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Blog October 25, 2019 Rohan Narula

A SUMMARY OF CORPORATE TAX RATE CUTS

In September 2019, the Government of India introduced new reforms by slashing corporate income tax rates significantly – from 30% down to 22%. The new rates, inclusive of additional levies, for companies that pay statutory corporate taxes of 22%, will now effectively be 25.17%[1].

Source: Kotak Securities

It was further announced that new companies that incorporate on or after the 1st of October, 2019, will be subjected to a lower tax rate of 17%. Along with this, the rate of minimum alternate tax (MAT) for those companies that continue to take advantage of incentives/exemptions has been reduced to 15% from 18.5%. 

Finance Minister Nirmala Sitharaman affirmed that this slash was implemented in order to revive growth in India’s broader economy[3]. It is anticipated that a lower rate in comparison with global rates, will make bigger companies in India more competitive and will also infuse these companies with more funds to invest and expand. This, in turn, is likely to persuade them to reconsider routing funds abroad to tax friendlier countries and increase investments in India. The lower rate is also likely to attract investors from other countries.

Getting Competitive With The World

The slashed rates in India are now on par with, or in some cases even lower than the prevailing rates in the industrialized and emerging countries. Prevailing corporate tax rates in the USA (27%), Brazil (34%), Japan (30.62%) and Germany (30%) now look a lot less attractive than India’s reformed tax structure. India is now competing with rates prevailing in South Korea and China — 25%. In comparison to the Singapore rates (17%), the effective tax rate for newer companies in India (17%) stands equivalent.

Source: Deloitte

Why The Slash?

Source: CEIC Data

On August 30, 2019, official income figures of the nation were released which revealed that the economy is in a relatively unhealthy state. While the economy’s health is diagnosed by the briskness of activity in agriculture, the auto sector, and retail consumption, these elements displayed weak numbers in the recently collected data. The Society of Indian Automobile Manufacturers (SIAM) reported that sales of passenger vehicles declined by 18.42%[2] during the second quarter of 2019 and the sales of vehicles across all categories showed a 12.35% decline — these were in comparison to the data for the same quarter the previous year. 

India’s economic growth was pegged at 5% for Q2 2019 lower than the achieved 8% growth in Q2 2018. This is also a further decline from the 5.8% growth in Q1 2019. The numbers imply that domestic consumption is experiencing a downtrend, and consumers are holding off buying expensive and aspirational goods such as televisions and cars.

In order to revive the Indian economy, the government reformed the corporate tax rate structure. Steps were taken to make India more attractive to global corporates and restore confidence in investors while boosting demand. The announcement by Nirmala Sitaraman was followed by other announcements as well that were meant to aid the goal of the rate cuts. These included the rollback of some unfavourable measures that were introduced in the 2019-2020 budget such as the enhanced surcharges imposed on capital gains made by Foreign Portfolio Investors (FPIs) who invest in India’s equity markets. Specific measures were introduced to stimulate and increase demand, such as front-loading the spend, easing bank credit rules and, critically addressing supply-side bottlenecks. 

Funding Of The Corporate Tax Rate Cuts

It will setback our Government Rs. 1.45 lakh crore per year as a result of the revenue opportunity cost relating to rate cuts. The fiscal deficit target[3] was set at 3.3% of GDP for FY 2019-20. Tax revenue numbers that do not meet the target will cause fiscal slippage. Funding for the rate cuts will be facilitated by the Reserve Bank of India (RBI) by transferring additional dividends and surplus. 

In FY 2019-20, in a surprise move, the RBI announced a surplus transfer to the central government amounting to Rs. 1.23 lakh crore. As counselled by the Bimal Jalan Committee on Economic Capital Framework, the RBI also resolved to transfer Rs. 52,637 crore of excess provisions. The surplus to be transferred is set at a number that exceeds the previous record which was during the FY16 (Rs. 65,896). A partial amount of Rs. 28,000 crore has been transferred in the form of interim dividend as of now. To plug any revenue gaps, our government now has an additional Rs. 58,000 crore along with the budgeted Rs 90,000 crore from RBI dividends[3].

The Effect Of Rate Cuts

This step taken by our government could expand the corporate space in our country by attracting and retaining more investors. It could also change the profitability equation in our country’s corporate ecosystem. Startups could break even sooner than what would have been the case with the previous rates. These substantially low rates could also cause the number of Indian profit-making companies to rise over a time period.

Source: Draft report of the task force on direct taxes

Net profit margins could rise above 10%[4], last seen in 2014,  and companies can sell products and services to consumers at reduced prices without any negative repercussions.

Source: Draft report of the task force on direct taxes

This favourable rise in profit margins could persuade those existing but reluctant companies to invest in our country, thereby increasing the capital expenditure. With increased volumes in investment, companies will consequently hire more employees for additional project capacities. These effects reiterate the goal of the rate cuts the resurgence of our country’s economy.

Disclaimer: This blog is published for educational purposes only and does not constitute investment, legal or tax advice or a recommendation or an offer for the purchase or sale of investments in any financial or alternate asset class or currency in any market, territory or country, or any other products, services, securities or financial instruments in any country irrespective of nationality or eligibility. Please consult a professionally certified tax or financial advisor for any investment or disinvestment related decisions.  All views contained in this blog are the personal opinions of the author based on publicly available research and news.

 

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