Why India needs to reduce its effective corporate tax rate: An analysis

Why India needs to reduce its effective corporate tax rate: An analysis

24 Jul 2019
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The Finance Minister of India, in the Budget 2019, announced a corporate tax cut of 5% — bringing it down to 25% from 30% — for companies that record an annual turnover of up to Rs 400 crores.

Announcing the tax cuts, the finance minister said that the new tax rates will now be applied to 99.39% of companies and that only 0.7% of companies will be in the slab of higher tax rates.

"Currently, a lower rate of 25 per cent is only applicable to companies having an annual turnover of up to Rs 250 crore. I propose to include all companies having an annual turnover of Rs 400 crore," said the finance minister during the Budget speech in the Lok Sabha on 5th July.

Corporate tax is imposed on the net income of public and private companies that are registered in India under the Companies Act 1956.

 

The move is said to cost the government around Rs 7,000 crore as the provision sees a revision from last year when the 25% slab was only applicable for companies that had a company of Rs 250 crore.

The Budget 2019, which brought in the lowered tax bracket can be seen as an attempt by the government to provide more incentive to smaller companies. This move could be beneficial for companies and startups — to provide them with a conducive environment for their growth. The budget also mentioned other forms of relaxation to these companies, on conditions of setoff ad carry forward of losses.

 

Hindsights of the tax cut

While corporate taxes are viewed by the public as an aggressive and harmless way to raise the revenue of the government, economists have argued that raising taxes for companies also lead to a reduced investment, which in turn brings down the rate of employment — an issue which has troubled the present government and found a way into the oppositions' arsenal in the general elections held this year.

It is believed that the costs that come with higher tax rates for the companies fall on the shoulders of employers who seek to move their operation to a state with lower tax brackets, as well as the workers who cannot afford to shift their skills or move to the new place. The workers are more immobile than the owners of capital — a loss of workforce, which in turn hampers the growth of the economy. This is called the classic Harberger intuition applicable to the closed economy. It states that the more the factors of productions such as the capital and workers can shift to lower-tax alternatives, the less do they wear the burden of taxation.

 

Focus on startups

 

The tax cuts also focus on India's strength — it's a hugely significant market, something which investors have been targeting for long. A lower tax for startups would mean that they can focus more on attracting investors — at least have the financial means to spread out in the fields of innovation and service that could use funding rounds. Besides, the angel funding for startups, lately, has taken a dip as well. According to Inc42, the number of angel investors deals in India tumble down in 2017 by 22%, while In 2018, the number of unique angel investors saw a 42% drop compared to 2016 and a 30% drop compared to 2017.

 

It has also been stated that the improvements in education standards to garner better skill sets and to improve the overall infrastructure in which companies tend to operate, can also have a direct impact on the growth of these companies.

 

However, a system which complements the work sphere of a company, along with effective tax cuts would mean that companies can get more involved in their operations in India and try to expand their services to create more jobs.

 

According to the income tax department, about 100 firms forming 0.012% of the total 8,00,000 companies in the country contribute more than 40% of the collection of corporate tax in India. Between 1997 and 2019, the average corporate tax rate stood at 34.94 %. Between 1985 and 2018, the average global corporate tax rate has fallen by more than half from 49 to 24%.

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