The right cut

There are two strong reasons for reviewing the deductions and exemptions available to companies under the Income Tax Act — to simplify the tax regime and weed out the incentives that are ill-chosen, misused and ineffective. The effective rate of tax paid by Indian companies in 2013-14 was 23.22 per cent — far below the statutory rate of 32.44 per cent. But the disturbing fact is that larger companies, which accounted for 40 per cent of the overall profit earned by all companies before tax, paid tax at an average of less than 20 per cent. At the same time, smaller companies paid higher tax, suggesting that these exemptions are availed of mainly by larger companies with better tax management capabilities. The Centre is now proposing to reduce the rate allowed for accelerated depreciation, phase out tax exemptions for companies located in specific areas, remove weighted deduction given to certain kinds of capital expenditure and R&D and specify April 1, 2017 as the date for commencing activity to claim certain exemptions. Of the deductions available, the accelerated depreciation exemption hurts the exchequer as it accounts for two-thirds of the revenue foregone from Indian companies. The government is right in targeting this incentive as it is clearly not helping boost capital expenditure. Investment as a percentage of GDP has been steadily declining, down from 37 per cent in 2011 to 29 per cent currently. It is doubtful if retaining the tax incentives will help better the situation as companies are currently reluctant to spend on additional capacities due to various reasons. One, slack demand, both external as well as domestic, is making them go slow. Two, the crash in commodity market has led many manufacturers to wait for a revival in these prices before pumping in further sums to add capacity. Three, those that are already leveraged are unable to take on additional debt to finance new projects. Further, the lack of demand is resulting in very low capacity utilisation of manufacturing units — around 70 per cent. This means that output can be improved without capacity expansion. Once demand revives, maybe helped along by the Seventh Pay Commission and OROP payouts and increased government investment on infrastructure, the output of companies will also improve.

However, the Centre must reconsider its decision to reduce incentives for research and development. The country suffers from the unwillingness of entrepreneurs to spend on R&D, which in turn prevents companies from moving up the value chain. If this sop is withdrawn, the government should draw up an alternative plan to promote higher spending on research. Similarly, the withdrawal of weighted deduction for expenditure incurred for skill development is also not a good idea since lack of skilled manpower is another factor that impedes Indian manufacturing. A clearer road-map on the reduction of corporate tax rate also needs to be spelt out.

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