Boosting investments into India with corporate tax cuts
On September 20, Finance minister Nirmala Sitharaman announced a reduction in the base corporate tax rate to 22% from 30%* as part of stimulus measures for foreign investment (*source: KPMG, India Finance Ministry). In particular, the following changes are to be implemented:
- Direct stimulus of INR 1.45 lakh crore (ca. $20bn) via reduction in corporate tax rate from 30% to 22% with effective tax rate lowered from 34.9% to 25.2% (including surcharge).
- Existing companies now have an option to either pay flat 25.2% tax with a condition that no tax holidays/incentives/exemption are availed or continue with prevailing tax rate of 34.9% with exemptions.
- Minimum Alternate Tax (MAT) for companies availing exemptions has been reduced from 18.5% to 15%. The effective tax rate as a result will be ~17%.
- A special 17% corporate tax rate for manufacturing companies incorporated on or after Oct 1, 2019 and starting new manufacturing facilities before March 2023 with the condition that no tax holidays, incentives or exemptions are availed.
- MAT will not be imposed on such companies (not availing exemptions) – existing as well as new.
- The additional surcharge on capital gains has been removed for all classes of investors.
- Listed companies which have announced a buyback prior to July 5 will not be subject to the new buyback tax.
- The scope of corporate social responsibility (CSR) activities has been increased to include incubators funded by the government, state universities, public sector enterprises, Indian Institute of Technology (IITs) and public-funded entities.
The announced measures are likely to turn the investor sentiment to positive as the tax cut will help corporate profitability, increase free cash and improve business confidence. Slashing the corporate taxes, although hits the fiscal deficit space, is a strong pitch for foreign investors to get into India. This, along with accommodative monetary policy, can have a positive impact on growth.
Moreover, the attendant impact on specific sectors of the economy will enable the existing companies to enlarge and prosper, boost exports and lead to job creation. As a result, investor can benefit from the growth in GDP and the government investment stimulus by investing in equities via fund structures like BAO Value Fund.
Yet, the move with the tax cut is credit negative for the sovereign, as it aggravates mounting risks for the government in meeting its fiscal deficit target. However, the government is getting set for a series of divestments — lining up strategic sales in four blue-chips, state-run companies and firming up plans for embattled Air India. Higher fiscal deficit expectation has led to spike in bond yields. Nonetheless, given low inflation in India and dovish stance of global central bankers, there is still scope for lowering interest rates in India. In addition, in the immediate future, Rupee might have depreciating bias due to concerns on fiscal deficit but if FDI flows improve and FII buying happens, the impact can be managed.