IMPACT OF CORPORATE TAX RATE CUT ON

ECONOMY

SYNDICATE GROUP 9
Ashish Kumar Saini (ePGPx02.014)
Arshiya Ghazanfar (ePGPx02.022)
Abhishek Shukla (ePGPx02.027)
Vaibhav Ahuja (ePGPx02.039)
Namrta Narula (ePGPx02.046)
Vibhor Goyal (ePGPx02.047)
Burhanuddin Hussain (ePGPx02.049)
Siddhi Kochar (ePGPx02.081)
 CONTENT

EXECUTIVE SUMMARY....................................................................................................................... 2
INTRODUCTION .................................................................................................................................... 3
RECENT ACTION BY GOVERNMENT OF INDIA ........................................................................... 4
RESEARCH AND ANALYSIS ................................................................................................................ 5
India increased attractiveness as an FDI destination ......................................................................... 5
Spurring investments from domestic investors ................................................................................... 6
Impact on Sectoral companies ............................................................................................................. 7
Negatively Negative impact on GDP and tax collections .................................................................. 10
Timely Positioning India as an alternative amidst USA – China trade war ................................... 11
BIBLIOGRAPHY ................................................................................................................................... 15

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 EXECUTIVE SUMMARY

With the current economic demand slump in the Indian economy which is impacting a wide
range of industries from automobiles to FMCG, to tackle this slowdown in the economy finance
minister Nirmala Sitharaman slashed the corporate tax rate to 22% without any exemptions or
incentives and to 15% from the current 25% for new manufacturing companies on September 20.
With this move the government is hoping to spur investment, revive growth and boost job
creation.

Most of the economists have mixed views about this tax reform. Some are hailing it as a positive
move, calling it the best reform after the liberalization in 1991 by the then finance minister Dr.
Manmohan Singh. The stock markets are looking at the reforms in a positive light and have
broken fresh records of capital infusion by FII’s as shown in Exhibit. While there are other
economists and credit rating agencies such as S&P have a critical view of this development. In
this paper we are going to analyse and illustrate all the catalysts that led to this tax reform. We
will also detail the potential impact this move is going to have in the medium as well as long
term on the Indian economy and beyond.

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 INTRODUCTION

Taxes influence day-to-day operations of businesses in a country and hence, investors review
effective tax rates, and ease of tax compliance before making any investment decision. Studies
examining cross-border flows suggest that on average, FDI decreases by 3.7% following a 1%
point increase in the tax rate on FDI.
But there is a extensive range of
estimates, with most readings finding
decreases in the range of 0% to 5%.
This variation partly reflects differences
between the industries and countries
being examined, or the times
concerned. Some new studies find, for
example, that FDI is becoming increasingly sensitive to taxation, reflecting the growing mobility
of capital as non-tax barriers to FDI are removed. Such estimates may be used to estimate the
long-run influence on FDI of corporate tax reform.

A complete and impartial legal and administrative framework (within which individuals, firms
and governments cooperate to generate income and wealth in the economy) has a strong bearing
on competitiveness and growth. Property rights, attitudes to markets and levels of trust, for
instance will influence investment decisions. Tax policy and administration can contribute to a
competitive economy in a number of ways under this pillar, including:

• Raising tax revenues in a way that is broadly accepted as fair is more likely to achieve high
levels of (largely) voluntary compliance.
• Good administration that is effective in deterring evasion reinforces social cohesion and
ensures no unfair advantage accrues to businesses that evade tax.
• Similarly, tax administration that is not open to corruption and that implements tax law
consistently, impartially make the tax regime predictable, and reduce the extent to which
it might discourage investment.
• Efficiency in tax administration reduces the amount of an economy’s resources that have
to be devoted to revenue collection

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 • Low compliance costs and burdens on business reduce the time that taxpayers have to
spend on tax compliance – time and effort that could otherwise be spent on creating income
and wealth.
• Tax policy making that is evidence-based and transparent, with the publication of the
revenue forgone from tax expenditures and periodic reviews of their cost-effectiveness,
estimates of the revenue effects of tax measures proposed in the budget, etc.

RECENT ACTION BY GOVERNMENT OF INDIA

India in the last 6 years has been working on improving its competitiveness by reducing its factor
and transaction costs. The recently published
world bank report, doing business 2019, puts
India at 63 rank, a jump of 79 position in the last
5 years. This increased competitiveness by
driving down transaction costs will positively
affect FDI and bring new investments in the
country in the short-to-medium term. In addition,
the rolling out of GST in 2017, brought increased efficiency in tax collection and compliance, as
per the doing business framework. However, India has been going through a rough patch in terms
of economic growth. The GDP growth rate of the economy has slipped to 5% in the first quarter
of FY20, the lowest in over six years. This is an indication of tougher times ahead. Be it the recent
collapse of the automobile sector or the rising number of non-performing assets (NPAs), sluggish
consumer demand or failing manufacturing sector; all have a hand in this deceleration of growth
rate. (Times, The dynamics of India's growth slowdown, 2019) To counter, India’s slowing down
economy, On 20 September 2019, Government of India announced the biggest tax cuts (~0.7% of
FY20 GDP or INR 1.45 tn in value terms) for corporates and rolled back most tax-related
amendments made in the Union Budget 2019. This tax cut in the backdrop of challenges on fiscal
deficit front and need for a massive boost for government expenditure speaks volumes about the
appetite for bold reforms of Modi 2.0. The Taxation Laws (Amendment) Ordinance, 2019 issued
on 20 September 2019, slashed the corporate tax rates from 34.94% to 25.17% (inclusive of
Surcharge and Cess) for all existing domestic companies; and 17.16% (inclusive of Surcharge and
Cess) for domestic companies incorporated on or after 1 October 2019. (India, 2019)

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 RESEARCH AND ANALYSIS

What will be the impact of corporate tax reduction in the country?

In this paper, we have tried to review the impact of change in corporate tax in India from 5
dimensions

• India’s increased attractiveness as an FDI destination

• Spurring investments from domestic investors
• Impact on Sectoral companies
• Negative impact on GDP and tax collections
• Positioning India as an alternative amidst USA – China trade war

India increased attractiveness as an FDI destination

The measure is expected to improve corporate savings, attract private investment (both Domestic
and Foreign Direct Investment), bolster the competitiveness of India as a manufacturing hub, and
support domestic demand as tax benefits are passed on to the end-consumer. The idea behind this
move is obviously to generate private investment, which is now at a low ebb, but an unstated
intention could also be to attract foreign investors looking for alternative sites for their global value
chains disrupted now by the tariff war between China and the U.S. With these cuts, the government
has delivered on a long-standing demand of Corporate India. The onus is now on the latter to
deliver, not just in terms of fresh investment but also in passing on the benefit of lower taxes down
the chain to consumers and investors.

Enhancing India’s Competitiveness as a Manufacturing Destination: India is one of the most

attractive markets for investments owing to large domestic market and fast improving doing
business environment. However, Global MNCs’ decisions are often driven by profitability and
they are naturally biased to choose countries with lower tax rates and efficient value chains.

The new corporate income tax rates in India will be lower than Brazil (34%), Germany (30%), and
is like China (25%) and Korea (25%). New companies in India with an effective tax rate of
17.16%% is equivalent to what corporates pay in Singapore (17%). (Times, Why Corporate India
must start investing now, 2019)

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It is a well-known fact that global value chain has disrupted owing to the trade conflicts. Several
countries in South East Asia have leveraged their lower Corporate Income Tax rates to attract
foreign companies. With a 17.16% tax rate, India is well placed to attract these companies with
new vigor.

SOURCE: (DELOITTE, 2019), (FOUNDATION, 2019)

Spurring investments from domestic investors

The tax cut is impactful because it will raise positive investment sentiment in the economy.
Encouraging corporate to create more investment is the best way to trigger positive sentiments
than the government directly making higher spending. Only if the corporate raise their investment,
the economy can come out of the slowdown. In this context, the present measures are useful as
they tempt the corporate to make investment, given the new tax rates. The low 15% tax rate on
new companies is tempting for corporate to make new investment. Such a nice and calculative step
may encourage investment sentiments.

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This might expand the corporate universe, as new firms will now be taxed at 15 per cent.
However, more importantly, lower tax outflow could increase the share of profit making
companies in India over time.

SHARES OF PROFIT-MAKING PROFIT MARGINS COULD

COMPANIES MIGHT RISE CROSS 10%
8,00,000 58 59 10
58
7,50,000 57 9.8
55
56
7,00,000 9.6
55 9.5 9.5
54
7,07,431
6,66,837

6,96,384

6,50,000
7,24,889

7,90,443

53
6,00,000 52
13-14 14-15 15-16 16-17 17-18 2013-14 2014-15 2015-16 2016-17 2017-18
Number of Corporate tax payers Net profit margin for profit-making companies
Share of profit-making taxpayers (%) (%)

But, lower tax collection could affect the government’s fiscal glide path. With a minor blip in
2016-17, combined fiscal deficit of Centre and states was nearing the 6 per cent of gross domestic
product (GDP) target.

Impact on Sectoral companies

Services firms are expected to be chief winners while manufacturing companies in the consumer
goods, capital goods and steel sectors will also gain significant benefits as many of them have an
effective tax rate of around 30%.

• Auto & Auto Ancillaries: As per ICICI direct research report, the auto sector would
hugely benefit from the corporate tax rate cut; their Profit After Tax (PAT) would be
between 5-15%. We can witness similar growth in the auto ancillary sector too.

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 Source: (BloombergQuint.com, n.d.)
• BFSI: Banks and other financial institutions in higher tax brackets would gain the most
from the corporate tax cut. As per ICICI direct research report, PAT would increase by 11-
15% on an average. Some of the biggest beneficiaries among banks would be State Bank
of India, HDFC Bank Ltd., IndusInd Bank Ltd., DCB Bank Ltd. Among non-bank lenders,
Bajaj Finance Ltd., Bajaj Finserv Ltd., M&M Financial Ltd., and Cholamandalam
Investment and Finance Company Ltd. will benefit the most. The average tax rate for the
sector for FY19 stood at 32.5 percent. (BloombergQuint.com, n.d.)

Source: (BloombergQuint.com, n.d.)

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• Capital Goods & Power: In the capital goods space, the companies under coverage have
effective tax rates from 25-34%. Power utilities are mostly regulated in nature wherein any
cost-benefit or inflation is a pass-through in the tariffs. On the same lines, the reduction in
mat tax rate from 21% to 17% will have a negligible impact on the profitability as the tax
savings will be passed through in the form of lower tariffs.
• Cement: Cement companies, which currently have higher tax rates would benefit
significantly from the reduction in the corporate tax cuts.
• Construction & Infra: Companies in higher tax brackets and who don’t take tax benefits
would benefit from this the most. These types of companies earning would increase by
15% because of less tax.
• Consumer Durable: Philip Capital said the corporate tax rate cut would lead to an earnings
benefit of 11-12 percent for consumer durables makers. In the white goods category,
companies like Whirlpool, CG Consumer Electricals Ltd. and Johnson Hitachi are expected
to benefit the most. The average tax rate for the sector stood at 32 percent in 2018-19.
• FMCG: Most of the country’s largest consumer goods makers stand to gain from the
corporate tax rate cut. The largest companies by market capitalization—Hindustan
Unilever Ltd., ITC Ltd. and Nestle India Ltd.—will see benefits to the tune of 5.5-8.6
percentage points. However, companies like Dabur India Ltd., Marico Ltd., Godrej
Consumer Products Ltd. and Jyothy Laboratories Ltd. will not get any benefit as their
current tax rate is below the revised one on the back of concessions availed in terms of
operating in special economic zones.
• Metals: A cut in corporate tax rates is positive for the metals sector amid a domestic
slowdown, the U.S.-China trade war and a stronger dollar bringing down metal prices.
Corporate tax rate cuts will increase earnings per share and improve cash flows of metal
companies facing higher leverage and rising working capital costs. With this move, the
entire pack will benefit between 4-17 percentage points. But, Tata Steel Ltd., National
Aluminum Company Ltd. and NMDC Ltd. would be the top tax-saving companies. The
government also allowed new companies to pay taxes at a lower rate. That’s expected to
bring in fresh capex in the manufacturing sector and boost metal demand.

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Negatively Negative impact on GDP and tax collections

A hole of 0.7 per cent of GDP due to tax cuts could compel them to borrow more, and disturb the
bond market. It can also cancel out the positive impact of rate cuts by the Reserve Bank of India
and slow the transmission process. Further, the share of corporate tax in the economy could go
down to 3 per cent of GDP in 2019-20. (business-standard, 2019)

FISCAL GLIDE PATH UNDER TROUBLE

10 9.3
9 8.3
7.8
8 6.9 6.9 6.9 7
6.7 6.7 6.6
7 5.9
6
5
4
3
2
1
0
08-09 09-10 10-11 11-12 12-13 13-14 14-15 15-16 16-17 17-18 18-19

Combined fiscal deficit of centre and states (% of GDP)

But, lower tax collection could affect the government’s fiscal glide path. With a minor blip in
2016-17, combined fiscal deficit of Centre and states was nearing the 6 per cent of gross
domestic product (GDP) target.

FISC UNDER STRESS, CORPORATE TAXES TO LOSE

BUOYANCY
Number of Corporate tax payers Share of profit-making taxpayers (%)

4.0 1.8
3.5 1.6
3.0 1.4
1.2
2.5
1
2.0
0.8
1.5
0.6
1.0 0.4
0.5 0.2
3.4 3.3 3.2 3.3 3.5 3.6 3.0
0.0 0
14-15 15-16 16-17 17-18 18-19* 19-20** 19-20***

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The rise in buoyancy will hit a speed-breaker this fiscal. However, the hope is that lower rates will
push up economic activity and increase revenue in the coming years.

Timely Positioning India as an alternative amidst USA – China trade war

The US-China trade war has escalated to levels previously unimaginable. After levying tariffs on
almost all imports from China, US President Donald Trump has not toned down his rhetoric. Either
side is determined not to blink first. Trump wants China to fall in line while China has not shown
any intent to do so. The global economy is feeling the pain from this spat.

U.S. goods imports from China totaled $539.5 billion in 2018, up 6.7% ($34.0 billion) from 2017,
and up 59.7% from 2008. U.S. imports from are up 427% from 2001 (pre-WTO accession). U.S.
imports from China account for 21.2% of overall U.S. imports in 2018.

Over the last few decades, the nature of their relationship was one of ‘co-operating rivals’ and both
were looking for a ‘win-win economic engagement’. But that changed post the 2008 global
financial crisis, which narrowed the gap between their economies. In 2007, the US economy was
four times that of China but by 2012, thanks to the great recession, this gap has narrowed down a
lot. There is growing anxiety in the US about rise of China’s economy. The Chinese believe that
the US is actively working to prevent their country from taking the rightful place in the world
order. Apart from the economic angle, China has also expanded its militarily base by spending
heavily on purchasing military equipment. China’s military, vexed at the US control over trade
routes, has been trying to test its strength in the South China Sea. The two nations have had their
share of skirmishes there.

The Belt and Road initiative which is perceived to be the brainchild of President Xi Jinping has
unnerved the US which sees it as an attempt by China to play a larger role in the world. It is clear
that China does not like the idea of a unipolar world, but the US wants to keep it that way. That
apart, the two nations do not see eye to eye when it comes to political values nor do they have
common security interests. So, this trade war is not just about trade. Going forward, their
relationship would at best remain frosty.

De-risking operations:

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This puts US and other western companies in a difficult position. Over the years, taking advantage
of low costs, they have increased their dependence on China for their supply chain needs and
manufacturing. It is the second largest exporter of auto parts to the US auto giants (after Mexico).
The list of sectors heavily dependent on China is long and US companies are realizing the need to
de-risk their operations — supply chain as well as manufacturing. Such is the depth of the
arrangement that over 50 per cent of the products HP, IBM, Dell, Cisco, Microsoft and Intel or
their suppliers use come from China.

The US is already pushing companies to reduce their dependence on China. Investors are also
questioning US companies on their backup plan to reduce operational risk from this trade war.

This situation presents a clear opportunity for countries such as India as the US and India see each
other as allies. Former US President Barack Obama even described the relationship as ‘one of the
most defining partnership of the 21st century’. Trump too wants a close relationship with India, a
democracy with shared values. Not surprising that US companies have already started making
enquiries about sourcing from Indian players, especially in the auto-component space.

But taking a share of China’s supply chain or manufacturing is easier said than done. Over decades
China has invested a lot in upgrading its infrastructure. Also, the scale of manufacturing is such
that it will be difficult for India to match in terms of cost. But the silver-lining is that the recent
imposition of tariff by the US has levelled the playing field, at least in select sectors.

Competitive enough

These sectors have certain common traits that help them to be as competitive as those in China.
They have good scale thanks to a strong domestic market in India. They have also built a solid
supply-chain network (this is critical as India cannot grab a share of the ICT exports from China
as it lacks proper supply chain, especially in semi-conductors). They also export a fair share of
their production and, consequently, their quality is tested and is as good as anywhere in the world.
Auto components, leather and textiles are some sectors that top the list.

The government must direct its ‘Make in India’ initiative on these sectors with suitable incentives.
However, low manufacturing cost alone is not enough. Logistics cost, to move the manufactured
goods from the factory to the destination, is critical. China excels here. India has been building

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roads, improving port infrastructure/connectivity to the hinterland through Sagarmala and
Bharatmala programs.

It is also trying to enhance coastal shipping and boost transportation through inland waterways. To
rival China on logistics costs, it has to redouble its efforts. In developed markets, companies
outsource 70 per cent of their logistics operations that can be outsourced to lower costs. In India it
is just 35 per cent. Even though India’s steep climb in the recent ‘ease of doing business’ ranking
is noteworthy, it still has a long way to go in reforming labour laws and the land-acquisition process
which are essential for lowering costs further.

Indian entrepreneurs, for their part, must take advantage of the situation and invest aggressively.
De-risking from China will remain a long-term strategy for the US and European companies.
Higher exports will also help in neutralizing domestic cycles that plague some sectors such as auto
components.

It will be a difficult call for Indian entrepreneurs to make as many of them have been investing
abroad to de-risk their investments in India. It is a leap of faith.

If they take it, India will not miss the manufacturing bus, as it did in the 1980s and 1990s that saw
emergence of East Asian Tigers and China as manufacturing hubs for the world, yet again.

A quick look at the list of nations benefiting from Trade war:

Australia: China imports a large portion of its food grain requirement. At the present moment,
China is importing in large quantities from America. However, China has also slapped retaliatory
tariffs on American food grain production. Hence, importers in China will find it expensive to
continue importing American grains. Hence, they will have to look for alternate sources. This is
where Australia perfectly fits the bill. Like the United States, Australia also has vast swathes of
land which are used for agriculture. Australia produces much more food grains than it can possibly
consume. On the other hand, China has a consistent demand for grains. Hence, it is likely that
China will start importing from Australia in the aftermath of this trade war.

Asian Economies: American companies like Wal-Mart get all of their merchandise produced in
China as of now. This includes apparels and household items like curtains, towels, etc. This
steady supply chain is going to be needlessly disrupted by a trade war. Hence, American

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companies will have to find an alternate source. They are likely to approach other Asian
economies like Bangladesh, Thailand, and Philippines. The reason is that these economies also
low costs of production like China. Although they lack in necessary infrastructure, they are the
closest replacement that American companies can find. The contract manufacturing of these
products will now, most likely be awarded to companies in smaller Asian countries.

Germany: America is importing a lot of Chinese cars. With the introduction of tariffs, the
import of this trade will also be disrupted. Only Germany can compete with China in the
production of cars. Since the quantity of imports from China will reduce, it is likely that the
quantity of imports from Germany will rise to fill the void. This will make Germany a
beneficiary of the ensuing trade battle between America and China.

Iran and Russia: China has a huge requirement for energy products like oil. This is because a
booming economy like China consumes large quantities of oil. For now, China was sourcing
most of its oil requirements from the United States. Also, China would source some of its
requirements from the Middle East which is a known American ally.

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 BIBLIOGRAPHY

BloombergQuint.com. (n.d.). How Corporate Tax Rate Cut Will Impact India Inc. Retrieved from
https://www.bloombergquint.com/markets/how-corporate-tax-rate-cut-will-impact-india-inc

business-standard. (2019, Sept 23). Impact of corporate tax rate cut on firms, economy: Explained in six
chart. Retrieved from business-standard: https://www.business-standard.com/article/economy-
policy/impact-of-corporate-tax-rate-cut-on-firms-economy-explained-in-six-chart-
119092300055_1.html

DELOITTE. (2019). Corporate Tax report. DELOITTE.

FOUNDATION, T. (2019). Corporate Tax Report. TAX FOUNDATION.

India, I. (2019, Sept 23). India Slashes Corporate Income Tax by 10% — Boldest Move to Stimulate
Economy Since 1991. Retrieved from Invest India: https://www.investindia.gov.in/team-india-
blogs/india-slashes-corporate-income-tax-10-boldest-move-stimulate-economy-1991

SECURITIES, K. (2019). Corporate tax rate impact. KOTAK SECURITIES.

Times, E. (2019, 09 09). The dynamics of India's growth slowdown. Retrieved from Economic Times:
https://economictimes.indiatimes.com/news/economy/indicators/the-dynamics-of-indias-
growth-recession/articleshow/71020942.cms?from=mdr

Times, E. (2019, Sept 20). Why Corporate India must start investing now. Retrieved from Economic
Times: https://economictimes.indiatimes.com/news/economy/policy/why-corporate-india-
must-start-investing-now/articleshow/71219495.cms?from=mdr

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