FY15. That for companies with PBT up to R1 crore was significantly higher, at 29.37%. The service sector has a higher ETR of 26.73% as compared to 22% of manufacturing. Between public and private sectors, the ETR of former was 25%, with the latter lower at 23.36%.
The tax revenue foregone due to 32 tax incentives during FY15 was R1,00,722 crore; the projected impact in FY16 is R1,06,363 crore. After reducing the net tax impact due to minimum alternative tax (R35,655 crore), total revenue foregone was R65,067 crore in FY15 and is projected to be R68,711 crore in FY16.
Accelerated Depreciation (section 32 of the I-T Act) accounts for the highest amount of tax incentive in FY15 followed by deductions availed by units located in SEZ (R16,686 crore) and undertakings engaged in generation, transmission and distribution of power (R9,621 crore). Tax foregone due to deduction/weighted deduction towards expenditure on scientific research was R8,402 crore, with R4,225 crore due to deduction of profits of undertakings engaged in development of infrastructure facilities. These five accounted for 80% (R80,465 crore) of incentives (R1,00,722 crore) in FY15.
In November 2015, the Central Board of Direct Taxes announced a detailed plan to reduce corporate tax rates—a phase-out of profit-linked, investment-linked and area-based deductions for both corporate and non-corporate tax-payers. In particular, tax provisions having a sunset date would not be advanced or extended. In case of tax incentives with no terminal date, a sunset date of March 31, 2017, will be provided either for commencement of the activity or for claim of benefit depending upon the relevant provisions of the Act. From April 2017, there will be no weighted deduction.
The AD under section 32 of the Income-tax Act was available up to 100% in respect of certain block of assets. The FM in Budget 2016 announced that AD will be limited to 40% from April 1, 2017. The new rate is proposed to be made applicable to all assets (whether old or new) falling in the relevant block of assets.
As per Budget 2016, no deduction under S35AC (tax deduction for expenditure on social projects) will be available from FY18; amendments have been made to S35 (expenditure on scientific research) to reduce weighted deductions to 150% during FY18-20 and from FY21 onwards, restricted to 100%.
Deductions under Secs 80-IA, 80-IB, 10A and 10AA have a sunset clause which cannot be advanced or deferred. However, a certain number of companies would meet their sunset clause annually.
AD accounts for the largest tax incentive to the corporate sector at R47,821.40 crore during FY17 (assuming a growth rate of 9.04%) It is about 41% of CIT foregone, R115,979 crore, in FY17. AD is an incentive for capital investment and capital-intensive firms, adversely affecting labour intensive firms. As banks have already announced lower interest rates recently, the AD deduction could be withdrawn completely. Such a withdrawal would add about 3.15% of CIT at FY17 rates. The revenue loss (including surcharge and education cess) of reduction to 25% at FY17 rates is estimated to be R75,945 crore.
From the year 2016-17, dividend tax at the rate of 10% is payable by individuals, HUFs and firms receiving aggregate dividend income in excess of R10 lakh per annum from a domestic company. Similarly, equalisation levy, at 6%,is applicable on specified services provided on or after June 1, 2016. The additional tax generated from the phase-out of AD, other deductions and exemptions, and contribution from these new taxes would recoup the revenue loss substantially, enabling reduction of CIT to 25% in one stroke.
The ETR of small companies (PBT up to R1 crore) is higher by 6.5% compared to the ETR of large companies (PBT of over R500 crore). Similarly, the service sector has a higher ETR,of 4.7% compared to manufacturing sector. By lowering the statutory income tax rate for all companies accompanied by a withdrawal/ phase-out of tax deductions, the difference in the ETRs of these companies will reduce significantly.
The combination of a high statutory rate and numerous deductions and incentives results in an inefficient tax system. A low-tax regime reduces the pre-tax profit expectation, reduces costs, makes credit available at lower interest, enabling higher investment, greater employment in manufacturing and services, and thus, higher growth. This will also reduce the cost of compliance and improve it. A low-tax regime combined with a lower interest rate and low-inflation regime would provide a high-growth momentum to the economy, thereby enabling Indian companies to compete globally.
In a labour-surplus country like India, a high CIT reduction will level the field between capital and labour, provide a stimulus for growth and employment. More than half the economy is in the services sector, the most dominant sector in terms of contribution to national and state incomes, trade flows, attracting foreign investment and providing large scale employment. According to the Economic Survey 2015-16, the services sector contributed almost 66.1% of gross value added growth in FY16, becoming an important net forex-earner and the most attractive sector for FDI. Despite the slow-down in the post crisis period (2010-14), India had the fastest service sector growth, with a CAGR of 8.6%, followed by China at 8.4%. In 2014, India’s services sector growth, at 10.3%, was noticeably higher than China at 8%. As per the International Labour Organization’s Global Employment and Social Outlook: Trends 2015 report, job creation in the coming years will be mainly in the service sector. A 5% reduction in CIT would help the services sector to create more employment, reduce its effective tax rate and maintain its vibrancy.
By reducing CIT accompanied by a phase-out of tax deductions, the manufacturing sector will not be adversely impacted. It will be able to write back into profits part of the deferred taxation created earlier under the AD head. With a lower CIT, their ability to invest will increase, increasing productivity and generating higher employment. This will help accelerate the prime minister’s “Make in India” programme.
A significant reduction in the CIT will enable MSMEs to grow rapidly, thereby creating high employment. This sector contributes about 38% of India’s GDP; 40% of the overall exports and controls 45% share in manufacturing output. According to the ministry of MSME, this sector has 100 million jobs in over 46 million units situated throughout the country. MSMEs not only play a crucial role in providing large employment opportunities at comparatively lower capital cost, but also help in industrialisation of rural areas. They suffer a disadvantage today due to high CIT.
There is thus a strong case for the FM to reduce the corporate tax rate by 5% in one stroke, from FY18 providing a booster dose to the Indian economy.
By- TV Mohandas Pai and S Krishnan
Pai is chairman, Aarin Capital
Partners, and Krishnan is a consultant