Lessons from a tax cut

Fears of a huge revenue loss from the 2019 reduction in corporation tax rates were exaggerated

Almost three years ago, the Modi government had introduced a new corporation tax structure. On Friday, September 20, 2019, months before the Covid pandemic took a heavy toll on the health system and the economy, Finance Minister Nirmala Sitharaman announced a major cut in corporation tax rates to revive growth that had begun to show early signs of a slowdown.

The new tax rate for all Indian companies, not availing themselves of the various exemptions and incentives like tax holidays, was brought down to 25 per cent (inclusive of a 10 per cent surcharge and a 4 per cent cess). In effect, this was a 10 percentage point cut in the existing tax rate of 35 per cent. For manufacturing companies, starting operations after October 1, 2019, the corporation tax rate was lowered to 17 per cent, including surcharge and cess, from 29 per cent. The Minimum Alternate Tax rate also was brought down from 21-22 per cent to 17 per cent.

How has that decision of 2019 impacted the government’s tax collections from India Inc? Initially, the government had estimated Rs 1.45 trillion to be the likely amount of revenue foregone as a result of the cut in the tax rates. Subsequently, there was clarification that some of this loss could be made good through increased buoyancy. Nevertheless, it would be important to assess how that tax cut played out for the government’s revenue.

But before undertaking that exercise, it would be relevant to gauge the trajectory of corporate tax rate reduction in the last three decades and place the 2019 decision in that context. Remember that in 1991, the corporation tax rate was raised from 40 per cent to 45 per cent in Manmohan Singh’s first Budget because of revenue concerns; and in 1994, it was brought back to 40 per cent. The first big reduction came in 1997, when finance minister P Chidambaram brought it down to 35 per cent after abolishing the surcharge as well.

But from 2000 onwards, surcharges were back, raising the total tax rate once again to almost 36-38 per cent for the next five years. It was

Mr Chidambaram again, who reduced the corporation tax rate to 30 per cent in 2005, although along with the surcharge the actual rate was about 33 per cent.

Illustration: Binay Sinha

The Modi government’s first term coincided with a phase of a gradual reduction in the rates from 2015. Arun Jaitley’s Budget in 2015-16 promised that the corporation tax rate would be reduced to 25 per cent in a period of four years along with a phase-out of exemptions. The following year, the rate was reduced to 29 per cent (excluding surcharge and cess) for companies with a turnover of less than Rs 5 crore. New manufacturing companies were allowed to pay a tax of only 25 per cent, provided they did not avail themselves of any exemptions.

A year later, Jaitley reduced the tax rate to 25 per cent (excluding surcharge and cess) for all companies with an annual turnover of up to Rs 50 crore, thereby covering almost 96 per cent of Indian companies. In February 2018, Jaitley went a step further by extending the benefit to all companies with an annual turnover of up to Rs 250 crore, covering 99 per cent of all Indian companies. Ms Sitharaman in her first Budget in July 2019 took the next step by extending the 25 per cent tax rate to cover all companies with an annual turnover of up to Rs 400 crore. With that step, almost 99.3 per cent of Indian companies were covered under the lower tax rate. And then followed the tax cut to 22 per cent (plus surcharge and cess) in September 2019.

It is noteworthy that the Modi government has been the most proactive of all in the last 30 years to bring about the biggest corporation tax rate cut in the shortest time. In just about three years, the total corporation tax rate for India Inc was reduced by 10 percentage points. What’s more, the reduction took place while exemptions and concessions were phased out.

The finance ministry data for 2019-20 shows that in the very first year of the reduction, almost 16 per cent of companies, accounting for about 62 per cent of the total income during that year, opted for the new scheme of a lower taxation rate while giving up exemptions and concessions. It is reasonable to assume that the data for the following two years should show more companies embracing the new scheme, ushering in a system where most companies would be taxed on a transparent basis without much scope for clever usage of the exemption and deduction benefits. Not surprisingly, the effective rate of corporation tax in 2019-20 came down to 22 per cent, compared to 28 per cent in 2018-19. The effective rate in 2017-18 was over 29 per cent.

Did the government have to forego revenue worth Rs 1.45 trillion after the tax cut, as was feared by the finance ministry? Total corporation tax collections in 2019-20 did decline by about 16 per cent to Rs 5.57 trillion, compared to Rs 6.63 trillion in 2018-19. But the decline was just about Rs 1 trillion and not Rs 1.45 trillion. The tax collection figures for 2020-21 are not relevant because of the Covid impact.

The latest provisional unaudited numbers with the Controller General of Accounts show that in 2021-22, corporation tax collections rose to Rs 7.12 trillion, surpassing by a good margin the collections made in 2018-19. In terms of their share in GDP, corporation tax collections in 2021-22 were still at 3 per cent, marginally lower than the 3.5 per cent seen in 2018-19. But it would not be unreasonable to expect corporation tax revenues to breach that ratio soon. The advance tax collections in the first quarter of 2021-22 have continued to show healthy growth. And the dispersion of tax liability spread over a larger number of companies in different income levels, seen in 2019-20, should continue to help overall collections buoyancy.

The 2019 decision to cut the corporation tax rate underlines once again an age-old and time-tested theory. Tax cuts with fewer exemptions leading to stable and moderate rates usually result in revenue buoyancy as compliance improves and coverage gets wider. Fears of tax cuts resulting in revenue loss are often exaggerated as the experiment of 2019 will once again show. Hopefully, this principle will be borne in mind by the Union and state governments while they frame their approach to many other taxes in the days to come.