Point blank. The corporate tax conundrum

The year 2019 was a watershed for corporate taxes as the rates were slashed to unleash the animal spirits of India Inc. and make them invest in capital formation. The largesse was triggered by the looming threat of a prolonged recession that year.

The tax cuts were massive — effective income tax on companies was slashed to 25.17 per cent, down from the highest rate of 34.94 per cent and the rate for minimum alternate tax was lowered from 18.5 per cent to 15 per cent. Companies responded with a thumping hurrah and there was a virtual stampede to move to the lower tax regime. Of the largest companies earning taxable income of over ₹500 crore, 246 had shifted to the new tax regime by the end of FY20 and only 130 remained in the old regime. These larger companies account for over 50 per cent of the taxable income.

It’s clear that the companies greatly benefited from the new tax regime. A businessline analysis of companies forming part of the Nifty500 index shows that the tax rate for these companies (based on the tax paid by companies and taxable profits) was 27.09 per cent prior to the tax cut, in FY19. It plunged steeply to 22.09 per cent by FY20 as companies made the most of the tax cut bonanza. The tax rate for these larger companies has been moving further lower since then and stood at 20.77 per cent towards the end of FY22.

There were initially concerns that the revenue collection from corporate taxes would decline due to the lower rates. But tax collections have been robust in the last two years, growing 39 per cent and 21 per cent in FY22 and FY23, respectively. What could be behind this conundrum of lower tax rate and higher tax collection?

Lower tax rate, higher collections

Corporate tax collections are directly impacted by the growth in the economy and tend to decline during periods of growth slowdown. There was a 16 per cent decline in corporate tax collection in FY20 as growth slid sharply due to slowing consumption caused by tightening bank liquidity. The next year was marred by Covid-led lockdowns and saw corporate tax revenue decline 17.8 per cent. But collections have picked up since then. The current year witnessed collections of ₹4.28-lakh crore between April and November 2022, compared with ₹3.53-lakh crore in the corresponding period the previous year.

One reason why collections are higher despite falling tax incidence is because the larger companies have been recording strong profit growth over the last two years. Taxable income of the companies forming part of Nifty500 grew 38 per cent in FY22. In fact, even during the Covid-hit FY21, the profits before tax of these companies grew 34 per cent due to super-normal profits of commodity companies. These larger companies were also able to garner the market share conceded by smaller companies, which faced economic distress due to the pandemic.

And not all companies have paid tax at the lower concessional rate. Around 107 companies have paid over 26 per cent of their taxable income as tax. But also, around 156 companies have paid less that 20 per cent of their income as tax. This shows that companies are being deft at making the most of tax exemptions and leeway to reduce their tax outgo.

A case in point is Reliance Industries, which paid tax at the rate of 1.68 per cent in FY22, making the best use of its battery of tax consultants to bring down its tax outgo.

Laffer curve at play

The improvement in corporate tax collection also proves the Laffer curve theory right. This theory had expounded that there are two consequences of tax cuts or increases — arithmetic and economic. While tax rate cut should result in reduced tax collection and vice versa for tax increases, based on arithmetic, the economic impact could be the reverse. As people or companies use the tax cuts to consume more, it results in increase in demand which results in increasing tax revenue. Similarly, tax increases could eventually lead to lower demand and lower tax collection.

It is apparent that India Inc. did not utilise the saving from the tax rate cuts to increase capital expenditure. Only a handful of companies have invested in expanding capacities and the growth in private capex over the last two years is not much to exult about.

Instead, businesses seem to have used the savings from the cut in tax outgo to insulate themselves against pandemic-led slowdown, to improve their cash flows and to expand their business outreach.

What next?

As the saying goes, you can only take the horse to the water. It may not be possible to either coerce or cajole India Inc. to spend the money saved from lower taxes in capital investments unless they deem it necessary based on the demand environment in the industry. To give the devil its due, some companies have been investing heavily in capex since FY19.

Reliance Industries has spent the highest on capex between FY19 and FY22, recording an increase in its fixed assets of around ₹5,30,731 crore. Others such as ONGC, Bharti Airtel, JSW Steel and Adani Green have also spent large amounts in capital investments.

It can be hoped that as demand improves over the coming years and export market also revives, additional capacities will also come up. Till then, companies will continue to use the lower tax to shore up their profits. And that is not a bad thing, going by the tax collection figures.

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