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How to make the corporate tax cuts work

N Madhavan | Updated on September 26, 2019 Published on September 26, 2019

With a focussed approach, India can bag a fair share of the capacity re-alignment that US-China trade war has triggered

The Modi government’s decision to effect a sharp cut in the corporate tax rate on September 20 has been by far the most significant stimulus that has been offered in a bid to revive an economy that has significantly slowed, weighed down by both cyclical and structural issues. Through this ₹1.45 lakh crore gambit, the government hopes to unleash the animal spirits that have been sorely absent in the economy and pump-prime the GDP that is fast hurtling towards the erstwhile ‘Hindu rate of growth’.

The government’s choice of an investment-led growth revival (the lower corporate tax rate should ideally attract lots of investment, create jobs and catalyse economic growth) rather than a consumption-led one (offering sops to the people on the hope that they will spend more and the ensuing demand will push up GDP growth) is right. With low consumer confidence, any money put in the hands of the people would be saved rather than spent and such a move never creates a lasting demand. Critics have argued that, in the absence of demand, corporates have no incentive to invest.

The government, it appears, is banking on the improved sentiment that this announcement could bring for people to open up their purse strings. The stock market’s celebration of the move is, however, premature as the tax cuts will be effective only if the government follows up the announcement with some calibrated measures. Otherwise, all it will be left with is a gaping hole in its fiscal numbers.

There are two parts to the tax cut — for existing companies and new investments. While a 22 per cent tax rate (almost a 10 percentage point reduction in effective tax rate) for existing companies looks attractive on paper, it is not clear how many of them will go for it. Those companies that have made significant capital investments may not as they will end up losing out on additional depreciation, investment allowances and other benefits which, if not considered, will push up their taxes even at the lower rate.

Then there are the issues of MAT credit and carried-forward losses that need further clarification. Such companies will have to be content with the 3 per cent reduction in MAT. Only those corporates that are not availing themselves of the aforementioned benefits will opt for the new rate. Experts say that the ₹1.45 lakh crore revenue loss the government has estimated is too optimistic as most large companies may not opt for the new rate.

Holds more promise

It is the second part of the tax cut, for new investments, that appears more promising when it comes to reviving the economy. Any new investment by a domestic company registered after October 1, 2019, will have an effective tax rate of just 17.01 per cent as against the earlier 29.12 per cent. The only condition is that it will have to commence production before March 31, 2023. This incentive has been offered by the government with an eye on the realignment of the global supply chain that is taking place consequent to the US-China trade war. If India plays its card well, it can grab a fair share of this capacity and `Make in India’ for the world will get a massive fillip.

The opportunity is clearly there. US-China relationship is undergoing a fundamental change. Before the 2008 financial crisis they saw each other as ‘co-operating rivals’ who were content with a ‘win-win economic engagement’. That was when the US economy was four times the size of China’s. Post the ‘Great Recession’, this gap narrowed. By 2012, the US economy was only double China’s.

This rapid catch-up has unnerved many in the US. Chinese, for their part, feel that the trade war has been unleashed to prevent their country from taking the rightful place in the world.

That these two nations neither see eye-to-eye on political values nor have common security interests has only complicated the relationship. They now see each other as ‘competing rivals’. Under the circumstances, their future relationship is likely to be, at best, frosty.

This change has caught American companies on the wrong foot. Taking advantage of low costs and favourable policies, they had increased their dependence on China over the last three decades for both their supply-chain needs and manufacturing capacity. Now that the ground has shifted beneath their feet they are being forced to de-risk their operations. They have been scouting for opportunities in other countries, including India.

But grabbing a share of China’s supply chain is not easy. Over the years it has built such a scale that cost of production is almost unmatchable by any other country. That they have a superb road and port infrastructure ensures overall costs remain low. In fact, if some US companies are to be believed, their sourcing costs from China are still lower than other options even after the recently levied tariffs.

Identify high-potential sectors

A sharp reduction in corporate tax rate has levelled the playing field substantially for Indian companies. At 30 per cent tax rate, Indian manufacturing was pricing itself out of the market. Not any more. What the government should do next is to identify sectors that offer the best potential in terms of cost for re-locating capacity from China and hand-hold investments in them.

Only those sectors that have a strong domestic market, a well developed supply-chain and significant exports can come anywhere near matching China’s costs. Auto component, textile and leather sectors come to mind immediately. Rather than spread the cheese fine, the government should focus its energies on ensuring that it promotes investments in such sectors for best outcomes.

Entrepreneurs, on their part, should drop their risk aversion and stick their necks out to invest in creating large capacities that would be needed to meet the demand that shifts out of China. Even though the current economic prospects may look gloomy, the opportunity from US-China trade war is real and permanent. As the Chinese economy grows, the rivalry between the two countries will only increase. India can position itself as an alternative manufacturing hub in select sectors. For that, the corporate tax cut for fresh investments is a good beginning.

Published on September 26, 2019
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