TV Mohandas Pai & S Krishnan
The US recently reduced the federal corporate tax (CT) rates from 35% to 21%, a reduction of 40% in one stroke, the largest single CT rate cut in the world. In the UK, the CT main rate (for all profits except ring fence profits) is 19%, further reduced to 17% for the year starting April 2020. A study on the CT rates around the world in 2017 reveals the worldwide average CT rate is 22.96%, measured across 202 tax jurisdictions. When weighted by GDP, the average is 29.41%. Seventy-five countries have CT rate lower than 20% and 167 countries have a CT rate below 30%. Thirty countries have CT rates between 30% and 35%. With a CT rate of 34.61%, India ranks 18 in the 20 highest CT rates in the world. A dozen countries in this group have a CT rate of 35%. This study was conducted by Tax Foundation, a tax policy non-profit organisation based in the US. Europe has the lowest regional average CT rate at 18.35% (25.58% when weighted by GDP). Conversely, Africa and South America tie for the highest regional average CT rate at 28.73% (28.2% weighted by GDP for Africa, 32.98% weighted by GDP for South America). Asia has a regional average CT rate of 20.05% (26.26% weighted by GDP). OECD member states have an average statutory CT rate of 24.18%, while the CT rate for BRICS countries is 28.32%. The worldwide CT rate has declined significantly since 1980 from an average of 38.68% to 22.96%, a decline of 41%. It has consistently decreased since 1980, with the largest decline occurring in the early 2000s.
With the US announcing a huge CT rate cut of 40%, the dynamics of conducting business with the US will undergo a significant change. The transfer pricing policies adopted by multinational companies to compensate cross-border transactions will also change, as also the commitment of budget outlays of US companies to Indian companies. With the statutory CT rate at 34.61%, India is among the high tax countries in the world. India’s CT rate is higher by 10%-plus compared to the worldwide average statutory CT rate. This high rate in the country is negatively impacting the competitiveness of Indian multinational companies and that of India as a destination for investment. Our tax laws incentivise automation, capital-intensive and big industry at the cost of labour-intensive and small-scale industries which create more jobs. The manufacturing industry’s increased use of capital and automation along with huge tax incentives is leading to reduced employment growth in a labour-surplus country. For too long, India has incentivised big industry and more automation, discriminating against labour and jobs. While automation increases productivity, jobless growth will destroy our society, and creating jobs remains the foremost priority.
Tax deductions and tax incentives make up the difference between the statutory CT rate and the effective tax rate (ETR). The accompanying table provides the revenue impact of top six tax incentives for CT payers during FY16 and FY17. The impact of the lopsided incentive schemes is reflected in the ETR of companies in the manufacturing and the job-intensive service sectors. The service sector, which is more job-oriented, has a higher ETR of 30% in FY16, as compared to 26% of manufacturing, which adopts capital-intensive automation. This is one of the major reasons for the lack of good jobs in the last decade. During FY16, about 46% of the companies in India contributed 1.4% to CT, reflecting an ETR of zero and less than zero (indicating losses). Another 11% of companies had ETR between 0-20%, contributing 3.84%. About 57% of companies contributed a disproportionately lower amount of 5.24% in relation to their profits. About 24% of companies had an ETR between 30-33%, contributing the substantial part of CT (45.63%). Only about 7.77% of companies accounting for 12% of CT had an ETR approximately equal to the statutory rate. This shows that CT across companies is unevenly distributed, primarily due to various tax preferences in the statute.
India’s finance minister, in his 2015 Budget, promised to reduce CT rate from 30% to 25%, with corresponding withdrawal of exemptions over the next four years. He then withdrew many exemptions. In his 2017 Budget proposal, he only announced a reduction in CT rate to 25% for smaller companies with annual turnover up to Rs 50 crore, effectively reducing the high rates. Now, this last Budget needs to reduce the CT rate to 25% and keep the promise. Also, accelerated depreciation accounts for the largest tax incentive. The projected revenue impact in FY17 due to accelerated depreciation is Rs 54,345 crore. It accounts for about 43% of gross revenue foregone of Rs 1,25,119 crore. Accelerated depreciation is provided as an incentive for capital investment, incentivising capital-intensive firms and adversely affecting labour-intensive firms.
As banks have already reduced interest rates, this deduction could be reduced to 10%, with a corresponding reduction in CT rate to 25% from FY19. Such a withdrawal could provide about Rs 20,000 crore to CT, reducing the revenue loss and keeping the effective tax almost constant. Similarly, the phaseout of other income tax deductions already communicated could provide about Rs 10,000 crore to the increase in CT. The revenue loss (including surcharge and education cess) due to reduction of CT rate to 25% is estimated to be Rs 40,000 crore at FY18 rates, net of the phaseout of deductions. Analysts expect a rise of 15% in profits for 2018-19, so growth in CT, net of rate reduction, without buoyancy could be 8%-plus.
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 Rs 10 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 phaseout of accelerated depreciation, other deductions and exemptions, and contribution from these new taxes and growth in CT at about 15% during FY19 would recoup the revenue loss substantially, enabling reduction of CT rate to 25% in one stroke. By reducing the threshold rate accompanied by a phaseout of tax deductions, the manufacturing sector will not be adversely impacted. They will be able to write back the deferred taxation created in the books towards accelerated depreciation claimed in tax returns to mitigate impact next year. With a lower post tax cost of capital, their ability to invest will increase, generating higher employment. This will help accelerate the Prime Minister’s “Make in India” programme, invigorating the manufacturing sector to make India a global manufacturing hub.
A reduction in the CT rate will reduce the cost of credit from the banking system over time and also reduce the cost of capital, and make the job-intensive sectors more competitive. A reduction in CT rate by 5% will enable banks to write back deferred taxes up to Rs 10,000 crore and corporates will be able to write back about 15% of Rs 2 lakh crore in deferred taxes. It will reduce costs from regulated industries as they get a cost-plus return. By lowering the CT rate, the labour-intensive industries will have more cash to grow faster and create more jobs, which is India’s number one priority. It will also enable the NDA to keep its promise of reducing corporates taxes to all by 2019.