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Corporate tax rate & links to incentives
October, 12th 2015

A sensible tax policy announcement by the finance minister in the last Union Budget was his intention to reduce the headline corporate tax (CIT) rate to 25 per cent. It would be decreased in phases pari passu with identification of alternate revenue sources. Subsequently on July 1, the government reassured that a linked policy package would follow within 45 days. It is awaited. Soon a new Budget exercise will begin. There is urgency in the matter.

India’s CIT rate including surcharge and education cess stands at 30.9 per cent for taxable profit less than Rs 1 crore, rising to 34.61 per cent above Rs 10 crore. For foreign companies, rates are 41.2 per cent and 43.26 per cent, respectively, though they do not pay the 15 per cent dividend distribution tax (plus surcharge and education cess on DDT) that domestic companies pay. This rate structure is among the highest in the world, comparing only with the United States (40 per cent), Argentina (35 per cent) and Brazil (34 per cent effective). The US frequently discusses corporate tax reform though it can essentially set it at will reflecting its economic might, while Argentina collects relatively little from individual income tax and Brazil from consumption or production taxes at the central level, their revenue dependence shifting disproportionately to CIT.

A selection of countries from where India attracts investment or where India’s own capital is going reveals that they generally offer better CIT rates including Australia (30), Germany (29.65), South Africa (28), Bangladesh (27.5), China, Colombia and Malaysia (25), Chile (22.5), Russia, Turkey and United Kingdom (20), and Singapore (17). Thus, India’s announcement of achieving 25 per cent is apt and timely.

Despite best intentions, there are real challenges in achieving 25 per cent. The prevailing effective CIT rate – how much tax is collected in proportion to corporate income – is 23 per cent. Thus, (1) the difference between 30.9/34.61 per cent and 23 per cent is substantial and mainly represents tax incentives (or tax “expenditures” quantified in every Union Budget). And (2) after the CIT rate reduction, there will remain very little revenue space between 25 per cent and 23 per cent to accommodate tax incentives (on a revenue neutral basis). Yet absence of tax incentives will be tough for industry to swallow, used as it is to special tax regimes. Hence the challenge is to convince productive sectors that a lower general rate would benefit all and remove the prevalent system of favours targeted towards narrow industry and service sector groups.

It is thus important to identify existing tax incentives and take a view of the landscape. To begin, they include agricultural income (Section 10(1)), new units in SEZs (Section 10AA), new 100 per cent export-oriented units (Section 10B), and charitable/non-profit organisations (Section 11). The next are infrastructure development in industrial undertakings (Section 80IA) including projects of highway, bridge and rail, water supply, water treatment, irrigation, sanitation, sewerage, solid waste, port, airport, inland waterway and others. This is followed by non-infrastructure (Section 80IB) such as cold chain facility (Subsection 11), processing, preserving and packaging fruits, vegetables and meat (Subsection 11A), biodegradable waste (Section 80JJA), rural hospitals (subsection 11B), and hospitals in non-excluded areas (subsection 11C). Some of these are being phased out while others not.

Others excluded from tax are offshore banking units (Section 80LA) and cooperative societies (Section 80P) engaged in most categories of economic activity. Another kind of incentives is regional, for special category states (Section 80IC) and North Eastern states (Section 80IE).

If prevailing conditions of infrastructure – be they highways, bridges, railways, hospitals, irrigation, sanitation or sewerage – or growth in the targeted states are considered, one immediately notices their sorry state. Incentives have not worked and continuing them would not help the sectors develop. Experience also reveals that even high profile NPOs may be prone to tax avoidance or even tax evasion despite the overall legitimacy of the sector. Certainly it is time for them to contribute to the exchequer in a regularised manner. Exclusion of export oriented profits from taxation made little sense in the past and even less at this point when India is flushed with foreign exchange. There can be little justification for continuing windfall profits generated by income- or profit-oriented tax incentives.

In the past, eradication of tax incentives has remained well-nigh impossible. In the 2001 Tenth Five Year Plan Committee Report that I chaired, tax incentives were listed in detail that Yashwant Sinha, then finance minister, promised to remove in his 2002 Union Budget. He barely began his task before he became external affairs minister. The 2009 Direct Tax Code on which we toiled from 2007, recommended a 25 per cent CIT rate and streamlined tax incentives but it was unsuccessful, for the 2010 DTC reinstated many (though DTC 2010 did correct some poor DTC 2009 features that were later re-installed in DTC 2013 ostensibly to protect powerful interests). I intensively managed the 2013 DTC as assigned by Finance Minister P Chidambaram, mainly to recoup lost reform areas and to carefully consider recommendations of Chairman Yashwant Sinha’s parliamentary finance committee. DTC 2013 did not go to Cabinet despite completing the rounds of line ministries. Detractors of fundamental tax reform and seekers of tax incentives remain in powerful places inside and outside government. Whether the present government can bite the bullet and finally eradicate incentives remains the crucial question.

Unless a slash and burn policy against tax incentives is unleashed, a 25 per cent headline CIT rate is infeasible. Government could afford to leave intact only a handful of investment incentives, while eschewing profit based incentives altogether. Help could have appeared from revenue productivity of a new GST but GST is unlikely to lead immediately to GDP growth or bountiful revenue reflecting its structural distortions from continuation of cascading. Thus a severe cut back of tax incentives is imperative, matched with a lower and more equitable CIT. This will impulse economic growth and, in turn, generate additional revenue. If the Finance Minister undertakes deep cuts in tax incentives through a pre-announced sequence comprising a three-year process, he could simultaneously achieve his stated policy of a 25 per cent headline CIT rate successfully.

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