Corporate Tax Rate Cut – Impact On Economy

The government recently announced a series of amendments to the Income Tax Act, 1961 and the Finance Act, 2019 through an ordinance on September 20, 2019, intended to revive economic growth and promote fresh private investment in the economy.

Primarily, the corporate tax rate for domestic companies has been reduced to 22 per cent, provided they don’t avail any exemptions or incentives. The effective tax rate for such companies will now be 25.17per cent, inclusive of surcharges and cesses.

To promote investment

Moreover, to promote investment, new domestic companies (incorporated from October 1, 2019, making fresh investment in manufacturing and commencing production before end-March 2023) will have an option to pay income tax at the rate of 15per cent if they do not avail any exemptions. The effective tax rate for such companies will now be 17.01per cent, inclusive of surcharges and cesses.

How it will affect economy?

“The lowering of the Corporate Tax rate is expected to provide a substantial and broad-based boost to business sentiment in the immediate term and is a long term structural positive, although it would result in an increase in fiscal stress in the short term. This measure would also have a modest knock-on impact on improving consumption demand, particularly for big ticket items,” ICRA said in its report.

To support growth outlook

Harsha Upadhyaya, CIO (Equity), Kotak Mahindra Asset Management Company, said, “The decision to lower corporate taxes meaningfully is a key structural measure to support India's growth outlook. One of the key objectives of the sharp cut in corporate tax rates is to make India globally competitive. This step significantly boosts medium-term investment potential in the economy.”

Fiscal stimulus capex driven

She went on to explain that the focus of fiscal stimulus is capex-driven rather than consumption-driven and thus poses limited risks to macro stability. Even if it is difficult for government to remain within the FRBM mandated fiscal target in FY20, a combination of expected tax buoyancy and higher proceeds from divestment due to improved valuations should enable it to come back on fiscal roadmap over the medium term. Any slip in short term should be seen as a fiscal price to spur growth in domestic economy.

Impact of fresh investment

However, the impact on fresh investment activity may be visible only with a lag. Given the moderate capacity utilisation in various sectors, we don’t expect a broad-based pickup in capacity expansion by the private sector, until there is greater visibility of a sustained uptick in domestic consumption demand, ICRA said in its report.  

Addition of new jobs

Moreover, new factories are likely to be relatively automated, raising concerns on the extent of jobs that could be added. In our view, land and labour reforms along with regulatory clarity and consistency are areas where additional measures are required to complement the impact of the tax cut.

Nevertheless, the secular reduction in the tax rate is welcome, as it does not benefit only specific targeted sectors. In ICRA’s view, this is a preferable alternative to other measures that were being put forth, for instance, the demand to cut the GST rate for automobiles, which would have generated similar requests from other sectors.

“Moreover, if firms pass through a portion of their tax savings through lower prices of goods and services, the benefit could potentially reach a larger number of people than an income tax reduction, given the limited number of income tax payers,”, ICRA report stated.