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Saturday, Nov 06, 2004

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Opinion - Taxation
Corporate - Investments

When companies can sweat it out...

K. Parthasarathi

... do we need to reduce corporate tax, asks K. Parthasarathi

ARE companies investing their earnings in productive activities, as is expected of them, or simply placing them in bonds, shares and mutual funds? What is the share of the "other income" in the total profits of these companies that clamour for lower rates of tax? Is this "other income" rising over the years?

While these are questions worth pursuing, what is obvious is that companies enjoy soft rates of interest. Predictably, companies have swapped the high interest debts with newer ones carrying lower rates. These have reflected favourably in their bottom lines, signifying that the higher profits are not necessarily from increased sales or higher productivity.

It would be good to know how much of these increased earnings have been utilised for acquisition of new plants and machineries and whether the purpose of a soft rate regime has been fulfilled.

Can it be expected with certainty that the increased earnings out of a reduction in the corporate tax would not be deployed for investing in bonds or funds to earn interest or in speculation? Rather than reduce the tax for all, is it possible to give a benefit of lower tax for the portion deployed for investment? This would give an impetus for larger investments in building productive assets.

There is yet another point made by the manufacturing industries, perhaps rightly, that the services sector, whose share in the GDP is substantial, contribute much less towards taxes than the industrial sector whose share in GDP is lower than the services sector.

As per RBI's FY03 revised estimates services, agricultural and industrial sectors contributed 56 per cent, 22 per cent and 22 per cent respectively to GDP.

The industrial sector is sore that it is being asked to bear a larger burden of taxes. It is true that the effective tax rate of services sector was much lower than the manufacturing sector in a sample of 30 cases. This raises the question whether taxes are equitably administered and why the services sectors get away with a smaller contribution towards the revenues of the Government.

Unfortunately, given the precarious situation of growing fiscal deficit and mounting public debts, with practically very few avenues for finding the resources for undertaking major poverty reduction measures, reducing corporate taxes should be of least priority. The statutory rate of tax in India is not high in comparison to some developed countries.

Although there appears a broad convergence of corporate statutory tax rates amongst the different countries, the tax rates imposed and the revenue generated among these countries bear no resemblance owing to the varying tax systems.

It appears the ratio of total corporate taxes paid to the pre-tax corporate profits vary from 50 per cent in Japan, Italy and Australia to 10 per cent in the US, the UK and Canada. There is, therefore, little point in comparing with other countries as the ground realities such as the state of economy, the extent of development, the poverty level and the state of infrastructure differ from country to country. In India, too, the paper rate bears little relation to what companies actually pay after taking into account the depreciation, investment credits, deductions for operating losses, and a wide variety of other tax benefits.

As a result, the tax base has always been very narrow not consistent with growth in corporate profits. Many companies took shelter under these tax preferences to pay zero tax, leading to the introduction of MAT. There is still no limit to their insatiability.

If we are to achieve the desired growth rate, capital expenditure in areas of power, roads and infrastructure that has been crowded out both at the centre and state levels has to be restored. There is the compelling need to raise the tax to GDP ratio from the present 9 per cent to around 15 per cent in five years. A formidable task indeed.

There is a strong case for a revision of the corporate tax from the flat rate to a graded one with higher rate slabs for companies that wallow in high profits.

A flat rate for corporate sector seems incongruent when seen with direct taxes on the income of the individuals graded with different slabs. The argument that corporate tax should generally be lower than direct income-tax will not hold water in our country where the tax base is very small, most of its people poor and the tax-GDP ratio, low. The Finance Minister should explore the possibility of having three slabs of 30 per cent, 35 per cent, and 40 per cent with suitable limits that should bring in the much-needed larger revenue to the Government.

The fear that this will deter foreign investors appears exaggerated, if we take note of the fact that deployment of profits towards productive activities can reduce the tax rate. It is not a fact that healthy economies can be sustained only with low corporate tax rates and that extensive corporate tax benefits revive stagnant economies.

Amongst the free-market nations Japan and West Germany have very high corporate tax rates. The Finance Minister should not succumb to the pressures on grounds of political expediency and must examine de novo the case for introduction of a graded tax.

Simultaneously, it is necessary to broaden the tax base by minimising the tax concessions and to abridge the gap between the nominal and effective corporate tax rates. From out of several choices before him, he should select that which benefits a larger section of the country.

(The author is a Chennai-based freelance writer.)

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