How low Can it go? March 2018 issue

How low Can it go?

Finance Minister Arun Jaitley recently presented the current government’s first Budget post GST and probably the last full Budget before the next Lok Sabha elections.

A lot was being expected from him for this very reason. And, of course, also because this Budget would decide the fate of the various flagship programmes of Prime Minister Narendra Modi’s government – not to say, the most important of them all, the Make in India programme – besides addressing the issues that had come into play after the implementation of GST. It did… it did not… the debate goes on!

Well, I have no intention to be a part of the debate. But, one Budget announcement that I do would want to mention is the lowering of corporate tax rate to 25% from 30% for businesses with turnover up to Rs.250 crore. It wasn’t just a long-pending need, but an imperative in the wake of the global trend towards lower corporate tax rates. No doubt, the move will benefit the MSMEs that account for 99% of companies filing taxes. It will not only leave more funds at their disposal and improve their competitiveness but will also ensure more foreign inflows into the country while promoting businesses to invest locally. So far, so good! But then, what about the remaining 1% corporates that contribute a huge amount to government coffers every year and are actually the ones that make the largest of investments in the economy to propel growth? Don’t they deserve a pat on the back? And above all, is the concession enough to lure foreign direct investments into the country or to be more apt stop them from flowing out from India? Just in case you missed the news, the gross fixed capital formation in India has already come down from a high of 37% of GDP in FY2008 to 28.9% for Q2 of FY2018 (Central Statistics Office data). Corpoarte tax rate in India is among the world’s highest. In fact, India is one of the few countries where the tax rates further increase on account of additional levies like the surcharge and cess. This not only makes Indian companies uncompetitive by having a spiralling effect on their overall tax cost, but also impacts the overall investment environment of the country. A closer look at the numbers and you would understand it all!

While domestic companies (with an annual turnover of more than Rs.250 crore) are taxed at 30%, income of foreign companies from Indian operations attract a tax rate of 40%. And this isn’t all. A surcharge of 7% or 12% on tax where the total annual income exceeds Rs.1 crore or Rs.10 crore respectively and an education cess of 3% on tax plus surcharge come as add-ons. Interestingly, the Finance Bill 2018 proposes to further increase the 3% education cess to 4% and name it as health and education cess. The new cess will be applicable from April 1, 2018 once the Finance Bill has been passed by both the houses of Parliament and has received Presidential assent.

Compare this to countries that are the world’s leading exporters (and also amongst the leading manufacturers) and you would reailse the gravity of the situation. While the corporate tax rate in China is 25%, income of small scale enterprises is taxed at much lower rates ranging from 10% to 20% depending on the business they are in. For instance, new or high technology enterprises and advance technology service enterprises that perform qualifying outsourcing services are taxed at 15%. Even enterprises based out of certain specific regions or into encouraged businesses attract lower special rates. Similar is the case in US, Germany, Japan and Hong Kong (the next four biggest exporters, and in that order) where corporate tax rates hover around 21%, 15%, 23.4% and 16.5% respectively. In fact, US has recently introduced some drastic changes to the domestic tax system by abolishing alternative minimum tax besides modifying the rules for expensing capital investment, the deduction for interest expense, among others. This is bound to have a positive effect on the investment scenario in US while negatively impacting the flow of capital into emerging economies with high corporate tax rates like India. The solution seems simple: Lower the headline tax rate and make India an investment-friendly destination once again. Sounds good. But then, it only sounds good and is no practical solution. The reason is simple – corporate taxes account for about one-third of the government’s total revenues and rationalising them further without thinking of alternatives would hit the government’s fiscal position hard. In fact, very hard!

Having said that, if India wants to become a global manufacturing hub it needs to attract foreign investments and for that to happen it needs to promise investors more of profits and less of taxes. Can policymakers do that? Yes, they can, by improving the efficiency and effectiveness of the indirect tax structure and shifting the balance from direct taxes to indirect taxes. And how soon? That’s just something only they know!

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