The Finance Minister on 20th September 2019 announced a sharp reduction in corporate tax rates. Manufacturing companies not availing of tax sops can now opt for a 22% corporate tax rate, while new manufacturing companies that register and start production between 1st October 2019 and March 2023 can avail an even lower tax rate of 15%.
At present, business income is taxed at 30%, exclusive of cess and surcharge, other than in the case of companies with sales of up to Rs.400 cr and new manufacturing companies which are taxed at 25%. Now, the effective tax rate, including cess and surcharges, for the existing companies comes down from 34.94% to 25.17%, while for new companies, it falls from 29.12% to 17.01%. The FM also announced a reduction in the rate of minimum alternate tax (MAT) from 18.5% to 15%.
The rationale behind keeping the base rate for existing companies at 22% was to keep the effective tax rate (with surcharge and cess) at around 25%, which would ensure India’s competitiveness globally. The US levies a 25.89% corporate tax rate, including sub-national levies on corporate income if that were to be a global benchmark. The UK charges 19% and France 32.02%, including sub-national levies, according to the Organization for Economic Cooperation and Development (OECD). The lowest corporate tax in Asia is Hong Kong’s 15%.
Then we have all these talk of US-China trade war & business shifting from China to India. The corporate tax rate in China is 25%. The government’s decision to reduce the corporate tax rate for new manufacturing companies to 17.01% has turned India into an attractive investment destination for firms that want to relocate supply chains from China. India now has the lowest corporate tax rate in Southeast Asia. The tax rate in Singapore is 17%, Vietnam 20%, Thailand 20%, Indonesia 25%, and the Philippines 30%. I expect big FDI shifting from China to India. In addition this should also boost FII flows.
The announcements did not contain any mention of proposed rate cuts for foreign companies, which will continue to be taxed at a higher rate of 40% plus surcharge/cess. For them, having a local subsidiary may now be a much more compelling proposition than ever before. Similarly, no rate changes are proposed for limited liability partnerships and full partnerships, but the fact is that these entities also benefit from not being subject to dividend distribution tax.
The latest changes will be made through an ordinance, and come as part of efforts to revive GDP growth that slipped to 5%, an over six-year low, for the three months ended 30th June 2019.
The corporate rate cut is expected to result in an Rs 1.45 lakh cr loss to government coffers. This can partly be made good by higher disinvestments and higher tax collections due to higher profitability. The Rs 1.45 lakh cr that remains with corporates will have a trigonometric multiplier impact on the economy.
The tax cuts will be effective retrospectively from 1st April 2019, the start of the fiscal year, and any advance tax paid by companies will be adjusted. Thus for companies paying full tax & making profits, will report bumper Q2 profits. In Q1FY20 if they paid ~35% tax in Q2 they will only be paying ~15% tax, this additional Q2 PAT should boost market sentiments.
Post corporate tax rate cut; there is a big discrepancy with personal income tax. Thus going ahead we expect some rationalization of personal income tax rates in line with the recommendations of the task force on direct tax.
Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 10 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata. He also manages a portfolio on the online platform Kristal. Find link to the strategy named ‘The Tortoise’