17 Dec

Reduction of Corporate Income Tax and its Implications

< General Studies Home Page 

Content

• Introduction
• Positive Implications
• Concerns

---

Introduction: 

• Corporate tax rates which used to be more than 50% in early 1990s was brought down to 30% by 2004- 05 as per the recommendations of Shome Committee (2001) and Kelkar Committee (2002).
• But, even at the basic rate of 30% the effective corporate tax paid by Indian companies was around 35% which was on the higher side compared to its peers.
• This high tax rate led to low investments which reduced economic growth potential.
• So, through Taxation Laws (Amendment) Ordinance following changes were made in Sep 2019.
  • Income Tax rate of 22% (Effective 25% with surcharge and cess) for all domestic companies (provided they don’t claim deductions under the Income Tax Act)
  • Domestic manufacturing companies set up on or after Oct 1, 2019, to pay tax at a lower 15% rate (effective 17%) if they forego other incentives.
    • Note: These companies must start manufacturing before April 1, 2023.
  •  If a company applies for new rates than the same will be applicable in subsequent years.
  • Provisions related to Minimum Alternate Tax (MAT) will not be applicable for companies choosing new tax rates.
  • Minimum Alternate Tax (MAT) has been reduced from 18.5% to 15% for companies not choosing the new tax rates.

Positive Implications

• India’s tax rates have become on par with competing Asian peers.
  • This will increase the profitability of the corporate players and thus will contribute to making India an attractive destination for investment.
• It may also increase the export competitivity of Indian companies as now they will be able to price their products at lower prize for same profitability.
• Sectors like telecom sector, which are facing high debt burden, can use the extra money to pay off the debt and thus will contribute to better functioning of India’s banking system.
• Contribute to easy credit availability.
• In long run, the enhanced economic activities will increase the tax base and thus may also
  boost tax collection.

Concerns

• Revenue loss and thus increased fiscal deficit in short run.
  • For e.g., recently, finance ministry announced that the government faced a revenue loss of more than 1 lakh crores in FY21.
• Hasn’t kickstarted investment: RBI has recently noted that the new tax regime didn’t kickstart the intended Investment Cycle.
  • In an annual report for 2019-20, the RBI said that tax rate cut may have been used for debt servicing, building up cash, and other current assets.

Way Forward

• Reduced tax rates alone can’t deal with the key challenges faced by Indian economy. It is a bold move but is only one of the supply side reforms. Other steps required are:
  • Land and Labor Reforms -> to further simplify the ease of doing business in the country.
  • Banking reforms -> to ensure easy credit for consumption and investment.
• Further, the supply side reforms should be complemented with demand side reforms. Without increase demand, increasing supply will be of no use.
  • Here, there should be focus on increasing income of working and middle class. Here
    reforming agricultural sector would be crucial as it provides income and employment to more than 50% of the India’s population.
  • Continuation of the reform process also calls for Rationalizing Personal Income Tax Rates in alignment with the new CIT rates.
• Further, since there is going to be a large slippage in fiscal deficit, the central government would do well to enhance the efforts to garner additional non-tax revenue as well as disinvestment proceeds over and above the budget estimates.

Conclusion: In long run, the corporate tax cut, can indeed boost economic activities. It’s important that to fully utilize the potential of this cut other complementary steps such as reform in labor laws, strengthening of the banking sector also takes place.