Corporate tax reduction is credit positive for companies as it enables them to generate higher post-tax income and this incremental money is channelised further.
By Sandeep Jhunjhunwala
The mini budget announced by finance minister Nirmala Sitharaman on September 20, 2019, leading to the biggest-ever reduction in corporate tax rate to among South East Asia’s lowest, was warmly welcomed by the investor community. The Centre has slashed the corporate tax rate to 22% from 30% for existing companies, and to 15% from 25% for new manufacturing companies.
Taking cognition of the stimulus package of the 10-percentage point tax reduction, India’s equity markets, too, cheered the decision and headed to its biggest gain in a decade, wiping out the entire year-to-date losses. While these tax cuts would provide instant profit after tax (PAT) and earnings per share (EPS) enhancements for corporates, it would also create a tailwind for Indian equity performance and strengthen India’s long-term growth story.
Corporate tax reduction is credit positive for companies as it enables them to generate higher post-tax income and this incremental money is channelised further. In addition to the snowball effect of reinvesting incremental profits back onto the balance sheet, corporates may decide to retire existing debts, reward shareholders and key employees with higher payouts, or make further CapEx (for capacity expansion) or OpEx investments (including more HR and research & development spends, marketing spends and promotions, digital initiatives etc) to streamline the production processes, using the incremental profits.
If the incremental profits are utilised to retire existing debts, it would lead to reduction in the overall cost of capital, besides pumping-in of additional funds into India’s lending pool, which may aid in further reduction of lending rates by banking and non-banking finance companies. CapEx or OpEx by corporations may spur production in the future years. If the benefits are converted into additional dividends to the shareholders, it would have a demand-side effect as well. Investors could be the ultimate beneficiaries of the windfall corporate tax cuts (specifically in a non-price-competitive industry) and expanded cashflows could serve to line the pockets of investors through buybacks, dividends, or other cash repatriation strategies. Assuming the fair value P/E multiple of companies remains unchanged, any increase in profits would result in a corresponding increase in the share price of the company, thus benefiting investors. Downward alignment of corporate tax rates should result in a multiplier effect that will show up in discretionary or staple consumption pattern of consumers.
However, in the Indian scenario, the “super-rich” tax for high net-worth investors and buy-back tax, may continue to hurt entrepreneurialism.
The Centre is reportedly planning several alignments in the direct tax structure for equities, in order to attract foreign investments and enhance investor sentiments. The existing provisions for Long Term Capital Gains tax, Securities Transaction Tax, Dividend Distribution Tax, etc., are being looked at, in light of the recommendations by the Direct Taxes Code expert committee.
A stable government, lower income tax rates benefiting businesses and investors, a more liberal exchange control regime and improvement in India’s ranking in the World Bank’s Ease of Doing Business index clearly indicate that India is business-fit for the future.
The writer is director, Nangia Andersen LLP