The Finance Minister (FM) last week announced a historic decision of reducing the corporate tax rate from 30 per cent to 22 per cent. For new manufacturing companies registered on October 1 or afterwards, tax rate has been reduced to 15 per cent.
These rates are exclusive of cess and surcharge. The companies availing of 22 per cent tax rate cannot benefit from any other exemption/incentives.
The step has been hailed as the second most landmark measure after the 1991 reforms announced by then Finance Minister Manmohan Singh. The Sensex was up nearly 2000 points, the highest rally in a day in a decade. Tax cuts have been a long pending demand of corporates.
This decision increases the competitiveness of industry and brings India’s tax structure on par with the countries with the lowest tax rates in the world. It is expected to activate the animal spirits of our entrepreneurs, resulting in investments and capacity additions, boosting GDP growth.
The whole exercise is expected to result in a loss of Rs 1.45 lakh crore loss to the exchequer. This is likely to push up fiscal deficit from 3.3% levels projected for 2019-20 to 3.6% levels if all other numbers projected are achieved (a big task, given the lag in tax collections this year).
The government has coughed up Rs. 86,000 crore extra from RBI, which will help absorb some of this loss. In the Budget presented in July this year, the Finance Minister had already extended the tax rate cut to 25 per cent for companies with a turnover of up to Rs 400 crore, representing 99.3 per cent of the entire universe.
This cut is expected to accrue to and benefit top 6,000 companies in India, which account for more than 80% of government’s corporate tax revenues.
The 15% tax rate for new manufacturing companies is likely to help India take advantage of the trade war between US and China. It is a big step to woo companies shifting their manufacturing base out of China and will give a boost to our exports while creating thousands of jobs.
Many commentators have hailed it as an early Diwali for corporate sector. It has given a boost to the investor sentiment. The government has fulfilled their wish and now the onus is on the corporates to take advantage of this step and create jobs and take the economy out of slowdown.
The demand for goods and services in the economy has taken a beating due to the liquidity crisis, post the IL&FS default. The demand from biscuits, to shampoos, to automobiles to housing has been badly impacted. Unless this is revived and capacity utilisation ratio of companies goes up to 85%, corporates would tread with caution before investing. So, what do the companies do with this tax gain? Some of them are expected to pass a portion of the gains to the consumer by offering discounts in the hope of reviving demand. Some could even give their employees a Diwali bonus. This also could help putting a break on further job cuts.
Some would just keep the cash and build reserves in anticipation that global headwinds are likely to continue for some time, while others could pare their debt and improve their balance sheet health.
Then there are those who could pay higher dividends, specifically the public sector companies, thus helping government to recoup some of the tax forgone.
While investor sentiment has been restored, there is growing demand now to slash personal income taxes. Income above Rs. 10 lakh for individuals is taxed at 30 per cent. Only a relief would leave more money in the hands of individual taxpayers and give a boost to demand.
However, with the Model Code of Conduct now in place for Maharashtra and Haryana elections, it will be difficult for the government to take any such step. Further, there is not much fiscal room left this year after the bonanza to corporates. In the medium to long term, this step will prove to be a big positive and boost growth. However, this is not the steroid needed to provide immediate relief and improve consumer sentiment.