High depreciation rates accompanied by low tax rates give an unnecessary advantage to large companies, which already have low effective tax rates.
By TV Mohandas Pai and S Krishnan
India’s Finance Minister, Nirmala Sitharaman, gave a much-needed impetus to the Indian corporate sector in September 2019, by providing an option to existing companies to pay base income-tax at 22% from FY20. In order to attract fresh investments in the manufacturing sector and to incentivise the Make in India scheme, she gave new companies incorporated after October 2019, and commencing production before April 2023, an option to pay base income-tax at 15%. The effective tax rate (ETR) would be 25.17% and 17.16%, respectively, inclusive of surcharge and cess. These companies would not be entitled to any income-tax exemption or incentive, and Minimum Alternative Tax (MAT) would not apply to them. Companies that do not opt for the concessional tax regime would continue to pay tax at the pre-amended rate, and be entitled to the tax exemption/incentive. MAT for these companies was reduced to 15% from 18.5%.
The statement of revenue impact of tax incentives under the central tax system for FY19 and FY20 (Annexure 7 of the Receipt Budget FY21) reveals that corporate tax (CT) liability for FY19 is Rs 4.95 lakh crore, inclusive of surcharge and education cess, and Rs 45,844 crore for Dividend Distribution Tax, compared to Rs 4.48 lakh crore and Rs 40,369 crore, respectively for FY18. Companies in the 30% statutory corporate tax rate continue to contribute the highest share to CT. About 72.66% of the total CT liability in FY19 is contributed by a minuscule 0.23% of all companies! About 56% of CT liability was contributed by 424 companies with profits before taxes (PBT) of `500 crore, and above and 16.5% of CT liability was contributed by 1,404 companies with PBT of Rs 100-500 crore. Companies having effective tax rate (ETR) of less than 25% only contributed about 26.5% of the CT liability in FY19.
The accompanying graphic shows the ETR and the average statutory CT rate for the past five years for all companies, and for companies in the manufacturing and service sectors.
The ETR of 27.84% for all profit reporting companies in FY19 is lower than the ETR of 29.49% in FY18. Companies with PBT greater than Rs 500 crore had the lowest ETR at 26% in FY19. This indicates that larger companies avail higher deductions and incentives compared to relatively smaller companies. This is further corroborated by the ratio of total income to PBT, which is 93% for companies having PBT of `1 crore or less, and 73% for companies having PBT greater than Rs 500 crore.
The ETR for companies in the service sector has reduced by about 2.4% to 28.13% in FY19, compared to 30.55% in FY18, whereas the ETR for manufacturing sector reduced by only half a percent to 27.36% in FY19.
Tax deductions and tax incentives make up the difference between the statutory CT rate and the ETR. The accompanying graphic provides the revenue impact of top six tax incentives for CT payers during FY19 and FY20.
Former FM Arun Jaitley, in his 2015 budget speech, announced a roadmap to reduce CT rate from 30% to 25%, along with a phasing out of exemptions, incentives, and deductions. He implemented this in 2016, by providing an option to new manufacturing companies, incorporated after March 2016, to be taxed at a base tax rate of 25% provided they do not claim profit-linked or investment-linked deductions, and do not avail of investment allowance and accelerated depreciation. On the CT deductions, he restricted the highest depreciation rate on all assets to 40% from April 2017. In the case of new manufacturing companies incorporated after March 2016 and opting for the lower 25% CT rate, the highest depreciation rate on all assets was reduced to 40% from April 2016.
After the new lower corporate tax rates announced in September 2019, the maximum ETR for all companies would be about 25%, inclusive of surcharge and cess. The government could consider lowering the maximum depreciation rate for all assets from 40% to 25%, and in the case of assets presently entitled to a deprecation rate of less than 40%, the depreciation rates could be reduced to 10%. This is especially required when inflation has been down for five years running, and the tax rates have also been reduced. High depreciation rates accompanied by low tax rates give an unnecessary advantage to large companies, whose ETR is already low. Lowering this will enable the government to ensure equity between those who claim high depreciation and those who do not, as well as have a minimum revenue reduction.
Pai is Chairman, Aarin Capital Partners and Krishnan is a tax consultant. Views are personal