Finance Minister Nirmala Sitharaman’s move to slash the corporate tax rate to 22 per cent from 30 per cent is a bold move and marks a departure from the incremental approach to economic reforms the government has pursued until now. Sitharaman has also lowered the tax incidence on new companies that will commence production before March 2023 to 15 per cent, hoping to spur fresh investment. With these measures, the government has moved India’s corporate tax rates in line with its regional competitors, increasing the country’s attractiveness as an investment destination. This should incentivise firms relocating from China to set up manufacturing units in India. Coupled with the decision to do away with the surcharge on capital gains on listed securities, these measures will go a long way in shoring up sentiment. Indicative of this, the BSE Sensex ended the day 5.32 per cent higher than its previous close.
The government’s latest measures appear to be designed to push growth through an increase in investment rather than consumption. Though the increase in profitability could help existing firms launch fresh investment, increase dividends or deleverage, to the extent that higher tax rates were a deterrent for investment, these cuts could spur fresh investment. Also, by providing corporates the option of choosing a lower tax without taking advantage of exemptions and incentives, the government seems to be moving towards a simplified tax architecture which would help reduce tax litigation. Bigger firms facing a higher effective tax rates will be more inclined to switch to this simplified structure, while those with lower effective tax rates currently will shift once the sunset clauses for exemptions expire. However, lower tax rates for new manufacturing firms will put existing firms at a disadvantage. This may incentivise existing firms to set up “new firms” to take advantage of the tax differential. Though this could be kept in check through the General Anti Avoidance Rules (GAAR) provisions, it does open up the possibility of further rate rationalisation in the future.
The finance minister has stated that the revenue forgone on account of these tax cuts amounts to Rs 1.45 lakh crore. And though the government is hopeful that lower rates will increase compliance, offsetting some of the revenue loss, meeting the fiscal deficit target will be a tall order. The advance tax figures aren’t encouraging. Both direct and indirect tax collections are well short of expectations. Bond yields surged 15 basis points on Friday in anticipation of an increase in government borrowing to finance the higher deficit. To plug the widening gap, the government must opt for a more aggressive disinvestment programme.