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Major Tax Reforms to Boost Indian Economy
In an attempt to boost foreign investment and stimulate the Indian economy, the Indian Government recently made a path breaking move by introducing Taxation Laws (Amendment) Ordinance, 2019. The biggest change that has been brought by this ordinance is the drastic reduction of corporate tax rate of domestic companies to 22% (15% for new manufacturing units). This reduction in the tax rate is expected to result in higher profits for the stakeholders thereby increasing their disposable income followed by increase in demand and consumption. The reduction in the rate would incite foreign investors to make an investment in India. The other changes made by this ordinance include rollback of the enhanced surcharge which was introduced earlier by the budget, reduction in Minimum Alternate Tax (MAT) rate to 15% (earlier it was 18.5%), withdrawal of buy-back tax on certain listed shares.
Reduction in Corporate Tax Rates:
Under the current provisions of the Indian Income Tax Act, 1961, the corporate tax rate for domestic companies is 30%. The ordinance has reduced the corporate tax rate to 22% (15% for manufacturing companies set up and registered after 1st October, 2019). Two new provisions have been introduced through the ordinance which are section 115BAA & 115BAB which state the tax rates and the conditions to comply with. Here is the summary of new tax rate scenario:
- Companies which have total turnover or gross receipts not exceeding $ 56 million during the financial year 2017-18 shall be taxed at 25%
- Manufacturing Companies set up & registered on or after 1st March 2016 shall have the option to be taxed at 25%, provided relevant conditions are met
- Manufacturing Companies set up and registered on or after October 1, 2019 and commence manufacturing before March 31, 2023 shall have the option to be taxed at 15% subject to compliance of certain conditions
- Domestic companies that satisfy the prescribed conditions shall have the option to be taxed at the rate of 22%
- For all other companies, the tax rate will be 30%
Corporate tax rates play an important role in any country’s inbound investment due to which we have seen that in the last few years, countries across the globe have reduced corporate tax rates to boost investment, consumption and labour market participation. As a result, the average corporate tax rate among the OECD countries has reduced to 32.5% in 2000 to 23.19% in 2018. Realizing the importance of a balanced corporate tax rate, the then Indian FM in 2016 announced a roadmap of significant reduction in the corporate tax rate from 30% to 25% in four years. However, the current FM of India made a bold move to boost Indian market and investment in the country, reduced the rates further to 22% which not only made India an attractive jurisdiction from a tax perspective for making investments but also a competitive one among the ASEAN countries. With this new tax rate, India is now in competition with countries like Singapore, UK, US, Thailand etc. which have had low tax rates historically.
Since the government has allowed foreign investment in an LLP, setting up of Limited Liability Partnerships have gained popularity. The main reason behind this is that after payment of corporate tax of 30% on the total income, no further tax is charged on the distribution of profits to the partner and hence, around 65% of the total income of the LLP can be received by the partners. Therefore, partners in LLP tend to receive more profits than the shareholders of a company as in case of companies dividends are subject to dividend distribution tax at effective rate of 20.55%. On the other hand the LLP has its own drawbacks such as it is not able to issue bonds or other types of securities. So whether an LLP or a company should be set up is to be decided on case to case basis. But with this new tax rate the difference in what a shareholder will receive and what a partner will receive has been reduced to only 5%.
Rollback of enhanced surcharge:
Earlier this year, the FM announced that a higher surcharge would be applicable on individuals having taxable income from INR 20 million to INR 50 million ($ 0.28 million to 0.70 million) and INR 50 million and above so that the effective tax rates for these two categories would be increased by around 3% and 7% respectively. However, in the print of Finance Bill 2019 it was mentioned that the increased surcharge would be applicable to not only individuals but also to HUF, AOP, Body of individuals and any other artificial judicial person which resulted in Foreign Portfolio Investors set up trusts and category III alternate investment funds also coming in purview of this enhanced surcharge which negatively affected the investments into Indian capital markets.
This turned out to be a major concern for large part of funds industry and is also considered as one of the main reason of economic slowdown. After several industry representation, the FM finally withdraw the increased surcharge to the extent applicable to long term and short term capital gains tax on listed equity shares, unit of an equity oriented fund & unit of a business trust. In case of FPIs, the tax payable on gains arising from transfer of derivatives would also be exempted form levy of enhanced surcharge. Taking it a step further, the ordinance provides that the increased surcharge will not be applicable on tax payable by FPIs on long and short term capital gains on transfer of securities including derivatives.
Reduction in rate of MAT:
Under section 115JB of the Indian Income Tax Act, in case the income tax payable by a company on the total income computed is less than 18.5% of its book profit then such book profit would be deemed as total income and shall be taxed as Minimum Alternate Tax at the rate of 18.5%. The ordinance provides that MAT will be payable if the total income computed as per the provisions of the Act is less than 15% of its book profit and also it reduced the rate of MAT to 15%. This step is expected to boost foreign investments especially for investments into companies that enjoy several deductions/exemptions under the Act.
Withdrawal of buy-back taxes in case of listed shares:
As per section 115QA, any amount of distributed income by a domestic company on buy-back of shares from a shareholder shall be taxed at the rate of 20% in the hands of the company. The Finance Act, 2019 extended the purview of this section to listed companies as well which means any buy back of shares from a shareholder by a company listed on recognized stock exchange on or after July 5, 2019 would also be subjected to a buyback tax at the rate of 20%. The ordinance seeks to amend this section and provides that it shall not be applicable on buy back of listed companies’ shares provided that the public announcement in respect of buy back has been made prior to July 5, 2019 in accordance with SEBI regulations.
Indian Government’s strong step of rationalizing tax rates and withdrawal of enhanced surcharge has not only been welcomed by Indian companies but it is also being appreciated globally. On many occasions the foreign corporates have complaint about high tax rates in India but now this move will provide them relief and is expected to open the doors for more foreign investment in the country which will in-turn revive the Indian economy. With respect to concessional rates of tax, the ordinance has clarified that the companies that don’t wish to avail the concession currently may do so after the expiry of the tax holidays or exemptions which they may be enjoying right now. However, once the company decides to avail the concessional tax rates under new sections, it cannot subsequently elect to be governed by the other sections of the Act including tax holidays/exemptions. Therefore, it is advisable to companies to carry out an in-depth cost-benefit analysis so as to assess the impact of availing these concessional tax rates.
3 December 2019