The new corporate tax system gets off to a flying start
The sharp increase in tax collection in 2021-2022 was one bright spot in a year ravaged by the second and third waves of the pandemic. The Ministry of Finance recently revealed that the actual tax revenue for the previous year could exceed revised budget estimates by almost ₹5 lakh crore. Much of this growth is due to the collection of direct taxes, which in turn has been supported by strong growth in corporate tax revenues.
Some quarters may have feared that corporate tax collections could be weaker in 2021-22, as it is the first full year of assessment since the introduction of the radically corporate tax regime. lower in September 2019. Former Finance Minister Arun Jaitley promised in 2015 that he would cut the corporate tax rate from 30% to 25% over the next four years. He tackled the task in a phased manner, first reducing the tax rate to 25% for small businesses.
But with growth having slowed sharply in 2019-20, the corporate tax rate was reduced to 22% for existing domestic companies and 15% for newly incorporated manufacturing companies in September 2019. The intention was to give a boost investment and stimulate demand. The preferential tax rate was subject to the condition that the companies did not benefit from any tax incentives or deductions. Companies opting for the new regime were also exempted from having to pay the alternative minimum tax.
The finance minister had then said that the loss to the treasury from this tax reduction windfall would be a staggering ₹1.45,000 crore. But the lower tax rate seems to have been placed in the sweet spot on the Laffer curve. Not only were gross corporate tax collections in 2021-22 32% higher than the previous fiscal year at ₹8.6 lakh crore, but large corporations have been quick to embrace the new tax regime. This has reduced effective tax rates for these companies, improved compliance and also helped public finances.
Figures published in the EU budget on the number of companies that have migrated to the new corporate tax regime reveal that the majority of large companies have found it beneficial to switch. For the financial year 2019-2020, about nine lakh companies filed tax returns. Of these companies, about 1.45 lakh have filed returns under Section 115BAA which allows a preferential tax rate of 22% and 1,244 companies have filed under Section 115BAB which allows a preferential tax rate. 15% tax for new manufacturing companies. While the overall proportion of companies that migrated may seem low, at 16%, only the smallest companies chose to stay in the old regime.
About 8.5 lakh enterprises, accounting for 94% of the total number of enterprises, have a total revenue of less than ₹1 crore. Only 14% of these small or loss-making businesses moved to the new corporate tax system, with 86% remaining under the old tax structure.
But among companies with total income above ₹50 crore, more than 60% have opted for the new corporate tax regime. Companies with income above ₹50 crore account for 78% of taxable income and corporation tax. It will therefore be fair to say that most corporate tax payers have approved of the new corporate tax regime.
Why did they migrate?
Tax advisers confirm that almost all of their corporate clients have preferred to switch to the new corporate tax regime. The main reason for this change is the attractively low tax rate applied uniformly to all businesses, whether large or small. With many of the tax incentives and corporate tax preferences phased out in recent years, companies have had no qualms about changing the regime. Those with tax credits carried over from previous years may be biding their time, but most others have moved on.
Another factor that has weighed heavily on companies is the provision that companies in the new regime are not subject to the alternative minimum tax. The simpler tax filing process, without the hassle of accounting for various incentives and maintaining multiple books for accounting and tax purposes, would also be an attraction.
Impact of migration
The new regime has clearly reduced the tax burden on businesses. Our Nifty500 corporate effective tax rate analysis for the nine-month period ending December 2021 shows an effective tax rate of 22.7%. The tax rate was 24 percent in the corresponding period of FY21 and 30.7 percent in FY20.
Despite the reduction in tax rates, tax collections have been robust due to strong growth in large corporate profitability during the pandemic. While some pockets of consumer discretionary have been hit during the pandemic, most companies have found a way to sell through online channels and, in fact, have taken advantage of small business financial struggles.
Going forward, as earnings growth moderates, corporate tax revenue growth may also decline, but the tax incentive savings may offset the reduced revenue. The revenue impact of major corporate tax incentives in 2020-21 was ₹1.03 lakh crore.
New tax regime
The migration to the new income tax regime has, however, been rather lackluster, with very few takers. This seems to be due to the concept of the new scheme which is more beneficial for low-income people. High earners don’t have much to gain, especially if they take advantage or intend to take advantage of tax incentives for investments, insurance, mortgages, etc.
Replicating the success of the new corporate tax regime to income tax may therefore not be so straightforward. But for now, she can rejoice in the success of the corporate tax system.
April 27, 2022