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Breaking it down: Corporate income tax rate cuts and what it means


In a mini-Budget of sorts, Finance Minister Nirmala Sitharaman on September 20 announced major changes in corporate income tax rates to revive growth in the broader economy.

Here’s a lowdown.

What has the government done?

The government has slashed the corporate income tax rate from 30 percent to 22 percent for all companies. Inclusive of cess and surcharges the effective corporate tax rate in India now comes down to corporate tax to 25.17 percent.

Newer companies, which are set up after October 1, 2019, will be subjected to an even lower effective tax rate of 17 percent.

For companies who continue to avail exemptions/incentives, the rate of minimum alternate tax (MAT) has been reduced from 18.5 percent to 15 percent.

A higher surcharge, announced in the Budget in July, will now not be applicable to capital gains on the sale of equity made by foreign portfolio investors (FPIs) as well as individuals and other classes of investors.

Also, there will be no tax on buyback of shares by listed companies that have announced buyback plans before July 5, 2019.

How do these rates compare globally?

The new rates bring India closer, in some cases lower, to the rates prevalent in many of the emerging and industrialized countries. The new corporate income tax rates in India will be lower than USA (27 percent), Japan (30.62 percent), Brazil (34 percent), Germany (30 percent) and is similar to China (25 percent) and Korea (25 percent). New companies in India with an effective tax rate of 17 percent is equivalent to what corporates pay in Singapore (17 percent).

Why did it do what it did?

The latest measures are by far the biggest, and the boldest step to revive the Indian economy, which until recently, was feted as a global growth engine. The goal is to turn India into an investors’ darling, demonstrate the government’s intent to walk the talk on economic management, restore investors’ confidence and boost sentiments and demand.

The Indian economy is currently going through its worst deceleration in six years. The earliest markers of an economy’s health are found in car showrooms, retail malls and the rapidity of activity in farms. Recent months’ data related to these would suggest that the Indian economy is going through a bumpy ride.

Official national income figures released on August 30, 2019, confirmed these fears. The Indian economy grew 5 percent in April-June 2019, from 8 percent in the same quarter last year and 5.8 percent in the previous quarter (January-March 2019), implying that people are putting off purchases on aspirational items such as cars and televisions.

According to Society of Indian Automobile Manufacturers (SIAM) data, passenger vehicle sales declined 18.42 percent during April-June. Vehicle sales across all categories declined by 12.35 percent during this period compared to last year.

There was pressure building upon the government to engineer a quick turnaround through appropriate policy interventions. On August 23, 2019, Sitharaman announced a slew of measures to revive India’s broader economy that appeared to be falling off a cliff.

The government rolled back some of the controversial measures introduced in the federal budget for 2019-20, including the enhanced surcharge levied on capital gains made by foreign portfolio investors (FPIs) investing in India’s equity markets. There were specific measures to stoke demand, including a rejig of its spending program by front-loading it, addressing supply-side bottlenecks and easing bank credit rules, even as she promised to end “tax terrorism” that has left businesses jittery.

Two more sets of measures followed soon after including an amalgamation of public sector banks and a fund to boost the beleaguered realty sector.

What will this achieve?

The move will likely alter the profitability dynamic of the Indian corporate ecosystem. For one, given the substantially lower rates would imply that many corporates will break even much ahead than what would have been the case with the earlier rates.

Lower taxes should, ideally, the result is higher profit margins. This should bolster their books, and some of these companies should be able to pass on the higher margins in the form of lower product prices to consumers.

Lower corporate income tax rates and the resultant change in profitability will likely prompt companies to invest more, raising their capital expenditure (CAPEX). This will be particularly true for those who have the funds but have remained non-committal on deploying investible money in adding new capacity lines.

Additional capacities will, eventually, through a second-round effect, prompt these companies to hire more employees.

The problem in the Indian economy is more about low demand. People are buying fewer goods and the companies have a number of unsold inventories. How will these measures help revive consumer demand?

Lowering corporate income tax rates addresses supply-side issues. But, these could raise consumption demand through what is called the “wealth effect”. The wealth effect is a behavioral economic phenomenon where consumers start spending more because of greater confidence driven by higher values of their financial and physical assets. For instance, households feel richer if the value of their investment or real estate portfolios rise quickly, even though their fixed investment values have remained the same. This pushes up their confidence and prompts them to spend more. Likewise for corporates, who tend to hire more and increase their Capex levels buoyed by rising asset value.

Why has the government brought an ordinance to bring in these changes?

Changes in income tax rates (both corporate and individual) require legislative amendments. These require Parliamentary ratification. When the Parliament is not in session, the government can bring these changes through an Ordinance and later bring a Bill when Parliament convenes.

Under normal circumstances, income tax rate changes take place in the Union Budget during the passage of the Finance Bill. The government’s decision to bring about an ordinance mirrors the urgency attached to the economic situation. The next Parliament session—the Winter Session—is about two months away (November-December). The government did not want to wait until Parliament convened for the Winter Session for bringing in these changes, given the economy’s wobbly state and the need to soothe frayed nerves of the corporate community.

Wasn’t this supposed to happen after the adoption of the Direct Taxes Code?

On August 19, a government-appointed committee on direct tax reforms has suggested a string of measures to overhaul India’s income tax regime that is currently governed by the six-decade-old Income Tax Act 1961. The new tax code is aimed at simplifying the rather complex tax laws with fewer slabs and exemptions.

Many of the announcements on corporate income tax rates announced on September 20, 2019, are believed to be based on recommendations that this committee has made.

Can the same happen with personal income tax?

Usually, alterations in income tax rate changes are brought through the Union Budget and Finance Bill. There are heightened expectations that the government will propose major changes in the individual income tax rates and slabs in the next budget for 2020-21 to be presented in February 2020.

How will the corporate tax cuts be funded?

The revenue foregone for the government because of the latest corporate income tax cuts will be to the tune of Rs 1.45 lakh crore a year. This has triggered concerns of fiscal slippage, given that tax collections have been far below the budgeted estimates.

The government has set a fiscal deficit target of 3.3 percent of GDP for 2019-20. Lower tax revenues could upset the fiscal math. The government may fund part of the revenue foregone because of corporate tax cuts through the additional transfer of dividends and surplus from the Reserve Bank of India (RBI).

The RBI has decided to transfer a record Rs 1,23,414 crore of its surplus to the central government for the fiscal year 2018-19 or FY19 (July to June), and an additional Rs 52,637 crore of excess provisions as recommended by the Bimal Jalan Committee on Economic Capital Framework (ECF).

The surplus transfer, commonly called “dividend”, is almost double the previous record of Rs 65,896 crore. Of the total, Rs 28,000 crore has already been transferred to the government as interim dividend.

The government had budgeted for Rs 90,000 crore from RBI dividends. It now has an additional Rs 58,000 crore, which can be used to plug revenue gaps.





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