Has Modi govt reduced the tax burden for India Inc?

The government's plan to cut the corporation tax rate while phasing out exemptions may be sound, but it may not mean a reduced tax burden for India Inc, notes A K Bhattacharya.

Finance Minister Arun Jaitley had announced in February this year that he planned to reduce the corporation tax rate from 30 per cent to 25 per cent over the next four years.

That reduction would not come alone, he had said. Along with the cut, there would be a corresponding phase-out of tax exemptions.

India Inc had then celebrated the announcement in the hope that its overall liability on account of corporation tax would decline by five percentage points. Were those celebrations a little premature?

The Central Board of Direct Taxes has now moved a note detailing a schedule of phasing out the various exemptions that result in foregone revenues as a consequence.

What it reveals should make India Inc wonder if the new regime of a lower corporation tax without the exemptions would mean an increase in the effective rate of corporation tax on it.

Consider the following. If the Union government phases out all the corporation tax exemptions it offers to India Inc, it would increase its total tax collections under this head by at least 15 per cent.

In other words, the government's corporation tax collections, which were Rs 4.26 lakh crore last year, would have increased to Rs 4.88 lakh crore if all the current exemptions were withdrawn. 

To place this windfall gain in context, it would be appropriate to mention that since 2007-08, the annual growth in corporation tax collections has been higher than 15 per cent only in two years.

If without changing the tax rate and by simply withdrawing the exemptions, corporation tax collections go up by 15 per cent, the obvious question would be why the government has been slow in moving in this direction.

A bigger question would be whether the move would upset India Inc. If the effective corporation tax rate, after taking into account the exemptions, is estimated at 23 per cent (remember that this is an average rate and not all companies enjoy this advantage), then removing all the exemptions should raise the effective rate to closer to 30 per cent.

Now a reduction in the corporation tax rate to 25 per cent essentially means the actual rate for many companies would go up, and not decline.

All those companies, which are carrying a tax burden at the rate of 25 per cent or less, would have to shell out more or pay at the same rate.

Only those, who are now paying more than 25 per cent tax would benefit.

There are more than 4,000 companies that operate in over 200 special economic zones across the country.

They enjoy a host of tax concessions on their exports. Last year, revenues foregone by the government on account of tax exemptions on exports by units in the special economic zones were estimated at Rs 18,394 crore (Rs 183.94 billion), compared to Rs 17,036 crore (Rs 170.36 billion)  in the previous year.

If these exemptions go away, not only will the government gain by way of higher tax collection, but the new tax burden on these 4,000 companies would be substantial.

This will not only affect their profitability, but will also undermine their export competitiveness.

They were set up on the premise that they would get the tax concession. But once that concession is gone, most of these units would have to adjust their costs to remain in business.

Another area where India Inc could be adversely affected by the phase-out of exemptions is their investments in plants and machinery.

Many companies enjoy depreciation benefits at an accelerated rate, which resulted in foregone revenues for the government to the tune of Rs 37,010 crore (Rs 370.10 billion) in 2014-15, compared to Rs 34,278 crore (Rs 342.78 billion) in 2013-14.

If the depreciation rate comes down, companies making investments in plants and machinery would have to shell out more tax at the end of the year.

The overall corporation tax rate may come down, but the actual tax incidence on companies may not decline after these exemptions and deductions are disallowed. 

Who will gain from the proposed tax rationalisation exercise? Apart from the Union government, whose gross corporation tax collections would go up by at least 15 per cent, it is the states which would gain.

Gross corporation tax collections account for about a third of total tax revenues of the Union government.

Thus a 15 per cent increase in corporation tax collections would raise total tax revenues by five per cent.

In other words, states too would gain as they now have a share of around 36 per cent in the Centre's gross tax revenues.

Tax experts would of course argue that end-use-based tax exemptions are not a healthy practice as these concessions result in sub-optimal allocation of resources.

Companies undertake investments not because they always need to do so, but to take advantage of a tax benefit.

The government move to phase out exemptions may thus be sound, but it may not mean a reduced tax burden for India Inc.

Another crucial issue would be the calibration between the reduction in the corporation tax rate and the phase-out of the exemptions.

Any imbalance in the sequencing of cutting the tax rate and ending the exemptions could further upset India Inc.

The Long View is an occasional series that will analyse different scenarios.