Notwithstanding its acute budget constraints, the government on Friday went the whole hog and unveiled a massive fiscal stimulus of Rs 1.45 lakh crore or 0.7% of the gross domestic product (GDP), mostly in the form of surprise, more-than-asked-for tax cuts for the whole of corporate India.
Hitherto, the government has been trying to spur the lethargic economy via easing of credit flows, making loans cheaper and bolstering liquidity across the financial-sector entities, rather than via a potentially hazardous fiscal digression.
Analysts estimate the steepest corporate tax cuts in nearly three decades, announced by finance minister Nirmala Sitharaman here, would provide a direct cash booster of 10% of profit before tax (PBT) for most domestic companies across all sectors above an annual turnover of Rs 400 crore; for those below this size (99.3% of the firms registered), the reduction in the tax rate will be roughly 4 percentage points. Friday's package also opened a legit facility for companies to reduce the tax incidence on part-business by a dream-like 20% of PBT by using a new benign effective rate of 17% announced for "those making fresh investments in manufacturing".
Markets cheered the move, so did leaders of Corporate India. At Friday's close, the BSE Sensex went up 5.3%, the largest daily rise in a decade. The Nifty went up 5.32%.
The largesse has met the long-standing demand from the industry for the headline corporate tax rate comparable to the Asian peers (see chart), but it widened the tax disparity between domestic and foreign companies with branch operations here, the larger ones of which are under a rate of 44%.
For sure, the steps, aimed at creating a "virtuous cycle of investments", will disturb the Centre's fiscal maths in a big way and will necessitate a major reformulation of the medium-term fiscal glide path, as per which the fiscal deficit is to be 3.3% of GDP in FY20 and the FRBM-mandated 3% in FY21. Ceteris paribus, the fiscal deficit this fiscal will widen to around 4% owing to the stimulus; if extra transfers from RBI are counted, the deficit's size could be 3.8%.
Large infrastructure, oil&gas and capital-goods companies, along with banks and automobile firms, will benefit the most as these firms, using less and less of the tax incentives and waivers now with these being progressively phased out, are under effective tax rates of 32-35%.
As for firms that still enjoy incentives and therefore end up paying minimum alternate tax (MAT) on book profits, the benefit is lower,
as it corresponds to the 3.5 percentage points reduction in effective MAT rate to 15%. Most IT firms are in this category.
When asked if the Centre was still sticking to the budgeted fiscal targets for FY20, Sitharaman said, "are conscious of the impact of the tax rate cuts on the fiscal deficit. We are quite seized of all these details. We will be taking all of them on board to reconcile as to how the situation is now and how we want to take it forward".
Given that tax buoyancy is low and net tax receipts have grown at just 15.8% in April-July against an increase of 29.5% required to meet the FY20 target, the big tax reliefs look even more generous. On the other revenue fronts like disinvestment too, the Centre is facing challenges while an extra Rs 58,000 crore received from the Reserve Bank of India is a source of comfort. A likely fall in the nominal GDP from the level seen in the Budget poses another risk to the charted fiscal path.
It is a vexed question whether the cumulative impact of the latest steps would give an opportune impetus to aggregate demand, with analysts differing in their views on this. Any pick-up in investments by companies could be partly negated by a reduced headroom for budgetary capital spending by the Centre, though this could be marginal as such spending is just about 5% of aggregate investment.
It is also uncertain if and to what extent the tax cuts for firms could give a timely leg-up to lagging private consumption. Of course, the cut in corporate tax could improve firms’ profitability in the coming quarters, but the extent of this would also be reliant on how fast the demand conditions in the economy improve.
Public spending this year could, however, get a boost from state governments and their companies, while some decline estimated earlier of central PSU capex this year could be partly addressed as they too are to get the benefit of the latest tax cuts.
Corporate tax rate cut decoded! Why FM Sitharaman’s announcement is a Diwali bonanza for economy
Prime Minister Narendra Modi termed the move as ‘historic’. He tweeted: "It will give a great stimulus to #MakeInIndia, attract private investment from across the globe, improve competitiveness of our private sector, create more jobs and result in a win-win for 130 crore Indians." Calling the big tax reliefs a "bold move", RBI governor Shaktikanta Das said it would be highly positive for the economy.
To be sure, domestic companies will have now the option of paying tax on their income effective FY20 at 22% (25.17% including surcharge and cess) or pay the 30% rate (34.94%) and avail themselves of assorted incentives to reduce the actual tax incidence. If the latter route is still used (there are only small section of firms which would still find this route attractive, tax experts say), then if they fall below the MAT threshold, the new MAT rate will be 18.5%, against 15% previously.
Also, effective this fiscal, any new domestic company formed on or after October 1, 2019, and making fresh investment in manufacturing will have the option to pay corporate income tax at a rate of 15% (17.1% inclusive of surcharge and cess), provided they don’t avail themselves of exemptions and incentives. Currently, the peak rate for domestic manufacturing companies, set up on or after March 2016 and not claiming any incentives or exemptions, is 29.12%.