Corporate tax cut, MAT relief: Key takeaways from Nirmala Sitharaman’s press conference and Impact on Economy

In order to promote growth and investment, Finance Minister Nirmala Sitharaman on September 20 slashed the effective corporate tax from 30 percent to 25.17 percent, inclusive of all cess and surcharges for domestic companies. However, the move, effective from April 1, is subject to the condition that they will not avail any other incentive or exemptions.

In effect, the corporate tax rate will be 22 percent for domestic companies if they do not avail any incentive or concession. The changes in the Income Tax Act and Finance Act will be made effective through an ordinance.

Here are the key takeaways:
- Corporate tax rate cut for domestic companies and new domestic manufacturing companies
- The tax rate will be 22 percent without exemptions
- Effective corporate tax rate after surcharge to be 25.17 percent
- To attract investment in manufacturing, local companies incorporated after October will pay tax at the rate of 15 percent
- Effective tax for new companies shall be 17.01 percent, including cess and surcharge
- Companies enjoying tax holidays can avail concessional rates after the exemption period
- Minimum alternate tax (MAT) reduced to 15 percent from 18.5 percent for companies continuing to avail exemptions and incentives
- Enhanced surcharge to not apply to capital gains by foreign portfolio investors (FPIs)
- Revenue foregone for reduction on corporate tax and other measures pegged at Rs 1.45 lakh crore per year
-The government has also decided not to levy the enhanced surcharge introduced in Budget 2019 on capital gain arising from sale of equity shares in a company liable for the securities transaction tax (STT).
- Also, the super-rich tax will not apply on capital gains arising from sale of any security including derivatives in hands of foreign portfolio investors (FPIs).
- In another relief, the minister said listed companies which had announced buyback of shares prior to July 5 would not be charged with super rich tax.
-Also, the companies have now been permitted to use their 2 percent CSR spend on incubation, IITs, NITs, and national laboratories.

Sitharaman expressed confidence that the tax concessions would bring investments in Make in India, boost employment and economic activity, leading to more revenue.

The impact sent the benchmark Sensex up more than 1,200 points and the Nifty above the psychological 11,000 mark. Among sectors, the Bank Nifty and Auto index surged three percent each.

Nirmala Sitharaman said the revenue foregone on reduction in corporate tax and other relief measures will be Rs 1.45 lakh crore annually.

Corporate tax cut to have 'minor' impact on fiscal deficit: Niti Aayog.

The Rs 1.45-lakh crore tax giveaway is unlikely to widen the fiscal deficit much, as the shortfall will be met through increased tax collections due to higher growth , Niti Aayog Vice Chairman Rajiv Kumar said on September 21.

The new tax rate will be applicable from April 1, involving a revenue loss of Rs 1.45 lakh crore this fiscal. "I don't think tax cuts will leave a gaping hole in the fiscal numbers. There will be some, which will be minor," Kumar said at an 'India Today' event.

The budget had estimated fiscal deficit at 3.3 percent of the GDP for the current fiscal but many analysts have pegged it overshooting by at least 70 basis points to 4.1 percent as the quantum of the giveaways is worth 0.7 percent of the GDP.

Kumar said direct and indirect tax revenues are expected to go up with growth picking up after these tax cuts. Kumar also said another area for his optimism is the government focus on divestment which he budgeted at Rs 1.05 lakh crore.

Mr. Kumar was optimistic to achieve a nearly 6.5 per cent growth this year and said we will be on track for doubling up our per capita income in the next five years.

Views and Opinions:

The success of the move depends on the government’s approach to tax administration; its management of public finances; the other steps it takes to address structural issues and boost investment; and the manner in which firms choose among available tax structures (PTI)

Private consumption, the engine of the economy that had been firing most consistently in recent years, is losing steam. Two other engines — investments and exports — seem to be slowing down again after a brief period of robust activity. The result is 5% growth.

The government’s finances have been under pressure. Tax collections have not grown at expected rates. To meet the fiscal deficit target, the government has pushed a lot of borrowing off-budget, making government agencies borrow more. It has also allowed the National Small Savings Fund to lend to a number of government agencies. Most of household financial savings in India now go towards financing the government and its agencies.

The new structure of corporate tax rates leaves more money for investors to save and invest in a manner of their choosing (corporate tax incidence is mainly on capital or investors); it can help Indian firms become more competitive globally (corporate tax rates were higher than most countries); and it can boost consumption by lowering prices.

The nature and scale of impact of this move will, however, depend on four factors:-
- First, will the decision trigger a deeper change in tax policy and administration vis-à-vis businesses?
- Second, how will the government pay for these tax cuts?
- Third, the benefits will depend on which firms really benefit from this reform and how.
- Fourth, the impact will also depend on what else the government does to improve the investment climate in India, in terms of financial sector reforms, land and labour market reforms, opening access to foreign capital, solving problems of public sector banking, easing infrastructure constraints, improving contract enforcement, and so on.

The move to cut corporate tax rate is consistent with the Indian government’s tendency to reform from crisis to crisis. Due to the context, this reform also presents a big fiscal risk. Its overall impact will depend on certain choices that the government and firms will make in the next few months.

What the Analysts say:-

Moody's Investors Service on September 21 said the cut in corporate tax increases the government's fiscal risks while headwinds from cyclical factors such as rural stress, weak corporate sentiment and slow credit pose threat to near-term growth.The rating agency said it does not expect the corporate tax rate cut to revive growth to the extent that stronger tax buoyancy compensates for the loss of revenue.

The reduction brings India's corporate tax rate closer to peers throughout Asia and will support the business environment and competitiveness, but a host of cyclical factors, including rural financial stress, weak corporate sentiment, and a slow flow of credit in the financial sector, remain headwinds to near-term growth.

Moody's said the cut in corporate tax is credit positive for companies because it will enable them to generate higher post-tax incomes. Commodity and information technology (IT) services companies will benefit most from the tax rate cut.

“The step to cut corporate tax is historic. It will give a great stimulus to #MakeInIndia, attract private investment from across the globe, improve competitiveness of our private sector, create more jobs and result in a win-win for 130 crore Indians," Prime Minister Narendra Modi said on Twitter.

"Prime Minister Narendra Modi's goal of making India a $5-trillion economy is completely doable if all stakeholders come and work together," the minister said. Piyush Goyal, who on Saturday unveiled the India Pavilion design of the WORLD EXPO 2020 in Dubai, expressed optimism that going ahead, India taxes were likely to be much more lower. "We all must work together to see how we can showcase India for attracting investments," Goyal said. The WORLD EXPO 2020 beginning October next year was a big opportunity to achieve this objective, he added.

Arvind Virmani, former chief economic adviser in the finance ministry, tweeted: “One of the most important recommendations of tax economists, implemented. This will apply to new companies moving #SupplyChains to India."

HDFC chairman Deepak Parekh said after the cut in corporate tax, the government needs to focus on land and labour reforms to attract foreign investors. “We have to show that it is easier to invest in India," he told CNBC-TV18.

Former chief statistician of India, Pronab Sen, said the tax cut is essentially a supply side measure and has very little effect on the demand constraint the economy is facing. “Investments are held up because companies have not seen demand growth. Unless that is reversed, no investment will happen," he added.

Sudhir Kapadia, national tax leader, EY India, said the tax cut will effectively leave companies in the hitherto nominal tax rate of 35% with a direct cash booster of 10% of their profit before tax across all sectors. “Hopefully, this should result in a virtuous cycle of increasing investments, consumption and growth," he said.

The tax cuts will help following sectors:

Historic corporate tax rate cuts will have varied impact on sectors:
- Fiscal bonus to be used for investment or for passing on the benefits to consumers
- FMCG & Auto will pass tax benefits to consumer to revive demand
- Banks: Mixed impact, private capex cycle revival can be positive
- Government’s higher borrowing and crowding out effect would need to be watched

Friday’s unprecedented corporate tax rate cut is set to boost company earnings. All other things being equal, the cut from 30 percent to 22 percent  would mean that companies paying taxes at the full rate should see their earnings jump by 11 percent. Indian equities, therefore, look well-positioned in the short to intermediate term. Highly taxed companies will be early winners.

However, there are many grey areas. For example, the effective corporate tax rate of many companies may be well below the new proposed tax rate, which along with surcharge and cess works out to around 25.17 percent.

Hence, the impact of the various tax provisions will vary across sectors, sub-sectors and businesses.

Tax reduction to be beneficial across sectors

India remains a service-based economy as it contributes more than half to the country’s GDP. The share of manufacturing, pegged at around 18 percent currently, had been on the rise owing to the government’s focus on investment and job creation. But manufacturing activity has slumped in the past year due to sluggish consumer demand and the weak economy.

The manufacturing growth rate has declined from 12 percent in Q1 FY19 to just 1 percent in Q1 FY20. The revision in tax rates should revive demand across industries and put the economy back on the growth track. The impact on various sectors would differ in terms of how they plan to utilise this fiscal bonus. This could range from reviving investment, lowering prices to increase demand, paying out higher dividends or repaying debt.

FMCG companies may pass on tax benefits to boost volume growth

For FMCG companies, the tax cuts would result in more cash in hand, which could be utilised for spurring demand through trade discounts in the upcoming festival season. To give an estimate, FMCG companies on the Nifty (ITC, Nestle, Britannia, HUL), would see their effective tax reducing from 29-35 percent to 25 percent, leading to retention of a cumulative Rs 2,000 crore earnings on the basis of FY19 numbers. This corresponds to 9 percent of net earnings for FY19.

Credit cycle can get a boost and benefit banks

The finance minister said a new domestic company incorporated on or after October 1, 2019, will pay income tax at the rate of 15 percent. This comes with a rider that production should commence before March 31, 2023. We believe that the move can hasten the private capex cycle and if this happens, credit growth will rise and banks would be key beneficiaries.

However, government borrowing will also go up to make up for the revenue foregone by reducing the tax rate. This in turn would exert upward pressure on interest rates. In sum, therefore, it will have a mixed impact on banks.

The tax measures could particularly be helpful in accelerating investment in chemical and pharma APIs (active pharmaceutical ingredients) business lines as they position themselves for import substitution strategies.

Tax reduction can refuel demand in auto sector

The Indian automobile sector, which contributes 7.5 percent to the country’s gross domestic product (GDP) and 49 percent to manufacturing GDP, has been under the weather for almost a year on the back of multiple headwinds the industry is facing.

Factors such as non-availability of retail finance, liquidity crunch and slowdown in economic activities have hurt demand. But the biggest reason for the lack of demand has been the increase in total cost of ownership led by mandatory long-term insurance and implementation of safety regulations.

How will the tax cuts help the sector? The reduction in tax rates would improve the profitability of companies in the auto industry, but more than that it, may help companies pass on the benefits to the customers in terms of discounts and freebies ahead of the festive season, which may boost demand and would make more liquidity available to the companies for further investment.

The ongoing China-US trade war has led MNCs to look for an alternative to China as far as their supply chain is concerned. As of now, a few Asian nations such as Vietnam, Indonesia and Thailand have been ahead of India in benefiting from this trade and investment shift. Now, the competitive taxation rate and ongoing efforts towards ease of doing business should help in India becoming a manufacturing destination of choice.

Source: Economic Times, Business Line, Liv Mint, Money Control, First Post, Business Standard etc.

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