Flip side of the corporate tax relief

Corporate India was awaiting Budget 2017 with concern as well as eager anticipation. The concern primarily stemmed from the demonetisation exercise over the latter part of 2016, and whether another shock from the government was in the offing. On the other hand, there was widespread anticipation that the Finance Minister would come up with some sort of sops to revitalise the economy.

The government, for its part, did a balancing act by largely maintaining status quo while trying to solve some problems being faced by the taxpayers. The absence of any blockbuster reforms means that business carries on as usual and with the pain from demonetisation now easing, the economy can get back to a growth trajectory.

That said, the Budget did feature some important changes on the tax front. Smaller corporates received the relief of the tax rate being reduced to 25 per cent, provided their turnover in FY 2015-16 was ₹50 crore or less. In his Budget speech, the Finance Minister mentioned that this reduction will benefit approximately 96 per cent of the corporate taxpayers. Doing some math would reveal that 96 per cent of the total corporate taxpayers are contributing approximately 33 per cent of the total tax collections — on the flipside, the balance 4 per cent of the corporate taxpayers are contributing a whopping 67 per cent of the total tax collections.

The Finance Minister mentioned that the effective tax rate of large corporate taxpayers is 25.90 per cent but this essentially is painting all mid-sized as well as large corporates with the same brush. Such a statement implies that all mid-sized as well as large corporate taxpayers enjoy tax holidays and benefits while the smaller ones do not.

As this is simply not true, one wonders whether a better course of action could have been to allow for lower tax rates for companies who do not claim any tax exemptions. For reasons unknown, the rates will apply on the basis of a monetary limit which will result in discriminatory treatment.

The mid-sized companies will suffer most since they will become uncompetitive compared to their smaller peers. The risk remains that mid-sized companies may consider splitting themselves into multiple companies, each having a turnover of less than ₹50 crore. This will be economically inefficient and undesirable.

Larger companies, on the other hand, may legitimately complain that the progressive tax system has been imposed in the corporate space as well where those who earn more, pay more.

The taxes are ultimately borne by (a) the shareholders in the form of lower earnings, dividends and market value; (b) employees — who may get unfairly squeezed; and (c) the customers who end up buying the products or services at a higher price. Essentially, the higher tax burden is shared by multiple persons and the same is undesirable. While the intention of the Finance Minister, of making the micro, small and medium enterprises (MSME) sector more competitive as against the larger companies, is laudable, it is questionable whether lower taxes alone can achieve this objective. In any case, most large companies cannot be compared with the MSMEs due to the sheer scale of operations, cost efficiencies, etc, and simply reducing the tax rates may not be sufficient.

Another relief measure in the Budget which impacts Corporate India is the rationalisation of the domestic transfer pricing provisions. Essentially, transfer pricing seeks to address situations where related enterprises transfer profits from a high tax jurisdiction to a low tax jurisdiction by charging an artificially higher price for their products and services. Transfer pricing has become extremely relevant from an international tax perspective and was brought into the domestic fold as well. However, that is undesirable since two related parties paying taxes at the same rates in India would not be able to shift profits, except in certain specific circumstances.

Domestic transfer pricing led to a proliferation of disputes between the taxpayers and the tax authorities even in cases where there was no shifting of profits from a higher tax regime to a lower tax regime.

The Budget seeks to minimise litigation by eliminating, from the domestic tax purview, all related party transactions except those where an entity availing a profit-linked tax benefit is involved. This is a wise step because, now, the domestic transfer pricing legislation will only address those transactions where there is a possibility of profits being shifted from a taxable to a non-taxable/exempted taxpayer.

Corporate taxpayers have broadly got what they were asking for. The Budget, while low on breakthrough reforms, can be understood given the background of the current economic environment in the country. What the Budget does is offer stability and certainty.

The writer is Managing Partner, Nangia & Co

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