Nirmala Sitharaman, Union Finance Minister, has announced a slew of tax exemptions at GST council meeting. She proposed to cut corporate tax for domestic companies and new local manufacturing companies through an ordinance. The government slashed effective corporate tax to 25.17 per cent inclusive of all cess and surcharges for domestic companies.
The unprecedented corporate tax rate cut is been done to boost company earnings. The cut from 30 per cent to 22 per cent will affect the companies, as the taxes that are paid by them at the full rate should see their earnings jump by 11 per cent. Hence, Indian equities seem to be well-positioned in the short to intermediate-term, and highly taxed companies will be early winners.
However, as cons come along with pros, the are few grey areas for the same aa well. Such as, the effective corporate tax rate of many companies may be well below the new proposed tax rate, which along with surcharge and cess works out to around 25.17 per cent. So, the impact of the various tax provisions will vary across sectors, sub-sectors and businesses.
How Tax Reduction’s Benefit Across the Sectors:
Being a service-based economy, India contributes more than half to the country’s GDP. At present, the 18 per cent share of manufacturing had been on the rise owing to the government’s focus on investment and job creation. But, the manufacturing activity has slumped in the past year due to sluggish consumer demand and the weak economy.
As the manufacturing growth rate has declined from 12 per cent in Q1 FY19 to just 1 per cent in Q1 FY20, it is believed that revision in tax rates should revive demand across industries and put the economy back on the growth track. However, the impact on various sectors would differ in terms of how they plan to utilise this fiscal bonus. It can range from reviving investment, lowering prices to increase demand, paying out higher dividends or repaying debt.
FMCG Firms to Pass On Tax Benefits to Boost Volume Growth
The Fast Moving Consumer Goods (FMCG) companies are more in profit if we see it through cash in hand perspective. The cash could be utilised for spurring demand through trade discounts in the upcoming festival season. It is said that the tax cuts would result in more cash in hand for FMCG companies, which could be utilised for spurring demand through trade discounts in the upcoming festival season.
To give an estimate, FMCG companies on the Nifty (ITC, Nestle, Britannia, HUL), would see their effective tax-reducing from 29-35 per cent to 25 per cent, leading to retention of a cumulative Rs 2,000 crore earnings on the basis of FY19 numbers. This corresponds to 9 per cent of net earnings for FY19.
Credit Cycle to Get a Boost and Benefit Banks:
Nirmala Sitharaman, the Finance Minister said that a new domestic company incorporated on or after October 1, 2019, will pay income tax at the rate of 15 per cent. This implies that production should commence before March 31, 2023. It is believed that the move can hasten the private capex cycle and if this happens, credit growth will rise and banks would be key beneficiaries.
It is also assumed that government borrowing will also go up to make up for the revenue foregone by reducing the tax rate. This would exert upward pressure on interest rates. In sum, therefore, it will have a mixed impact on banks.
The tax measures could somehow be helpful in accelerating investment in chemical and pharma APIs (active pharmaceutical ingredients) business lines as they position themselves for import substitution strategies.
Tax Reduction Can Refuel Demand in the Auto Sector
Contributing 7.5 per cent to the country’s gross domestic product (GDP) and 49 per cent to manufacturing GDP, the Indian automobile sector, has been under the weather for almost a year on the back of multiple headwinds the industry is facing. The demand has been hurt by various factors such as non-availability of retail finance, liquidity crunch and slowdown in economic activities have hurt demand.
But the biggest reason for the lack of demand has been the increase in the total cost of ownership led by mandatory long-term insurance and implementation of safety regulations. It is said that the reduction in tax rates would improve the profitability of companies in the auto industry.
Eventually, the corporate tax may help companies pass on the benefits to the customers in terms of discounts and freebies ahead of the festive season, which may boost demand. Also, the move would make more liquidity available to the companies for further investment.
By all means, we can say that the corporate tax cut, announced by the Finance Minister has come with a lot of hope, to cope up with the leading political party’s and government’s vision of economic growth in the upcoming years. Meanwhile, the industry is also waiting for a GST rate cut on automobiles, which if it comes through would significantly boost demand. However, the GST fitment committee has ruled out GST cut for automakers.
