In September 2019, the Finance Minister Nirmala Sitharaman had made a deep cut in the corporate tax rate from 30% to 22%. India’s combined effective tax rate was among the highest in the world. After the tax cut, the effective tax rate for all domestic companies has been reduced to 25.17%. India’s base corporate tax, due to this move, is now on par with most Asian countries – increasing its competitiveness in the global market. This move comes in response to the brewing problem of the economic slowdown in the country. The cut in the corporate tax rate was seen as a boon by the corporates in the midst of the growing crisis within the Indian economy.
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What is tax?
- Taxes are the involuntary charges levied on individuals or corporations.
- This is enforced by a government entity – whether local, regional or Central – to finance the government activities.
- These taxes are collected to fund the public works and services and to build/maintain the infrastructure used by the public and the government.
- Taxation in India is divided into two types – direct taxes and indirect taxes.
What is Corporate Tax?
- Corporate tax comes under direct taxes.
- Direct tax is paid directly by the individual to the government.
- It is levied on the individual or corporations based on their income earned during a fiscal year.
- All the taxpayers are registered under the Income Tax Department and they pay taxes based on the income they earn annually.
- The direct taxes are divided into Income tax and Corporate Tax.
- Income Tax: This is the tax paid by the individual taxpayers to the government based on their individual annual incomes. They are taxed on the basis of slabs at different rates. All the taxpayers are registered under the Income Tax Department and they pay taxes based on the income they earn annually.
- Corporate Tax: This is the tax paid by the companies that are registered under the Companies Act, 1956 on the net profit obtained from the businesses. This taxation is based on the specific rates as prescribed by the Income Tax Act, 1961. The Income Tax department changes the rates of these taxes every year.
How is the corporate tax levied in India?
- The domestic and foreign companies operating within the Indian Territory are liable to pay the corporate taxes.
- The domestic companies are taxed based on their universal income.
- The foreign companies are taxed based on the income earned by them within the Indian Territory i.e., the income that comes from India.
- In order to levy taxes on the different types of companies, the Income Tax Act defined them as follows:
- Domestic Companies are those that are registered under the Companies Act of India. It also takes into account the companies registered in the foreign countries having their whole management and control within India. These companies include both public and private companies.
- Foreign companies are those that are not registered under the Companies Act. These companies have their headquarters located in a foreign territory.
Why has the government recently reduced the corporate tax?
- The Central Government, on September 20, had reduced the corporate tax rate.
- If the cess and surcharges are included, the rate would come down from 35% to 25%.
- If they are not included, then it would come down to 22% from 30%
- For the manufacturing firms that are set up after October 1, 2019, and starting the operations by March 31, 2023, the effective tax rate will fall from 29.1% to17%.
- This comes ahead of the festive-season – the one many sectors like automobiles have been relying on to boost their sales in the midst of the economic slowdown.
- This is one of the many steps taken by the government to deal with the slowing down of the economic growth of the country, which has dropped to 5% in the June quarter.
- The major reason for this move may be due to disapproval shown by the companies against the government’s economic policies.
- Many investors began pulling their money out of the country due to the additional taxes levied on them during the budget in July this year.
- The government, through this move, is hoping to attract more investments into the country so as to boost the manufacturing sector which is facing a slowdown in recent months.
- The reduction of the corporate tax can provide an incentive to the private entities to produce or contribute more to the economy as they are given free rein over their profits.
How does this tax cut impact the Indian economy?
- The recent tax cut can make India more competitive in the global market.
- The present corporate tax rate in India is almost equivalent to that of those in East Asia.
- The tax cut is expected to cause an annual revenue loss of Rs.1.45 lakh crore when the government is already struggling to maintain its fiscal deficit target.
- On the positive side, it may help revive the manufacturing sector and increase the employment opportunities and investments within the country.
- The corporates will have more money. Therefore, they may either invest in new or existing ventures.
- It may also be used by the companies to pay off their old debts or increase dividends to their shareholders.
- This move can boost income tax collection. Thus it can compensate for the losses caused due to the corporate tax cut.
- The big companies are expected to get relief of almost 10% points in the effective tax rate including cess and surcharge.
- Singapore with 17% and Vietnam, Thailand, Taiwan, and Cambodia with 20% with 20% tax rate are only other countries apart from India which are who are providing low corporate tax rates.
- Furthermore, India is much better than China in terms of the tax rate, transparency and tax administration.
- Thus, India, through this move, can take advantage of the recent trade tensions between China and the US as the reduced tax rate can attract those investors who are looking to pull out investments in China.
- This may encourage companies to increase their investments and may even look to expand their base within India.
- The demand slowdown in manufacturing may also be due to the reduction of supply or liquidity crunch due to GST or other reforms.
- Thus the corporate tax-cut can help boost the supply and employment opportunities within India.
Why is this move criticized?
- This move is seen by some as a concession to the corporate sector rather than a long-term structural reform to enhance economic growth.
- Some believe that this recent tax cut cannot boost the demand within the economy by itself.
- This tax cut can increase the government’s revenue deficit.
- The combined fiscal deficit of both the Centre and States in 2016-17 was almost 6% of the GDP target.
- This tax cut can force the government to borrow more, which may lead to problems in the bond market.
What can be the way forward?
- This tax cut must not be a temporary solution.
- The benefits of this move can be felt only if the government maintains this rate for a long period of time.
- To supplement this move, economic reforms must be made by the government to open up its markets for the purpose of increased inflow of investments into the country.
- The other reforms also should be implemented by the government to make India move competitive in the global arena.
- The government should also expand these tax cuts to small companies so that they too can compete with their larger rivals.
The corporate tax cut by the government is a need of the hour given the growing crisis within the manufacturing sectors of the country. It should be accompanied by economic reforms that promote the ease of doing business within the country so that India can make use of its full potential in the global market.