By Rajesh Gandhi & Gaurav Chandak, Deloitte Haskins & Sells LLP, Mumbai, India
In a development that surprised businesses and the stock market, India’s Finance Minister on Friday announced a significant reduction in the corporate tax rates.
While the Indian government announced a series of measures in the last few weeks aimed at reversing the slowdown in the economy, Friday’s announcement triggered a paradigm shift in sentiments, delivering better-than-expected support to the economy, especially to the manufacturing sector.
The changes were announced in an ordinance and are therefore immediately enacted into law. They are thus effective from the current financial year, i.e. April 1, 2019.
Through this radical change, the Indian government has not only initiated steps to boost the economy but to also make India an attractive investment and manufacturing destination, compared to its Asian peers.
The tax rate reduction will result in a revenue loss equivalent to USD 20 billion and it will be interesting to see what steps the government takes to bridge the gap and maintain fiscal deficit discipline.
Reduction in tax rates
Before Friday’s announcement, domestic companies were subject to base tax rate of 25 percent where turnover is less than INR 4,000 million (approx. USD 57 million). After considering surcharge and cess, the effective tax rate for such domestic companies ranged from approximately 26 percent to 29.12 percent.
Further, for domestic companies with turnover of more than INR 4,000 million, the base tax rate before the announcement was 30 percent. After considering surcharge and cess, the effective tax rate ranged from 31.20 percent to 34.94 percent.
The Indian tax law also provides for book profit taxation (also called the minimum alternate tax or MAT) in cases where book profit tax is higher than the tax under normal computational provisions.
The base tax rate under MAT was 18.5 percent, and the effective tax rate ranged from 19.24 percent to 21.55 percent.
New tax rate
The new Indian ordinance provides an option to domestic companies, irrespective of the turnover, to be taxed at the base rate of 22 percent as long as the company does not avail of any tax exemption or incentive under Indian tax law.
After considering surcharge and cess, the new effective tax rate works out to 25.17 percent. This will result in tax savings for domestic companies in the range of approximately 1–10 percent.
Further, it has also been provided that MAT or book profit taxation shall not be applicable to domestic companies that have opted to be taxed at the reduced tax rate.
The new ordinance further provides that once the option is exercised, it cannot be withdrawn. Further, no claim for the specified exemptions or incentives is permitted.
In addition, carry forward of tax losses (NOLs) will not be eligible for offset if the losses were attributable to specified exemptions or incentives claimed by the taxpayer.
New 15 percent Indian tax rate for manufacturers
Prior to the announcement, domestic companies that were engaged in manufacturing activities only and that were set-up after March 1, 2016, were subject to a base tax rate of 25 percent.
After considering surcharge and cess, the effective tax rate for such domestic companies ranged from 26–29.12 percent.
These domestic manufacturing companies were also subject to MAT or book profit tax at 18.5 percent. The effective tax rate ranged from 19.24–21.55 percent.
An option has now been provided to domestic companies set up after October 1, 2019, and engaged in only manufacturing activities to be taxed at the base rate of 15 percent.
After considering surcharge and cess, the effective tax rate works out to approximately 17 percent. This will result in tax savings of approximately 12 percent for newly set-up domestic companies that are engaged only in manufacturing activities.
Anti-abuse provisions have also been prescribed to ensure that existing companies do not avail of the concessional tax rate for brownfield investments by simply incorporating new companies and transferring the existing business to new companies.
It has also been provided that MAT or book profit taxation shall not be applicable for such domestic manufacturing companies that have preferred an option to be taxed at the reduced tax rate.
It should be noted that once the option is exercised, it cannot be withdrawn and that manufacturing activity needs to commence on or before March 31, 2023.
No claim for the specified exemptions or incentives is permitted and carry forward of tax losses (NOLs) will not be eligible for offsetting if the losses were attributable to specified exemptions or incentives claimed by the taxpayer.
Further, the domestic transfer pricing provisions are applicable where transactions are undertaken with a person having a close connection.
Domestic companies continuing to avail of exemption or incentives
Where domestic companies continue to claim tax exemptions or incentives, these companies will continue to be taxed at the rate applicable before the announcement.
However, once the period of exemption or incentive (such as a tax holiday) expires, companies will have an option to be taxed at a concessional base rate of 22 percent as outlined above.
Reduction in MAT rates
Irrespective of whether domestic companies were availing exemption or incentives, MAT provisions were applicable at the base tax rate of 18.5 percent where tax under MAT provisions was higher than normal provisions. The effective tax rate ranged from 19.24 – 21.55 percent.
It has now been provided that the base tax rate under the MAT provisions will be reduced from 18.5 percent to 15 percent.
This will result in 3.5 percent savings for domestic companies that were paying tax under MAT provisions.
Snapshot of tax rates
Here is a quick snapshot of tax rates for reference:
|
Type of Company |
Exemption/ incentive availed |
Rates prior to announcement |
Rates post announcement |
||
|
Normal Tax |
MAT |
Revised Tax Rate |
MAT Rate |
||
|
New manufacturing companies incorporated after October 1, 2019 |
Not availed |
~26% – 35% |
~19% – 22% |
~17% |
Nil |
|
Existing Domestic Companies |
Not availed |
~26% – 35% |
~19% – 22% |
~25%^ |
Nil |
|
Availed |
~26% – 35% |
~19% – 22% |
No change |
~17.5% |
|
We have also provided a comparative snapshot of tax rates of select Asian countries for reference:
|
Particulars/ Countries |
China |
India |
Philippines |
Malaysia |
Thailand |
Vietnam |
|
National rates |
25% |
22% |
30% |
24% |
20% |
20% |
Source: Deloitte – Corporate Tax Rates 2019
Relief on buy-back tax
Prior to Finance Act, 2019, buyback tax (i.e. tax payable by a company on profits distributed to shareholders by way of buyback of shares) of approximately 20 percent was levied only in cases where the buyback was undertaken by unlisted companies. The income from buyback of shares was exempt in the hands of the shareholder.
Finance Act, 2019 extended the applicability of buyback to listed shares. The levy came into effect immediately from the date of announcement of the budget, i.e. July 5, 2019.
According to Friday’s ordinance, it is now clarified that listed companies which have announced buyback before July 5, 2019, will not have to pay buyback tax.
Foreign portfolio investors (FPIs)
An enhanced surcharge of 25 percent and 37 percent was introduced by the Finance Act, 2019 for non-corporate taxpayers including FPIs having income beyond a prescribed threshold.
While India’s Finance Minister had announced earlier that these surcharges will be rolled back, the rollback has been formalised by way of the ordinance clarifying that the enhanced surcharge of 25 percent and 37 percent shall not apply to capital gains arising to FPIs from all types of securities and to capital gains arising to any other taxpayer on the transfer of equity shares in a company, a unit of an equity-oriented fund, a unit of a real estate investment trust, or a unit of an infrastructure investment trust.
Effectively, now only interest income of FPIs will be subject to the higher surcharge of 25%/37%.
The highest effective tax rate for FPIs on long-term capital gains on equity shares on the stock market now is reduced from 14.248 percent to 11.96 percent and on short term capital gains, it is reduced from 21.372 percent to 17.94 percent.
Key takeaways
While domestic companies need to start crunching the numbers to determine which option works best, at the optimum level, companies would be able to increase their bottom line by 10 percent due to the tax rate reduction.
Domestic companies will need to factor in the specified benefits and incentives such as tax holidays for exports, investment-linked allowances, the weighted allowance on specified expenses, etc. to determine whether to opt for the reduced tax rate.
It should also be noted that the ordinance has not specified whether MAT credit carried forward from the past years can still be availed even though MAT is not applicable for the subsequent years.
Another aspect to note is that these announcements are only applicable to domestic companies and do not impact tax rates of other legal forms of doing business in India such as limited liability partnerships (LLP), branches, etc.
Recent trends indicated that LLPs were being increasingly considered by both domestic and foreign investors due to the non-applicability of the dividend distribution tax on distributions of profits to partners, among other factors.
However, the LLP framework is no longer as attractive as it was prior to the announcement. Assuming a domestic company distributes its entire profit as a dividend, the savings in effective tax rates under the LLP option has now been reduced to approximately 3 percent compared to 6.25 percent to 11 percent in the past.
While these measures are expected to reignite the wheels of the economy by increasing investment, they have also raised expectations that the government might reduce personal tax rates to boost consumption, thereby powering the economy to new heights.
–Rajesh Gandhi is a Partner at Deloitte Haskins & Sells LLP, Mumbai, India
–Gaurav Chandak is Senior Manager at Deloitte Haskins & Sells LLP, Mumbai, India
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