Corporate tax reform is nice in theory but tough in practice. It usually requires lowering of tax rates and closing of loopholes. And whatever new, lower tax rate is determined, there will probably be another country willing to lower its rate further, creating what author of Too Big To Fail, Andrew Ross Sorkin, described as "a sad race to zero".
The US is in the process of putting theory into practice by lowering the corporate tax rate to 20% from 35%. Republicans claim this will boost growth and create more jobs. Indian industry, too, believes that a steep cut in our corporate tax rate will make a world of difference.
Lowering the rate to 18% from 30%, with the withdrawal of tax incentives and exemptions, surcharges and cesses, is the centrepiece of the Confederation of Indian Industry's Budget wishlist. This will send a powerful message to India Inc and global investors that India is an attractive investment destination.
Traditionally, corporate tax rates were not seen as defining the competitive advantage of nations. But the success of low-tax countries like Singapore and Hong Kong proved otherwise. Many others chipped away at their tax rates to attract inward investments. The US is keen to ensure that its own companies ship back their profits piled up overseas, making the goal somewhat different. What should be India's response? Policymakers do not favour a kneejerk reaction. India's strength is its huge market. GoI has already committed to lowering corporate tax rate to 25%, to attract foreign investors and give more liquidity to Indian companies to expand overseas. It would be wary of a steep cut in the absence of clear revenue collection trends from GST.
Many contradictions also need to be resolved. There are demands, for example, to create more special enclaves, with tax and legal regimes that are different from those for the rest of the country. Let us not forget that companies made a beeline to milk tax breaks in enclaves called special economic zones (SEZs), meant to promote export-oriented production. But resources were misallocated and revenues forgone.
Big Boys, Small Duty
The thicket of concessions must be cleared to raise the tax-to-GDP ratio. The current ratio - of the Centre and the states combined - is about 17%, of which about 5.7% comes from direct taxes, 7% from indirect taxes that have been subsumed in GST, and the rest from petroleum, customs and stamp duties. The target should be doubling the tax-to-GDP ratio to achieve the OECD average of about 34%.
Indian companies pay surcharge and cess, on top of the base rate of 30%, taking the total burden closer to 34.5%. These companies also pay dividend distribution tax, and the total burden does look steep for many. The effective tax rate has moved up to over 28% in 2015-16 from 24.6% in 2014-15, thanks to the phasing out of profit-linked incentives in some sectors such as telecom. This must be done in other sectors as well.
But the effective tax liability of the largest companies is lower than the smaller ones. That is because the larger ones can hire expensive tax planners. Some of them have also been able to house profit centres across the globe, including in tax havens, so as to move revenues around to minimise tax outgo. Companies with no global exposure are hamstrung, but these loopholes have been plugged now.
India has adopted the general antiavoidance rules to curb sharp tax practices. It has endorsed the OECD's rulesto prevent companies from shifting profits to shell companies in tax havens. Automatic sharing of information should be followed by the creation of a unique legal identifier to trace the beneficial owner. In these days of globalisation, countries including the US must cooperate to end base erosion and profit shifting. It will help lower the corporate tax rate.
There is also a difference now in the corporate tax liability between the services and manufacturing sectors. Services contribute to a lion's share of the GDP but bear a higher burden of tax due to fewer exemptions, whereas manufacturing bears a lower tax burden as it enjoys more exemptions, such as accelerated depreciation benefits on fixed assets. Yet, its share in GDP is still low.
In 2015-16, the effective tax liability of companies in the services sector stood at 30.3%, compared to 25.9% in manufacturing. Their tax liability must come down to foster a knowledge economy.
Eventually, a large slice of the total tax collections should come from direct taxes, not indirect taxes that impact the rich and poor in a similar way. If the GST is implemented well, indirect taxes should swell, and generate a broader base for direct taxes. Equally, collections will go up when tax rates become lower.
Duck Tax, Get Drenched
Reducing tax-planning opportunities and increasing the likelihood of tax evasion being detected will raise the cost of non-compliance. India is moving in this direction.
There is a need to hasten corporate tax reform to have a lower flat rate. An 18-20% rate without exemptions can put all businesses, whatever their size, on the same level. Direct tax collections would offer up a bounty. That would be nice not just in theory but in practice too.
DISCLAIMER: Views expressed above are the author's own.
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