Indian markets witnessed their biggest movement in 10 years following Finance Minister Nirmala Sitharaman’s announcement of lowering the corporate taxes.
The Sensex rallied 1921 points, its second-best single-day gains ever to close at 38,014.
Nifty surged 569.40 points or 5.32 percent to 11,274.20.
Amidst all this, Investors got rich by over 7 Lakh crores in a day. The market capitalization of NSE crossed $2 trillion marks.
All this was possible because Nirmala Sitharaman, our FM, did something extraordinary. The tax rate cut will have a great long-run impact on Domestic Companies as this is not a one time benefit.
The government was in pressure after depressing GDP growth numbers. A move to revive economic growth was anticipated.
In this article, I’ll discuss every possible detail of this move by the GOI, it’s possible effects and how it will help the Indian economy to sky-rocket once again.
But before we proceed let’s get familiar with some basic terms.
1] The Corporate Tax – What does it even mean?
Simply put, it is the taxes which corporates (companies) pay on their profits.
2] What is Effective Tax Rate (ETR)?
Effective Tax Rate is the net tax percentage which the company is paying in the form of income tax after exemptions.
Effective Tax Rate = Total Tax ÷ Earnings Before Taxes
Let’s try to understand this using an example
Suppose a domestic company ‘A’, is having earnings (profits) of Rs.1 crore. Also, the company is availing few deductions and exemptions amounting to Rs.20 lakh. Now, the company has to pay 30% tax(according to previous income tax rule) on only Rs.80 lakh which comes to Rs.24 lakh.
Tax Exemptions is the monetary exemption of persons, people, property, income, or transactions from taxes that would otherwise be levied on them. Tax-exempt status can provide complete relief from taxes, reduced rates, or tax on only a portion of items
So, we have Effective Tax Rate as 24% (24/100).
Hence, even though the Actual Tax Rate is 30%, the company is paying only 24% of its earnings/profits as tax. Thus, ETR can be on the lower side, if the company is availing tax benefits.
What changed after amendments?
The major amendments made by Finance Minister, Nirmala Sitharaman:
- The corporate tax rate for all companies will be slashed to 22 percent from 30 percent, if the companies do not avail exemptions.
- New manufacturing companies will have to pay only 15% tax from a previous high of 25%.
The Impact after slashing tax rates?
Before the amendment, the rate of tax for all domestic companies was 30%. However, adding all the surcharge and cess, the rate would shoot up to 34.94%
Now, after the announcement by our FM, the rate for domestic companies will come down to 22% and the surcharge and cess will make the rate go up to 25.17%.
So, we have the rate slashed from 34.94% to 25.17%. But, the condition is that the company must forgo all the exemptions provided to it under the Income Tax Act,1961.
Now, let me put an analysis of the Effective Tax Rates for different sectors. Here, what one must keep in mind is that for different sectors there are different sections in the Income Tax Act, 1961 which speak on exemptions and tax benefits. Hence, there will be a difference in the Effective Rate of Tax.
Let us analyze the companies with lesser ETR.
(Data Compiled from Moneycontrol)
For these sectors, there will be no great impact. As they will be better off if they avail tax benefits instead of going with the new rate of 22% which will effectively come to 25.17%.
The real beneficiaries are the companies who were ending up paying a larger amount of their profits as tax and where the ETR is more than 25.17%. Here is the analysis,
(Data Compiled from Moneycontrol)
So, for investors too, it will be prudent if they put more of their money in these companies. Here are the reasons:
- These companies will get directly benefited with lesser tax rates. Thus, they will have more funds in hands. These companies may think of passing on the benefits to their customers. Look at the automobile sector for instance! The lack of demand will now change as the automakers may slash their prices and there will be an increase in the consumption.
- The companies may think of spending extra funds in the form of advertising to increase their sales.
- There will be less slashing of employees as a measure to reduce cost.
- Improved ‘Earnings after taxes’ would mean more Earnings Per Share. EPS. More EPS would clearly reflect the market price of the share. (Read this to know more).
Impact on new manufacturing companies
The picture of the economy was gloomy with a decline in the private sector investment. However, now with a lower rate of 15% (from 25%) on new manufacturing companies, the private investment will certainly move up.
The only negative which pops up is the revenue loss to the government. The Fiscal deficit will increase due to the revenue loss.
For someone who is not aware of the term Fiscal Deficit, it is nothing but the difference between the Government’s revenue and Government Expenditure. As India’s difference is negative, we call it as ‘Deficit’, which implies our ‘Expenditure’ is more than our ‘Revenue’.
Thus, Fiscal Deficit= Public Expenditure – Public Revenue
Needless to say, lowering the tax on companies will increase the Fiscal Deficit as the Public Revenue will fall.
The government will probably try to fill this gap by selling subsidiaries of Public Sector Units (PSUs). With the rally in the stock market, the divestment of PSUs will give more revenue to the government. Also, the increase in demand and investment would likely revive the economy and we may probably see better revenue collections in the time to come.