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In an effort to boost investments over the medium term, the government has announced a major reform of corporate tax rates. Read this article to know how the recent corporate tax cut is going to impact the economy.
The Lok Sabha recently passed a bill replacing an ordinance for bringing into effect reduction of corporate tax rates, The Economic Times reported. Taxation Laws (Amendment) Bill, 2019, will amend the Finance (No 2) Act, 2019 and the Income Tax Act, 1961. For existing businesses, the base corporate tax has been brought down from 30% to 22%, and from 25% to 15% for new manufacturing firms established after October 1, 2019, and commencing operations before March 31, 2023. The lower tax rate options to domestic companies are intended to help boost growth and attract new investments in the manufacturing sector.
IHS Markit said in a report that this move could significantly improve the relative competitiveness of the country’s corporation tax rates compared with other Asian industrial economies, The Economic Times stated. Before the latest tax reform measures, India's corporate tax rates had been comparatively high when measured against its regional peers, the report added. Over the medium term, the reduced rates may help enhance corporate investments in the country.
A publication by South Indian Bank has said that the tax drop would improve profitability of companies and boost Nifty earnings growth. Analysts have reportedly revised earnings estimates upwards (to 25% from 16% for 2019-20). It further added that levying 15% tax on new production facilities shall help attract global capital. With lower tax outgo, the country could witness a rise in profit-making businesses over time. The slashing of the rates might bring up their profit margins above 10%.
The present tax cut can help the economy grow further, as businesses will now have more money in their hands. They can use the funds to reinvest in existing firms or invest in new ventures, if they view this course as profitable. It is essential to understand that the corporate tax rate influences to a great deal the manner by which investors allocate capital across economies. There is always pressure on governments around the world to offer low tax rates to attract foreign investors. The latest tax cut is expected to make India more competitive on the global stage.
Meanwhile, it is necessary to note that the tax reduction also slows down economic activity as money in the hands of the government (in the form of tax revenues) is reduced. The publication has stated that the government will have to forgo revenue of Rs. 1.45 lakh crores, which would be 0.7% of GDP. If included to the budgeted fiscal deficit of 3.3% of GDP, the consequence will be major, with the fiscal deficit reaching 4.0%, the publication reported.
In the medium to long term (anywhere from two to five years), the reduction in corporate tax can help boost investments and increase the economy’s productive capacity. While there will be a slump in demand in the short term, investment decisions are generally taken after looking at long-term demand projections. In case demand is expected to rise, investments will yield results and with lower taxes, profits will be more. These investments will also create more jobs and increase earnings in due time.