India's private sector is set to benefit from the single largest reduction in corporate income tax in almost three decades.
Announced by Finance Minister Nirmala Sitharaman on September 20, India's effective corporate tax rate will reduce by almost 10 percentage points for domestic companies.
More specifically, for the 2019-20 Financial Year:
- For existing domestic companies, the corporate tax rate is reduced from around 35 percent to 25 percent (for domestic entities that do not avail of any exemptions or incentives, the effective tax rate could be as low as 22 percent);
- For manufacturing firms incorporated after October 1, 2019 and beginning operations before March 31, 2023, the corporate tax rate is slashed from 25 percent to 15 percent (this will amount to an effective tax rate near 17 percent, including surcharge and cess):
- For companies that continue to avail of exemptions or incentives, the rate of minimum alternate tax (MAT) is reduced to 15 percent from the current 18.5 percent (the effective MAT will lower from 21 to 22 percent to 17 percent, including surcharge and cess).
Manufacturing firms likely to make fresh investments
The manufacturing sector stands to gain the most from the reductions in tax arbitrage.
Tax consultants predict that existing companies may consider forming new entities for future investments to benefit from the sizeable tax break.
To do this, companies will obviously need to plan their cash management, dividend distribution tax, and other matters of compliance to ensure they are not flouting legal norms or overly exposed to the tax department.
India wants to compete with ASEAN economies
The lower tax rate will allow India to compete with ASEAN's emerging economies – like Vietnam, Thailand, and Indonesia for foreign investment more effectively – particularly given India's larger market and cheap labor pool.
Moreover, as the wider global economic slowdown continues, the protracted nature of the US-China Trade War will trigger a shift towards building regional supply chains. India is stepping up its act to be the smart choice for Asia-bound investors. Moreover, the tax cuts seek to thrust the country's manufacturing sector up the global value chain and boost export-led growth.
In fact, just last month, India announced a series of relaxations in its existing foreign direct investment (FDI) norms, impacting single-brand retail, coal mining, and contract manufacturing. Notably, the government introduced FDI restrictions on digital news media companies at the same time, affecting fundraising and capital planning for a buoyant industry.
Investor appeal aside, India Inc. needed the help
Timing appears to be the biggest incentive.
The government's move to drastically lower the corporate tax rate comes at a time when the country's economic growth is at a six-year low, domestic capital is drying up, consumer demand is weak as consumption patterns are changing and the rural economy is in distress, and unemployment rates have crossed a three-year high at 8.4 percent.
The tax cut announcement also came immediately ahead of Prime Minister Narendra Modi's visit to the US. Several media reports indicated that international investors were "falling out of love" with the prime minister, but the new stimulus has reportedly inspired some global investors to rethink India.
The government now hopes that the US$20 billion tax relief will encourage private companies to redirect their savings from the decreased tax outgo into capital expenditure, with the promise of higher profit margins.
Whether companies do invest their tax savings will ultimately show how confident they are in India's economic trajectory.
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