Corporate tax cut unlikely to impact credit profile of top companies

The reduction in corporate tax rates is unlikely to materially impact the credit profile of large corporates, although the risk of fiscal slippage is likely to increase significantly.

An India Ratings and Research analysis of the top 1,000 listed corporates by revenue indicates that the total quantum of reduction in tax liability in FY20 is likely to range between ₹60,000 crore and ₹65000 crore.

Of this, 50-60 per cent of the benefit is likely to accrue to corporates with a relatively healthy credit profile marked by low leverage and comfortable interest coverage.

Per the rating agency’s estimate, about 54 per cent of the total tax savings are likely to accrue to consumer goods (12.18 per cent), auto (11.10 per cent), oil and gas (10.68 per cent), information technology (9.88 per cent), and metals and mining sectors (9.79 per cent) alone.

Within these sectors as well, corporates with a gross leverage of less than 1.50 times are likely to account for more than half of the total tax savings. This is primarily on account of a significant tax shield created by the high interest outgo of highly leveraged corporates.

Also read:Corporate tax stimulus might not lead to higher buybacks or dividends

Ind-Ra’s study indicates that most of the stressed corporates continue to report a relatively low effective tax rate (24.31 per cent in FY18, per the agency’s estimates), while their tax outgo as a proportion of revenue stood at 1.38 per cent in FY18. Consequently, the impact on the cash flows of corporates is unlikely to be material in the foreseeable future.

The reduction in tax liability permeates to broader economic growth primarily in the form of higher payments to factors of production in terms of higher wages, increase in manufacturing activity or investments. As demand continues to be lax and capacity utilisation remains modest, corporates have been reporting pressures on their profitability indicators.

This largely limits the likelihood of the corporates transmitting the benefit of lower tax rates directly. In the absence of such transmission, household demand by itself is unlikely to meaningfully increase, and therefore the boost to economic growth is likely to be limited.

Nonetheless, the indirect impact in the form of higher returns on shareholders’ funds cannot be ignored. The lower tax rate, especially on new manufacturing facilities, is likely to reduce the payback period for fresh capital expenditure undertaken by corporates in the long run.

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