Legislative Brief

The Taxation Laws (Amendment) Ordinance, 2019

Highlights of the Ordinance

  • Currently, domestic companies with annual turnover of up to Rs 400 crore pay income tax at the rate of 25%. For other domestic companies, the tax rate is 30%.  The Ordinance provides domestic companies with an option to pay tax at the rate of 22%, provided they do not claim certain deductions under the Income Tax Act.
  • These include deductions for: (i) newly established units in Special Economic Zones, (ii) expenditure on scientific research and skill development projects, (iii) investment in new machinery/ plant in notified backward areas, (iv) depreciation of new machinery/ plant, and (v) various other Chapter VI-A provisions.
  • The Ordinance provides new domestic manufacturing companies with an option to pay income tax at the rate of 15%, provided they do not claim the deductions specified above.
  • The Ordinance specifies that the provisions regarding payment of Minimum Alternate Tax (MAT) will not apply to companies opting for the new tax rates. MAT is the minimum amount of tax required to be paid, in case a company’s tax liability falls below a certain limit after claiming deductions.

Key Issues and Analysis

  • In 2017-18, 29% of the 8.4 lakh companies paid tax at an effective rate higher than 25%.  The Ordinance allows these companies a lower statutory tax rate option of 25.17%.  Note that these companies contributed 69% of the total income tax paid by all companies in 2017-18.
  • In case of the manufacturing sector, the effective tax rate after deductions was 28% in 2017-18.  This is much higher than the 17.16% statutory tax rate option provided under the Ordinance for new domestic manufacturing companies.
  • The Ministry of Finance has estimated the revenue impact of new tax rates and other measures under the Ordinance (includes exemptions to capital gains of certain investors from increased surcharge rates) at Rs 1.45 lakh crore.  This could increase the fiscal deficit for the year 2019-20 from 3.3% of GDP to 4% of GDP.
  • The Ordinance specifies that the MAT provisions (Section 115JB of the IT Act) will not apply to companies opting for the new rates.  It does not amend Section 115JAA, which allows companies to utilise MAT credit available with them to pay tax.  After the Ordinance, the Central Board of Direct Taxes issued a circular specifying that MAT credit cannot be utilised by companies opting for the new rates.  The question is whether a circular can override the MAT credit facility provided in the IT Act.

PART A: HIGHLIGHTS OF THE ORDINANCE

Context

In India, companies pay taxes on their income as per the Income Tax Act, 1961 (IT Act).  Under the Act, domestic companies (i.e. companies incorporated in India) with annual turnover of up to Rs 400 crore are required to pay income tax at the rate of 25%.[1]  For other domestic companies, the tax rate is 30%.1  In addition, companies are also required to pay a surcharge on income tax and the Health and Education Cess.  Including the surcharge and cess, the statutory tax rate for domestic companies ranges between 26% and 35% (see Table 1).

Table 1: Tax rate including surcharge and cess

 

Turnover up to Rs 400 crore

Turnover more than Rs 400 crore

Income up to one crore rupees

26%

31.2%

Income between Rs 1 crore and Rs 10 crore

27.8%

33.4%

Income more than Rs 10 crore

29.1%

34.9%

Sources:  The Finance (No. 2) Act, 2019; PRS.

In 2009, the draft Direct Taxes Code was released aiming to consolidate and simplify the IT Act and other direct tax laws, and establish an efficient and equitable tax system with minimum exemptions.[2]  It proposed a uniform tax rate of 25% for all domestic companies.2  Subsequently, the Direct Taxes Code, 2010 was introduced in Lok Sabha which proposed a 30% tax rate for domestic companies.[3]  It lapsed with dissolution of the 15th Lok Sabha.

In the 2015-16 Budget Speech, the Finance Minister noted that a higher basic corporate tax rate in India (30%), in comparison to the other major Asian economies, makes the domestic industry uncompetitive.[4]  On the other hand, due to excessive exemptions, the effective revenue realised by the government is at a lower rate (23%).4  The Finance Minister proposed reducing the tax rate from 30% to 25% over a period of four years, along with rationalisation and removal of various exemptions and incentives.4  In November 2017, the Ministry of Finance constituted a Task Force to review the IT Act and draft a new direct tax law, keeping in view the direct tax system of various countries and their best practices.[5]  The Task Force submitted its report in August 2019.

The Taxation Laws (Amendment) Ordinance, 2019 was promulgated on September 20, 2019 to amend the IT Act and the Finance (No. 2) Act, 2019.[6]  It provides lower tax rate options to domestic companies to promote growth and investment and attract fresh investment in the manufacturing sector.[7]

Key Features

New income tax rate option for domestic companies

  • Currently, for domestic companies with annual turnover of up to Rs 400 crore, the income tax rate is 25%. For other domestic companies, the tax rate is 30%.  The Ordinance provides domestic companies with an option to pay income tax at the rate of 22%, provided they do not claim certain deductions under the IT Act.  These include deductions provided for: (i) newly established units in Special Economic Zones (SEZs), (ii) investment in new plant or machinery in notified backward areas, (iii) expenditure on scientific research, agriculture extension, and skill development projects, (iv) depreciation of new plant or machinery (in certain cases), and (v) various other provisions in the IT Act under Chapter VI-A.
  • The Ordinance provides new domestic manufacturing companies with an option to pay income tax at the rate of 15%, provided they do not claim certain deductions (as specified above). These new companies must be set up and registered after September 30, 2019, and start manufacturing before April 1, 2023.  New manufacturing companies will not include companies: (i) formed by splitting up or reconstruction of an existing business, (ii) engaged in any business other than manufacturing or production, and (iii) using any plant or machinery previously used in India (except under certain specified conditions).

Provisions for companies opting for the new tax rates

  • A company can choose to opt for the new tax rates in the financial year 2019-20 (i.e. assessment year 2020-21) or in any other financial year in the future. Once a company exercises this option, the chosen provision will apply for all subsequent years.
  • Domestic companies pay surcharge at 7%, if income is between one crore rupees and Rs 10 crore, and at 12%, if income is more than Rs 10 crore. Companies opting for the new rates have to pay a 10% surcharge.

Minimum Alternate Tax

  • Minimum Alternate Tax (MAT) is the minimum amount of tax required to be paid by a company, in case its tax liability after claiming deductions falls below a certain limit. This limit is calculated as a certain percentage (i.e. MAT rate) of the company’s book profit (subject to certain adjustments).  The Ordinance reduces the MAT rate from 18.5% to 15% with effect from the financial year 2019-20.
  • The Ordinance specifies that the provisions regarding payment of MAT under the IT Act will not apply to companies opting for the new tax rates.

PART B: KEY ISSUES AND ANALYSIS

Impact of lower tax rate options provided to domestic companies

The Ordinance provides that domestic companies can opt for the 22% tax rate and new domestic manufacturing companies can opt for the 15% tax rate, provided they do not claim certain deductions.  Including surcharge and cess, companies opting for these tax rates are statutorily required to pay tax at the rates of 25.17% and 17.16%, respectively.  Before the Ordinance, the statutory tax rates for domestic companies ranged from 26% to 35% (Table 1); however, they could reduce their effective tax rates by claiming deductions under the IT Act.  In the following section, we examine the effective rates at which companies pay taxes (after claiming deductions) to understand how many companies could opt for the new tax rates and the likely fiscal impact of lower tax rates.

Table 2 provides data on the effective tax rates for 8.4 lakh companies that filed income tax returns for the financial year 2017-18.  These rates are the actual tax rates at which these companies paid tax in 2017-18.  About 29% of the 8.4 lakh companies paid tax at an effective rate that was higher than 25%.  The Ordinance allows these companies a lower statutory tax rate option of 25.17%.  Note that these companies contributed 69% of the total income tax paid by all companies in 2017-18.

For instance, in case of the manufacturing sector, the effective tax rate after deductions was 28% in 2017-18.  This is much higher than the 17.16% statutory tax rate option under the Ordinance for new domestic manufacturing companies.[8]

Table 2:  Effective tax rates after deductions (2017-18)

Effective tax rate after deductions

Proportion of companies

Share in total tax paid

Less than zero and zero

45%

1%

0% to 20%

10%

8%

20% to 25%

5%

22%

25% to 30%

19%

16%

30% to 33%

6%

42%

More than 33%

4%

11%

Zero profit before taxes

11%

0%

Note: Effective tax rate is calculated as tax paid after deductions divided by profit before tax.  Data is for both domestic and foreign companies.

Sources:  Statement of Revenue Impact of Tax Incentives, Receipt Budget, Union Budget 2019-20; PRS.

We analysed the latest quarterly filings (Q2 2019-20) submitted by the BSE100 companies to see how many of them are opting for the new tax rates under the Ordinance.  Of the 99 companies that have submitted their filings till date, 47 companies have opted for the new tax rates for the financial year 2019-20.[9]  The 52 other companies have not given a clear indication on opting for the new tax rates for 2019-20.

The fiscal impact of companies opting for the lower tax rate options would depend on: (i) the number of companies opting for these options, and (ii) the difference between their new and old effective tax rates.  The Ministry of Finance has estimated the revenue loss in providing the lower tax rates and other measures under the Ordinance (includes exemptions to capital gains of certain investors from increased surcharge rates) at Rs 1.45 lakh crore.7  This is equivalent to 5.2% of the government’s revenue estimate in 2019-20.  If all other parameters remain the same, this could increase the fiscal deficit for the year 2019-20 from 3.3% of GDP to 4% of GDP.

Deductions under the Income Tax Act

The Ordinance specifies certain deductions under the IT Act which cannot be claimed by companies opting for the new tax rates.  Table 3 shows the major deductions claimed under the IT Act in terms of their revenue impact (i.e. revenue foregone by the government in allowing the deduction).  The total revenue impact of these deductions was Rs 1.2 lakh crore in 2017-18.  Table 3 also classifies deductions depending on whether they can be claimed with the new tax rates.  Note that the Ordinance notifies only certain components under accelerated depreciation, export profits of SEZ units, and expenditure on scientific research which cannot be claimed by companies opting for the new tax rates.  The revenue impact data for these specific components is not available.

Companies presently availing deductions, which cannot be claimed with the new rates, may decide to continue with the existing system for some time.  They may do so till the benefits from deductions are more than those from lower rates.  Note that companies can opt for the new rates in 2019-20 or in any other year in the future.

Table 3:  Major deductions for companies under the IT Act and their revenue impact in 2017-18

Deductions that cannot be claimed

Revenue impact

Deductions that can be claimed

Revenue impact

Accelerated depreciation

Rs 58,326 crore*

Donations to charitable trusts and institutions

Rs 1,860 crore

Export profits of SEZ units

Rs 20,918 crore*

Employment of new employees

Rs 738 crore

Profits of power sector undertakings

Rs 13,157 crore

Contributions to political parties

Rs 133 crore

Expenditure on scientific research

Rs 6,832 crore*

 

 

Profits of undertakings set-up in Sikkim

Rs 2,321 crore

 

 

Profits of undertakings set-up in Uttarakhand

Rs 1,798 crore

 

 

Various other deductions

Rs 13,986 crore

 

 

Note:  * Certain deductions under these categories can be claimed with the new rates.  Data not available separately for these components.

Sources:  Statement of Revenue Impact of Tax Incentives, Receipt Budget, Union Budget 2019-20; PRS.

Utilisation of MAT credit by companies opting for the new tax rates

Minimum Alternate Tax (MAT) is the minimum amount of tax required to be paid by a company, in case its tax liability falls below a certain rate after claiming deductions under the IT Act.  A company paying MAT in excess of its normal tax liability (as per the other provisions of the Act) is provided MAT credit, equivalent to the amount of additional tax it had to pay.  The company can use this credit to pay tax in the future (within a 15-year period).  For example, a company with Rs 100 crore book profit is required to pay a minimum tax of Rs 15 crore (assuming 15% MAT rate).  If its normal tax liability after claiming deductions is Rs 10 crore (less than MAT), it is required to pay MAT of Rs 15 crore, and can use MAT credit of Rs 5 crore to pay tax in the future.

The Ordinance specifies that the MAT provisions (Section 115JB of the IT Act) will not apply to companies opting for the new tax rates.  This implies that such companies are not required to pay the minimum amount of tax set by MAT.  However, it does not amend Section 115JAA of the IT Act, which allows companies to utilise MAT credit available with them to pay tax.  After the Ordinance, the Central Board of Direct Taxes issued a circular specifying that MAT credit cannot be utilised by companies opting to pay tax at the new rates, as MAT is not applicable to such companies.[10]  It also states that since there is no timeline within which a company can opt for the new rates, a company may choose to do so after utilising its MAT credit, if it so desires.  The question is whether a circular can override the MAT credit facility provided in the IT Act.

Corporate tax rates in other countries

The table below gives a comparison of the corporate tax rates across major countries during the year 2018.

Table 4:  Comparison of corporate tax rates across major countries (2018)

Asia

Tax rate (in %)

Europe

Tax rate (in %)

Other countries

Tax rate (in %)

Hong Kong

16.5

United Kingdom

19

USA

25.8*

Singapore

17

Russia

20

Canada

26.8*

Thailand

20

Switzerland

21.1*

South Africa

28

Vietnam

20

Spain

25

New Zealand

28

Malaysia

24

Netherlands

25

Australia

30

Indonesia

25

Italy

27.8*

Mexico

30

China

25

Germany

29.8*

Argentina

30

South Korea

27.5*

France

34.4

Brazil

34

Japan

29.7*

 

 

 

 

India#

35

 

 

 

 

Note:  *Tax rate includes corporate tax rates levied by state governments in these countries.  #In case of India, the tax rate reflects the highest applicable tax rate (including surcharge and cess).  Including the dividend distribution tax, the tax rate would come out to be 48.3%.

Sources:  OECD Corporate Tax Statistics 2018; PRS.

 

[1].  The Finance (No. 2) Act, 2019, Ministry of Finance, August 1, 2019, http://egazette.nic.in/WriteReadData/2019/209695.pdf.

[2].  Discussion Paper, Direct Taxes Code, Ministry of Finance, August 2009, https://www.prsindia.org/sites/default/files/bill_files/Discussion_Paper.pdf.

[3].  The Direct Taxes Code, 2010, Ministry of Finance, August 30, 2010, http://164.100.47.4/BillsTexts/LSBillTexts/Asintroduced/DTC%20(110%20of%202010)%20To%20be.pdf.

[4].  Budget Speech, Union Budget 2015-16, February 28, 2015, https://www.indiabudget.gov.in/doc/bspeech/bs201516.pdf.

[5].  F. No. 370149/230/2017, Central Board of Direct Taxes, Ministry of Finance, May 22, 2018, https://www.incometaxindia.gov.in/Lists/Latest%20News/Attachments/249/Extension-time-Task-Force-drafting-New-Direct-Tax-Legislation-Scan-22-5-2018.pdf.

[6].  The Taxation Laws (Amendment) Ordinance, 2019, Ministry of Finance, September 20, 2019, http://www.egazette.nic.in/WriteReadData/2019/212631.pdf.

[7].  “Corporate tax rates slashed to 22% for domestic companies and 15% for new domestic manufacturing companies and other fiscal reliefs”, Press Information Bureau, Ministry of Finance, September 20, 2019.

[8].  Statement of Revenue Impact of Tax Incentives under the Central Tax System: Financial Years 2017-18 and 2018-19, Receipt Budget, Union Budget 2019-20, July 5, 2019, https://www.indiabudget.gov.in/doc/rec/annex7.pdf.

[9].  Q2 2019-20 filings submitted by the BSE100 companies.

[10].  F. No. 142/20/2019, Central Board of Direct Taxes, Ministry of Finance, October 2, 2019, https://www.incometaxindia.gov.in/news/circular_29_2019.pdf.

 

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