Date: 14/01/2023

Relevance: GS-3: Fiscal Policy and their effects on the economy; Tax structure and Tax Reforms.

Key Phrases: Fiscal Policy, Tax Reforms, Capital Expenditure, Gross Capital Formation, Corporate Tax, Policy stability, Effective tax rate, Developing Nations and Advanced Economies, Revenue impact.

Context:

• The year 2019 was a watershed moment for corporate taxes as the rates were slashed to unleash the animal spirits of India Inc. and make them invest in capital formation.

Key Highlights:

• Corporate tax cut of 2019 was one of the largest corporate tax cuts in world history that brought about dramatic changes in the overall economic fortunes of India.
• Interestingly, corporate tax is paid on corporate profits (after accounting for all expenses) and that may or may not have anything to do with tax rates.

Tax Reform: Corporate Tax cut of 2019

• The 2019 tax cuts were massive — effective income tax on companies was slashed to 25.17 per cent, down from the highest rate of 34.94 per cent and the rate for minimum alternate tax was lowered from 18.5 per cent to 15 per cent.
• Of the largest companies earning taxable income of over ₹500 crore, 246 had shifted to the new tax regime by the end of FY20 and only 130 remained in the old regime.
  • These larger companies account for over 50 per cent of the taxable income.

Effects of Tax cut:

• Corporate Profits
  • The company has greatly benefited from the new tax regime.
  • A business line analysis of companies forming part of the Nifty500 index shows that the tax rate for these companies (based on the tax paid by companies and taxable profits) was 27.09 per cent prior to the tax cut, in FY19.
    • It plunged steeply to 22.09 per cent by FY20 as companies made the most of the tax cut bonanza.
    • The tax rate for these larger companies has been moving further lower since then and stood at 20.77 per cent towards the end of FY22.
• Revenue Collection
  • According to the Finance Ministry tax collections have been robust in the last two years, growing 39 per cent and 21 per cent in FY22 and FY23, respectively.

Understanding Lower tax rate and higher collections:

• Corporate tax collections are directly impacted by the growth in the economy and tend to decline during periods of growth slowdown.
• There was a 16 per cent decline in corporate tax collection in FY20 as growth slid sharply due to slowing consumption caused by tightening bank liquidity.
  • The next year was marred by Covid-led lockdowns and saw corporate tax revenue decline 17.8 per cent.
• But collections have picked up since then.
  • The current year witnessed collections of ₹4.28-lakh crore between April and November 2022, compared with ₹3.53-lakh crore in the corresponding period the previous year.
• One reason why collections are higher despite falling tax incidence is because the larger companies have been recording strong profit growth over the last two years.
  • Taxable income of the companies forming part of Nifty500 grew 38 percent in FY22.
  • In fact, even during the Covid-hit FY21, the profits before tax of these companies grew 34 per cent due to super-normal profits of commodity companies.
  • These larger companies were also able to garner the market share conceded by smaller companies, which faced economic distress due to the pandemic.
• Not all companies have paid tax at the lower concessional rate.
  • Around 107 companies have paid over 26 per cent of their taxable income as tax and around 156 companies have paid less than 20 percent of their income as tax.
  • This shows that companies are being deft at making the most of tax exemptions and leeway to reduce their tax outgo.
• The improvement in corporate tax collection also proves the Laffer curve theory right.

Concerns:

• It is apparent that India Inc. did not utilize the savings from the tax rate cuts to increase capital expenditure.
  • Only a handful of companies have invested in expanding capacities and the growth in private capex over the last two years is not much to exult about.
• Instead, businesses seem to have used the savings from the cut in tax outgo to insulate themselves against pandemic-led slowdown, to improve their cash flows and to expand their business outreach.

Way Forward:

• There is more to the subject of tax cuts to corporations and the rich for that matter.
  • It is a widely prevalent policy which is sought to be justified by the dubious “trickle-down” theory.
  • The theory posits that tax cuts for the rich and wealthy benefit the non-rich or that the benefits trickle down.
• It may not be possible to either coerce or persuade India Inc. to spend the money saved from lower taxes in capital investments unless they deem it necessary based on the demand environment in the industry.
  • To give the devil its due, some companies have been investing heavily in capex since FY19.

Conclusion:

• It can be hoped that as demand improves over the coming years and the export market also revives, additional capacities will also come up.
  • Till then, companies will continue to use the lower tax to shore up their profits and that is not a bad thing, going by the tax collection figures.

Source: Business Line

Mains Question:

Q. Illustrate the impacts of the 2019 corporate tax rate cut on the Indian economy. Also discuss the related concerns. (150 Words)