A uniform tax rate of 15% (17.1% with add-ons) will, among other things, minimise tax litigation that arises largely due to multiple interpretations of a plethora of exemptions and deductions in tax legislation.
A major factor affecting India’s ability to attract foreign investment for long has been the high rate of corporate tax. In 2018-19, the rate of tax on domestic companies was 30%. Including surcharge and cess, the total tax incidence is 34.9%. This made India an outlier as the corporate tax rate in other countries is much lower; for example, the US (21%), the OECD average (21.4%), China (25%), Vietnam (20%), Thailand (20%), Singapore (17%), etc.
Under Indian tax laws, a plethora of exemptions and incentives are available that can help in reducing the tax liability. However, all that is not sufficient to lower the effective tax to a level anywhere near the rate in other countries. Of the 8,40,000 companies that filed tax returns for 2017-18, 2,50,000 had paid tax at an effective rate significantly higher than 25%. Of the top-21 companies listed on the Sensex, for 10 the incidence was in excess of 25%.
Besides that, exemptions/incentives make the Indian law cumbersome to a point whereby it makes any prospective investor scary. Without taking the services of a taxation firm (for which hefty remuneration is paid), that investor can’t even think of running an enterprise in India. All this also creates room for bureaucratic discretion giving rise to nepotism and corruption, and hampers ease of doing business.
The Narendra Modi government had committed to address both the anomalies. In the Union Budget for 2015-16, then-finance minister Arun Jaitley had announced a roadmap for a phased reduction in the corporate tax over a period of five years to 25%, accompanied by elimination of exemptions and incentives. This roadmap was complied with partially. The 25% rate was brought in only for start-ups/new enterprises, and firms having an annual turnover of less than Rs 400 crore. Including surcharge and cess, the total tax was 29.15%.
On September 20, 2019, the incumbent financial minister Nirmala Sitharaman handed out steep reduction in tax for new entities in the manufacturing sector (incorporated from October 1, 2019, and commencing production by March 31, 2023; this timeline has since been extended in view of Covid-19) from the existing 25% to 15%. Of course, this 15% comes with no exemptions and deductions. Including surcharge and cess, the total tax incidence works out to 17.1%.
When compared to all other countries, this is the lowest (sans Singapore, where the corporate tax rate is comparable at 17%). From this, one gets a sense that from an outlier India has become the most attractive investment destination. But, hold on, such a conclusion may be a bit premature.
The mentioned tax rates in other countries apply to all firms irrespective of when they were set up (in other words, all existing firms besides new), whereas in India the 15% rate is applicable only to new enterprises, and that too for those in the manufacturing sector. The comparison is not all fours. For meaningful comparison, we need to look at tax applicable to existing companies.
For existing companies, Sitharaman reduced the tax rate from 30% to 22%, but with this rate they won’t get exemptions and deductions. A company is free to either opt for 22% or stay on with the existing dispensation, i.e. 30% plus exemptions/deductions. The firms who decide to stay on get to pay the minimum alternate tax (MAT)—it is levied on book profits of a firm which has no taxable profit—at the rate of 15%, down from the existing 18.5%.
Under the new regime, the total tax incidence, including surcharge and cess, works out to 25.17% (this also applies to smaller firms having an annual turnover of less than Rs 400 crore; the special treatment they earlier got on par with start-ups stands withdrawn), which is higher than the tax rate in most other countries, including the US, the OECD countries, Vietnam, Thailand and Singapore (except China, where the tax rate is 25%).
As regards freedom from the current cumbersome regime with a deeply-embedded element of discretion, this won’t go away merely by stipulating that ‘companies have the option to choose’. There are only two ways it can happen. Either the government erases exemptions and deductions from the rule book. But this may not be practical.
Alternatively, it gives the option of 15% tax sans exemptions/deductions to all the existing companies. This will make the new regime sufficiently attractive for everyone—including those firms that currently make the best use of the available incentives to reduce their tax liability to a bare minimum. The existing incentives regime will automatically be rendered redundant.
The changes announced by the finance minister on September 20, 2019, have created one more anomaly. The effective tax on existing firms is 25.17%, whereas on new enterprises it is 17.1%. The differential of over 8% is big enough to prompt a company to float a new entity for any expansion work, which it could have done in a cost-effective manner within the existing set-up. A uniform rate of 15% (17.1% with add-ons) for all will remove this arbitrage.
In addition, this will greatly minimise tax litigation that arises largely due to multiple interpretations of a plethora of exemptions and deductions in tax legislation (currently, tax demand worth about Rs 5 lakh crore is locked up in disputes over corporate tax which the central government is trying to settle under the Vivad se Vishwas scheme). The precious time of the government and the judiciary could be better utilised for attending to more important matters.
Above all, this will make India unambiguously the most attractive destination for foreign investors.
As regards the loss of revenue (according to an estimate, Rs 2.5 lakh crore annually based on the earnings during 2018-19), this will be more than offset by tax buoyancy resulting from the big boost to investment and GDP (gross domestic product), increase in exports, better compliance, reduced litigation, enhanced recoveries and so on.
The author is a policy analyst