FM Sitharaman’s tax rationalisation measures show govt is reposing faith in business’ ability to generate wealth

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Published: October 2, 2019 2:12:59 AM

The effective corporate rates (including surcharge and cess) was almost 35% for large companies, and a little less than 30% for smaller companies.

Keeping out surcharge and cess on the new rates would have gone a long way in providing certainty to corporates, ruling out the possibility of increasing the rate indirectly by changing the surcharge rate.

While addressing the nation on Independence Day prime minister Modi said “Wealth creation is a great national service” Importantly, he went on to say, “The need of the hour is to recognise and encourage the wealth-creators of our nation.” The first, and most important step in that direction has been taken by the government with the tax rationalisation measures recently announced by the finance minister.
The FM’s announcement was quickly followed by an Ordinance to amend the relevant legal provisions. Over the last few weeks, the finance ministr has been engaging with most stakeholders, and has been coming out with a spate of announcements. None thus far were this significant. This could prove to be the most important one for economic revival, and sentiment. The reaction of key indices on the stock market clearly indicate that!

India has traditionally been a high corporate tax jurisdiction. The effective corporate rates (including surcharge and cess) was almost 35% for large companies, and a little less than 30% for smaller companies. The headline rate applicable for all domestic companies has been reduced to 22%, leading to an effective rate of a little over 25%. However, this is an optional rate—companies opting for this would not be entitled to any tax incentives, and would be outside the provisions of minimum alternate tax (MAT). Companies are required to elect the tax-rate regime they want to be governed by.

Additionally, a new provision has been introduced to provide for a beneficial rate of 15% (effective rate of 17.16%) for manufacturing companies set up after October 1, 2019, and commencing manufacturing before March 31, 2023. This should be a shot in the arm for the Make in India dream. The Ordinance also reduces the rate of MAT applicable from 18.5% to 15%.

While the impact of this on government finances, and a simplistic view of its impact on fiscal deficit would be the same as that of granting fiscal incentives, or tax holidays, the two are very different. A lower corporate tax rate leads to several positive economic impacts.
The foremost advantage is that the move puts more money in the kitty of corporates, who are one of the most efficient deployers of capital in the economy. Corporates with additional profits due to lower tax rates could increase wages, increase distribution to shareholders, invest in additional capacity or expansion, or pass it on to their consumers (by reducing the price of products or services). Each of these has an immediate positive impact on the economy.

A lower corporate tax rate also encourages investment by newer entrepreneurs or multinationals who aren’t in India now. Investments decisions, which were put off earlier as not being feasible at the higher cost of capital, could be revisited. Any additional investment would lead to demand for labour, higher wages, and higher employment over time. It is no secret that a high tax rate was one of the reasons for India being regarded as uncompetitive in drawing investments. Not to deny that this was in addition to many other reasons, such as inefficient labour laws, etc.

As per a study undertaken by Tax Foundation, an independent tax policy research organisation, a year or so back, the average statutory corporate rate across 202 jurisdictions was 22.96%. India is now very close to the average, and, in fact, closer than ever before in history.

A less talked about impact of the reduction in headline corporate tax rates is that it discourages ’profit shifting’ by multinationals since India’s tax rate would now be comparable to the average global corporate tax rate. In other words, the incentive, or the savings of shifting profits to tax havens would no longer be large enough to justify profit-shifting strategies.

The only trick the FM seems to have missed is providing certainty. Keeping out surcharge and cess on the new rates would have gone a long way in providing certainty to corporates, ruling out the possibility of increasing the rate indirectly by changing the surcharge rate. Overall, the rate rationalisation shows that the government is reposing faith in India Inc and their ability to generate wealth. The government is clearly betting on Indian business doing well, the economy expanding, and tax collections increasing with a lower tax rate and higher corporate profits.

Partner, Dhruva Advisors, LLP

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