India needs a combo of tax incentives and low tax rate
March, 19th 2015
The effective rate of corporate taxation in India is 23.2 percent for companies with an income of 100 million rupees ($1.6 million) or more, which is lower than the statutory rate by a full 10 percentage points. This is due to incentives to promote investments or to direct investments towards targeted activities.
But smaller companies have not been able to fully avail of the incentives. A study of 56,4787 companies by the Department of Economic Affairs for the year 2013-14 estimated that companies having an income of less than 100 million rupees ($1.5 million), excluding loss making companies, pay an effective corporate tax rate of 26.3 percent. These companies constitute more than 50 percent of firms in the study but earn less than 10 percent of the total income before tax.
Large companies with income of over 5 billion rupees ($79.7 million), numbering only 263, account for 60.3 percent of pretax income for all the companies and pay an effective tax of 20.68 percent against the statutory rate of 33.99 percent.
Other medium-sized companies numbering 6,325 had a 29 percent share in income before tax and a 31 percent share in taxes. The effective tax rate was 24 percent.
Also, the benefit of incentives accrues more to the public sector than their private counterparts. The 221 PSUs in the study earned 24 percent of the total pre-tax income, but paid only 20 percent of total taxes. As a result, the effective rate of taxation for PSUs was 19 percent against 24 percent for private players.
The projected revenue loss due to incentives in 2014-15 is estimated was 624 billion rupees ($9.94 billion). Accelerated depreciation and exemption on export profits from SEZs and power companies account for two-thirds of total incentives.
Accelerated depreciation alone account for one-third of revenue loss. But that is not really the right way to estimate revenue loss since total depreciation has to be paid in any case. With acceleration, the tax payable is only postponed and consequently, only the interest borne by government on the incentive should be considered as genuine loss.
When it comes to power, the sector was slow to attract investment because of excessive regulation, so removing incentives should not be considered. What about SEZs? Exports are critical and in an intensely competitive market, every country compensates exporters one way or the other. And benefits for companies in SEZs are anyway minimized by MAT against original tax exemption of export profits.
It would not be prudent to withdraw the incentives unless corporate tax is brought down substantially. A combination of tax incentives and a reasonable tax rate is best for a transitional economy like India.