If demand doesn’t improve, firms might retain the tax cut bonanza instead of investing. It would've been better to put more cash in the pockets of individuals by giving more IT relief
Amid an atmosphere of gloom and doom (triggered by growth plunging to a low of less than five per cent during the current year and muted projections for next year), it is necessary to closely scrutinise tax proposals in the Union Budget for 2020-21 to assess whether or not these will generate the much-needed growth impulses.
The four major factors impinging on a surge are private consumption, investment, export and spending by the State. The Modi Government has kept up the tempo of expenditure by way of building infrastructure and spending on welfare schemes. On the export front, given the all-round depressed growth and international trading environment, there is little that it can do in terms of using this lever for providing the much-needed fillip.
Therefore, much of the focus has to be on the first two levers, i.e. private consumption and investment. The big question is whether the tax proposals will help in boosting demand. First, let us look at the changes in personal income tax (PIT).
At present, a person having an income of Rs 2,50,001-Rs 5,00,000 per annum pays a tax of five per cent, those earning more than Rs 5,00,000 but less than Rs 10,00,000 pay 20 per cent tax whereas, someone having an income higher than Rs 10,00,000 pays 30 per cent. Accompanying this are a plethora of exemptions and deductions viz. Section 80C (annual investment, expenses, life insurance premium and so on, up to Rs 150,000), Section 80D (health insurance premiums), Section 24 (interest on home loans), Section 80CCD (including extra NPS contribution up to Rs 50,000), Section 80E (education loan interest) and Section 16 (standard deduction on salary income) and so on.
This Budget, even while retaining five per cent tax for annual income in the Rs 2,50,001-Rs 5,00,000 range, on income higher than Rs 5,00,000, proposes a differentiated structure with five slabs against two under the existing scheme of things. The proposed slabs and corresponding tax rates are 10 per cent for Rs 5,00,001-Rs 7,50,000; 15 per cent for Rs 7,50,001-Rs 10,00,000; 20 per cent for Rs 10,00,001-Rs 12,50,000; 25 per cent for Rs 12,50,001-Rs 15,00,000 and for those earning above Rs 15,00,000 a tax of 30 per cent. A person who decides to avail lower tax rates under the new scheme will have to forego most exemptions and deductions. In other words, he can either continue with the existing scheme or go for the new regime. No cherry picking is permitted.
For a person availing of most tax breaks, switch-over to the new regime won’t yield any savings. He could even be worse off depending on the income profile and deductions/exemptions availed. For instance, a person having an annual income of Rs 15,00,000 and availing tax breaks aggregating Rs 3,75,000 (Section 80C:1,50,000; Section 80D: 25,000; Section 24: 2,00,000) or net income Rs 11,25,000 will have to pay Rs 1,56,000 as tax. In case however, he opts for the new scheme i.e. taxable income remaining at Rs 15,00,000 but lower rates, his tax liability will be Rs 1,95,000. This being Rs 39,000 higher, he would prefer to continue with the old scheme. However, the reality on ground zero is that an overwhelming number of assesses are unable to avail of the tax breaks. This is because people in the early stages of their family life have high expenditure commitment and hence need more cash in hand, leaving little surplus to invest which is necessary for availing deductions. Then, there are people at the fag end, say age 55 years plus, who are under no compulsion to save (he has already built a house or nearly completed education of the children). Such people who are unable or unwilling to invest — due to economic circumstances facing them — and hence, unable to avail exemptions and deductions would stand to gain by switching over to the new dispensation. In the above example (annual income Rs 15,00,000), the tax liability of such a person under the old regime would be Rs 2,73,000, which is Rs 78,000 higher than under the new regime (Rs 1,95,000). Without doubt, he/she will be inclined to go for the latter. That apart, the FM’s proposals empower assessees to take their own decisions instead of being constrained by available tax breaks. Someone wanting to have more cash in hand can opt for the new scheme whereas another person keen to save more can continue with the old regime.
According to an internal exercise by the Union Finance Ministry, the proposal will entail a loss of Rs 40,000 crore to the exchequer, which means that much extra cash in the hand of tax payers which they can spend, thereby giving a boost to demand and in turn, growth.
Another proposal expected to put more cash in the hands of individuals, especially those earning less than Rs 10,00,000 per annum, relates to the manner of levying dividend distribution tax (DDT). At present, a company is required to deduct tax (known as DDT) at the rate of 20 per cent (including surcharge and education cess, this comes to 20.35 per cent) from the surplus/profit set aside for distribution of dividend to shareholders. The Budget proposes to substitute this by taxing dividends in the hands of recipients/shareholders.
This substitution means that retail investors, whose earnings are in the Rs 500,001-Rs 750,000 and Rs 750,001- Rs 10,00,000 range, will stand to gain as they will pay tax on dividend at 10 per cent and 15 per cent respectively, as against 20 per cent they pay currently. This will also be a booster to foreign portfolio investors (FPIs) who will be able to claim offset for the tax paid on dividend received from companies here in their respective jurisdictions (this is not possible under the subsisting dispensation of levying tax before distributing profit).
Implementation of this proposal will entail an annual loss of Rs 25,000 crore to the exchequer. This much extra money in the hands of investors will also help augment purchasing power. Coming to corporate tax, on September 20, 2019, Finance Minister Nirmala Sitharaman had announced steep reduction in the rate of corporate tax for “new entities” incorporated from October 1, 2019 in the manufacturing sector and start production by March 31, 2023 from the existing 25 per cent to 15 per cent. Such companies won’t have to pay minimum alternate tax (MAT) (levied on book profit of firms which have no taxable profit courtesy, exemptions and incentives).
Furthermore, the tax rate on existing companies was reduced from 30 per cent to 22 per cent (for small and medium enterprises (SMEs) annually with a turnover of less than Rs 400 crore. This was reduced from the already preferential 25 per cent to 22 per cent) sans exemptions and deductions. These firms are also exempt from MAT. For companies who decide to continue with the old regime viz. tax at 30 per cent with tax breaks, MAT was reduced from existing 18.5 per cent to 15 per cent. In the Budget for 2020-21, the FM has extended the benefit of 15 per cent rate to “new” power companies. Besides, “cooperatives” are eligible for the 22 per cent rate sans exemptions and deductions. The steep reduction in tax rate (for new enterprises, it is at 15 per cent. This is lower than other major countries viz the US 21 per cent, China 25 per cent; even for existing firms at 22 per cent, this is comparable) is a major structural reform aimed at making Indian firms more competitive and leaving more resources with them for increasing investment. The FM has given a choice, enabling them to choose either the old regime (higher tax rate with exemptions) or new regime (lower tax rate sans exemptions).
The Budget proposals (September 2019 and now) entail a mammoth giveaway of about Rs 1,50,000 crore per annum. This should help in spurring investment demand. However, considering that at present, consumption is subdued and already, surplus capacity exists in several sectors (major investment by way of setting up new projects can come only after existing capacities are fully utilised), its impact on growth in the short-term may not be much.
Unless private demand improves significantly, companies might be inclined to retain the tax cut bonanza instead of investing. It would have been better if the Government had put more money in the pockets of individuals by giving extra relief in PIT (say, by applying 10 per cent tax to the entire income range Rs 5,00,001- Rs 10,00,000 instead of limiting this up to Rs 7,50,000) as the need for resurrecting growth now is far more pressing.
To conclude, tax proposals in the 2020-21 Budget are in the right direction. However, a lot more needs to be done in terms of further reducing and simplifying the PIT. With regard to corporate tax, the Government should aim at 15 per cent rate applicable uniformly to enterprises in all sectors, new and existing (sans exemptions).
(The writer is a New Delhi-based policy analyst)
