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The Union Government on 20th September, 2019 announced a massive cut in corporate tax in a bid to combat the slowing economy. The Union Minister for Finance, Nirmala Sitharaman announced the new measure which brings down the existing tax rate on corporates from 35% to 25%.
This new tax rate is inclusive of all cesses and allied surcharges. The Union Government estimates that as a result of this tax cut, it will have to forgo a whopping revenue of Rs. 1.45 lakh crore. Following this announcement, the Nifty and Sensex rose by almost 5%, signaling the approval of the corporate sector and the common man to this measure.
The corporate tax reduction follows the already drastic measure taken by the Union Government by borrowing almost Rs. 1.76 Trillion from the Reserve Bank of India on 27th August, 2019 to infuse it into the economy.
It also comes in the backdrop of the various reforms already initiated by the Government such as an order by the Ministry of Corporate Affairs dated 18th September 2019, which announced the formation of a Company Law Committee. The Committee is to be chaired by the Secretary, Ministry of Corporate Affairs and will have a tenure of 1 year.
The above actions are part of the Central Government’s efforts to combat the slowing economy of India, which is currently growing only at a rate of 5% in the first quarter of the fiscal year 2019-2020 (FY 20), the lowest in almost over 8 years.
What are the reasons for the reduction in corporate tax?
India ranked 142 in the 2015 Ease of Doing Business rankings published on 29th October, 2014 by the World Bank. Since then it has jumped 65 places to reach its current 77th position in the 2019 rankings published on 31st October 2018.
The Ease of Doing Business ranking is published by the World Bank and is of international repute. A country’s ranking is a reflection of its business policies and the overall conditions in the country that either foster or inhibit growth of businesses.
The major policy changes introduced by the previous regime, like demonetization and GST, had severe impact on foreign investors. In order to improve the Ease of Doing Business ranking of India, various measures have been undertaken like setting up of Special Economic Zones (SEZ) and tax exemption to startups and angel investors.
However, these are not enough to help save the slowing economy. There is also a need for reduction in red tape and bureaucracy that hamper the climate of doing business in India.
Many reasons can be attributed for the government resorting to the drastic measure of cutting down corporate tax. Some of the reasons have been identified below:
- High Unemployment rate: A recent report by the Centre for Monitoring Indian Economy (CIME) reveals the massive rate of unemployment in India with a national average of almost 8.4%, which is the highest in the last three years.
- Slowdown of Sectors: Many sectors of the Indian economy like FMCG, real estate etc. have been badly affected due to monsoon, fund crunches, regulatory issues and consequently have been facing stagnant growth.
- Decrease in profits: The profits of majority of the listed Indian companies fell by almost 37% in the quarter which ended on March 31, 2019. Such a fall was experienced for the first time in six quarters in the financial history of the country.
- Global Economic Slowdown: Due to the US-China trade war, the world is facing a situation akin to the 2008 Wall Street Meltdown Crisis. To add to this are the growing problems of climate change and Artificial Intelligence.
- Economic Slowdown of China: China, the world’s second largest economy, is experiencing its lowest rate of economic growth since the early 1990s and is already burdened by a trade war with US. The Chinese government, like the Indian government, has taken far-reaching reforms such as reduction of tax and a slew of measures to enhance the liquidity system of their country.
What are the changes brought forth by the corporate tax cut?
This new move by the Union Government introduces different rates of taxe for corporates and non-corporates. The benefit of the different rates of tax is only available subject to conditions like amount of turnover, non-availment of tax incentives etc. Newly set-up companies that primarily focus on manufacturing will also have a different slab of tax. The important changes are summarized as follows:
- Domestic companies not seeking exemptions or incentives will have to pay tax at the rate of 22% only.
- Domestic companies not seeking relief or incentives will not have to pay Minimum Alternate Tax (MAT).
- Listed companies, having made a public announcement of buyback before 5th July, 2019, shall also have no tax applicable to them.
- Companies seeking exemptions or incentives will have to pay MAT of 15% which is reduced from 18.5%.
- New companies incorporated after 15th October, 2019 will attract only 15% tax rate.
- Enhanced surcharge under Section 2 of the Finance Act, 2019 will not be applicable to sale of equity shares.
- Manufacturing companies that will incorporate on or after 1st October, 2019 and which will commence production before the end of March 2023 will have an effective tax rate of 17% applicable to them.
Are there any legal issues involved in Corporate Tax reduction?
The power to legislate on matters relating to taxation is enshrined in the Constitution itself. Entry 82 of the Union List contained in Schedule VII of the Constitution empowers the Central Government to levy tax on any income. This includes the power to mandate tax cuts also.
In India, we do not yet have any major judicial pronouncements regarding the constitutionality of tax cuts. In the United States, on the other hand, there is a strong history of anti-tax movements with many judicial pronouncements upon petitions challenging the constitutional validity of tax cuts and imposition of tax cuts in the first place.
Examples include cases in which US citizens tested the constitutionality of the 14th, 15th, 16 and 17th Amendments to the US Constitution.
The way forward
While making the corporate tax rate of India at par with or even lower than its Asian competitors is a positive step, it is not sufficient. The onus is on the government to make other sectors of the Indian economy more attractive to foreign investors by cutting down the land and rent prices, railway freight rates, electricity tariffs, to name a few.
Reforms are also needed in major legislations like the Companies Act, 2013, the Limited Liability Partnership Act, 2008, the Indian Contract Act, 1872 and other allied legislations that primarily govern the realm of business in India in order to reduce the ambiguity present in the laws and to keep up with the international mandate on the same. Also, there is a need to simplify laws and end corporate nepotism, bureaucracy and red tape.
The government should also ensure enforcement of law and provide a means of judicial recourse that is fast and efficient. The fear of long pending litigation and enforcement of law is widely prevalent among foreign investors.
Therefore, the government should undertake measures to further strengthen the existing adjudicatory regime such as the National Company Law Tribunal (NCLT), Securities and Exchange Board of India (SEBI), the Prevention of Money Laundering Tribunal (PMAT) and other judicial, quasi-judicial, regulatory and statutory authorities to boost investor confidence.
Further, similar incentives should be given to the manufacturing sector, primarily the Medium and Small Manufacturing Industries (MSME’s) who form the backbone of the manufacturing sector, rather than just focusing on the large conglomerations and corporates.
As a result of the huge tax cut, the Central Government’s tax deficit will rise up to almost 3.7%. This will be detrimental to the Centre and may affect the release of funds to States and the discharge of other financial duties of the Centre. The Centre, therefore, will have to undertake more reforms to combat this deficit.
To conclude, the corporate tax cut is just a small step in the long path ahead to reform and revive the ailing Indian economy.
This article is brought to you in collaboration with Kaushik Chandrasekaran from School of Law, Christ University, Banglore.