Sting in the tail

Get set for migration of established companies with new business ideas to the low-tax regime for start-ups

The equity market finally got the trigger it was waiting for in the unexpected deep rate cut to 22% from 30% in the base corporate tax and scrapping of the surcharge on long-term capital gains for the super rich, capping nearly a month-and-a-half of monetary and fiscal stimulus in driblets. The Nifty gained 7.7% in two days, its best performance till date. If previous high-decibel actions including the recall of high-value notes in November 2016 and implementation of the universal goods and service tax from July 2017 and real estate regulations from May 2016 did not produce such a big impact, it was because their outcome was never meant to be visible in the short term. Their intention was to change entrenched habits to effect a transformation. The benefit of the latest fiscal reform to level the field with other competitive economies could be captured just like when the Reserve Bank of India slashed the lending rate to a nine-year low and kept provisioning at 5.5% of the balance sheet, instead of the earlier 6.8%,  to hand out to the treasury Rs 1.76 lakh crore of surplus. The market’s relief following the government deciding to front-load Rs 70000 crore into public sector banks was much more noticeable than the reaction to easing NBFCs’ access to liquidity, opening coal mining and contract manufacturing to 100% foreign direct investment and relaxing local sourcing norms for single-brand retail to an average of five years instead of every year.

The spurt in stock prices factored in higher earnings growth. If so, mid and small caps, too, should have bounced back when the eligibility for 25% corporate tax was hiked to include those with turnover of Rs 400 crore from Rs 250 crore in July, covering over 99% of all companies. Yet, the relaxation did not lift the market mood as many of the intended beneficiaries had opted for exemptions or the lower minimum alternate tax, now brought down to 15%, from 18.5%, of book profit plus surcharge and cess. Several were grappling with the execution of GST. A few would be disclosing more taxable income to avail of the input tax credit. That the latest tax bonanza is applicable across the board is a welcome realization that concessions should encourage risk-taking. Limiting them to size and nature of business distorts the marketplace. Booming orders from original equipment manufacturers can do more to encourage formalization of the unorganized support system relied on for outsourcing than preferential treatment. The indirect tax regime is already transiting to two-three slabs. Large, mid and small caps have gained in tandem, based on the premise that the savings in tax outgo will be used to expand capacity and product portfolio, diversify into new markets, revive consumption, clear debt, increase dividends or issue bonus. Even in the crowd, companies with no or negligible leverage populating certain sectors got more attention. Banks turned into favorites in the belief they would have more cash to lend and their borrowers would be in a better position to service their loans.

 Worries about fiscal deficit ballooning on tax revenues declining Rs 1.45 lakh crore without a rollback in government expenditure took a back seat because of the central bank’s bumper dividend and consolidation and capital infusion expected to spur a PSB turnaround. Higher payouts will improve the dividend distribution tax mop-up. The reluctance to reduce GST from 28% on automobiles sends a message that the sector’s woes stem from structural issues. The thrust on housing for all and infrastructure does merit a lenient view of cement. If the sector failed to get any sympathy it speaks of the doubts of pass-through of any benefit due to the tendency of the players to flock together. The stunningly low 15% tax rate on new companies setting up manufacturing between 1 October 2019 and 31 March 2023 is the sting in the tail. In the giddy euphoria of imagining an exodus of foreign investors from China to India, what has failed to get traction is the possibility of legacy companies taking advantage of the eight percentage point arbitrage in the tax rate to stay ahead.  When the cap on foreign direct investment limit was removed in many non-core industries, MNCs saw more drawbacks in compliance than upsides of raising capital from the Indian market to stay listed.  Those that were hobbled by the high price thrown up by the reverse book-building process to go private shied from new launches. Some set up new units to make value-added products. If Indian promoters turn copy cats, the shareholders hoping for bumper wealth creation going ahead will be disappointed. After enjoying a short-lived spike in valuations, investors will face a choice of a stagnant future or starting afresh.  

-Mohan Sule