Nirmala Sitharaman’s 2 cuts raise 4 expectations

Finance Minister Nirmala Sitharaman’s tax changes are the first steps taken by the new government on the economic side that addresses the core constituency of those who invest money, incorporate firms, build employment, deliver growth, create wealth — the entrepreneurs. These changes have taken their time coming. The distractions of socialist stances and moral but bankrupting high-grounds behind, the cut in corporate tax rates is the first direct policy action for the biggest and most impact-making constituency of economic growth. We welcome this metamorphosis of the government in general and Sitharaman in particular. While lots more needs to be done, such a step shows that high and rising economic growth is no longer a set of political motifs to be used in speeches but with little action on the ground. In Narendra Modi’s Season 2, economic growth is — finally — a priority and the entrepreneur a key participant in that conversation. In a nutshell, there are two key changes in tax rates that Sitharaman offers to companies, through the Taxation Laws (Amendment) Ordinance 2019. First, in order to attract new investments into manufacturing — that employs the most number of people and is, therefore, critical for job creation — the tax rate has been lowered to 15% for firms that get incorporated on 1 October 2019 and commence production before 31 March 2023. The effective tax rate works out to 17.01%. These companies will not have to pay the minimum alternate tax (MAT). On the spreadsheet of North Block, this is a good ‘nudge’ to attract investments. But taxes alone do not drive business decisions. With 42 months at their disposal, much depends on how quickly entrepreneurs to set up new enterprises. Putting together capital, organising talent, imagining and creating products and reaching markets will be the responsibility of entrepreneurs, getting out of their way but ensuring regulatory compliance the government’s. In the middle stands India’s biggest hurdle: the bureaucracy. Getting permissions from a rent-seeking bureaucracy — land and construction to water and safety — will remain a challenge. Corruption will be difficult to monitor but will thrive as wealth creators attempt to create wealth. Entrepreneurs must be given extra time for any such regulatory delays, for which state governments need to get their act together, one department at a time. Second, to make life easier for existing domestic companies, the corporate tax rate has been reduced to 22% — if they stop availing of any other tax exemption or incentive. Taking surcharge and cess, this number stands at 25.17% and they will not have to pay MAT, either. But giving up an existing system that stands on the foundations of tax incentives and exemptions will be difficult for companies in the short term. Sitharaman’s Ordinance takes that into account and allows these companies to opt for the reduced tax regime after expiry of their tax holiday or exemption periods. In the interim, these companies will pay MAT at 15%, down from 18.5%. Looking ahead, this tax cut has created four expectations. First, that the ongoing slowdown will abate because of lower taxes. Nothing of the sort. Remember, new manufacturing takes time to come up, and given the track record of hurdle-creating bureaucracy, entrepreneurs may miss the 42-month deadline altogether. At best, we may get announcements and intentions to invest. On the other side, existing payees will, again, need time to shift from their incentives-driven tax structures. That said, if things go smoothly, this tax policy could play out well in the four-year-long term of Modi Season 2. Second, it raises expectations of the Direct Taxes Code (DTC), of which this Ordinance is the first step — a simple system of direct taxes, free from the noise of incentives and exemptions. This should be pushed on the individual income tax side as well. The underlying idea should be: if there is an income generated, there is a tax paid. Once all exemptions and deductions are done away with, cut the tax rates and broaden the tax base. While at it, it is time to bring rich farmers into the tax net. Given that this government has taken tough decisions such as demonetisation, Balakot attack and abrogation of Article 370, this is definitely possible and Sitharaman must not let go of the goodwill her policy has created on the corporate side, and quickly move on introducing the DTC. Third, it has raised market expectations sky-high. The 2,000-point jump in the Sensex could be an over-reaction. It could be capitalising on the simple expectation that the government is finally taking the economy seriously. If this is a punt on intent, and the market expects returns on investment to be scattered over the next four years, all will be fine. But if this rise stems from expectations of better earnings over the next quarter, the fall will be as quick. All depends on how many invest in the long term India story that remains strong against all odds, versus those who are looking for the next quarter. And fourth, it has raised expectations of tax globalisation. The fall from 35% to 25% exemption free tax rate is big. In one quick decision, India steps out of the world’s 20 highest tax jurisdictions. Until 19 September 2019, India stood fifth among 208 jurisdictions, after United Arab Emirates’s 55%, Comoros’s 50%, Puerto Rico’s 39%, and Suriname’s 36%. It stood alongside Chad, Congo, Equatorial Guinea, Guinea, Kiribati, Malta, Saint Maarten, Sudan, and Zambia. At 25%, it is closer to the world average of 23%. As countries compete for investments, falling tax policies will play their part. India will have to engage with this discourse and benchmark its tax policy accordingly. If the government is looking beyond tax band aids and at a long-term cure of the economy, it needs to deliver the one thing entrepreneurs crave: policy predictability. Given the past track record of serial changes in policy, putting money on the India story is not a foregone conclusion. Entrepreneurs need to be told, repeatedly, that this is a policy that will stay unchanged. We believe, the government cannot and will not give this guarantee. Retaining the needless surcharge and cess, for instance, opens the possibility of expanding them over the next few years, while keeping the tax rate unchanged. This is tax manipulation. As a next step, like she has initiated steps to remove incentives and exemptions on the taxpayers’ side, Sitharaman should get rid of all surcharges and cesses on the tax collectors’ side. An additional Rs 10,000 crore of revenue foregone on the existing Rs 145,000 crore will not make any difference to collections. The clarity of tax structure, however, will go a long way towards India becoming a $5 trillion economic powerhouse.

• Indian Economy
• Economic Reforms
• India
• Direct Taxes Code
• Nirmala Sitharaman
• Tax Incentives
• Tax Structure

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