The steepest ever cut in tax that companies pay will improve relative competitiveness of India and should help boost corporate investment over the medium-term, IHS Markit said in a report on Friday.
The decision to implement the sweeping corporate tax reform measures reflects the slowdown in economic growth momentum in recent quarters as well as the need to improve India's international competitiveness as a manufacturing hub, it said.
The economy has been facing headwinds in 2019 due to weakening domestic demand. The RBI has eased monetary policy four times so far in 2019, by a total of 110 basis points, over concerns that growth momentum is slowing down.
The GDP growth in April-June 2019 slowed to 5 per cent year-on-year, the weakest pace of growth since 2013. The pace of manufacturing output growth has also stalled, heavily impacted by weakening auto sector sales. The auto industry has slumped into a crisis, with passenger vehicle sales down 31 per cent year-on-year in July 2019, while domestic passenger vehicle production lower by 17 per cent.
"The Indian government announced a major reform of corporate tax rates on September 20. This is expected to significantly improve the relative competitiveness of India's corporation tax rates compared to other Asian industrial economies, as India's corporate tax rates had been relatively high compared to regional peers prior to the latest tax reform measures," IHS Markit said.
The lower rates should help boost corporate investment in India over the medium-term, at a time when economic growth momentum has faced increasing headwinds, it said.
The corporate tax rate reforms reflect the global fiscal policy trend towards lowering corporate tax rates.
"The average corporate income tax rate across the OECD has dropped from 32.5 per cent in 2000 to 23.9 per cent in 2018, with notable corporate tax cuts in the US and UK in recent years," it said.
The base corporate tax rate has been cut from 30 per cent to 22 per cent. Companies that do not claim benefits for incentives or concessions will be eligible for the effective tax rate of 25.75 per cent, while new manufacturing firms established after October 1, 2019, are eligible for an even lower base corporate tax rate of 15 per cent (effective tax of just over 17 per cent) if they make fresh new investments in manufacturing by 2023 and are not claiming incentives.
"Services firms are expected to be major winners while manufacturing companies in the consumer goods, capital goods and steel sectors will also reap significant benefits as many of them have an effective tax rate of around 30 per cent," it said.
Since taking office in 2014, Prime Minister Narendra Modi has put a strong policy focus on improving the business landscape to attract investment by both foreign and domestic firms.
When the BJP-led NDA took office, India was ranked 142nd out of 189 countries in the World Bank's Ease of Doing Business ranking for 2015, which reflected results from the annual survey undertaken during 2014.
Reflecting significant progress in reducing barriers to business investment, India was ranked 77th out of 190 countries that are included in the World Bank’s Ease of Doing Business Index in 2019.
"The improving macroeconomic environment since 2014 has also helped improve India's attractiveness as an investment destination, as falling world oil prices have helped to reduce inflation pressures and also trimmed the current account deficit as a share of GDP as India's oil import bill has moderated," IHS said.
Sustained strong GDP growth over the past decade has also reinforced confidence among international investors towards the Indian economy.
"An important economic reform that has improved the competitiveness of India for manufacturing has been the introduction of the unified GST tax across all Indian states in 2017. This has helped to significantly reduce the regulatory burden on interstate transportation of goods. The unified GST is estimated to have substantially reduced logistics costs for firms, improving the efficiency and competitiveness of the domestic manufacturing sector," it said.
When Modi launched 'Make in India' in 2014, he set a target of increasing the contribution of manufacturing to GDP to 25 per cent. "However, by 2018, the manufacturing sector share of GDP was still at 18 per cent, which still leaves a substantial gap to bridge in order to achieve this vision," the report said.
Continuing to drive the transformation of India's industrial sector through 'Make in India' is a key strategic priority for the government, in order to improve manufacturing sector output growth and generate stronger employment growth.
Catalysing more dynamic growth in the manufacturing sector will, therefore, be very important as a key pillar to achieving India's objective of becoming an upper-middle-income economy by 2025, it said.
"The corporate tax reforms will lower India's effective corporate tax rates to levels that are more competitive with other Asian emerging markets, which should help improve India's attractiveness for investment into the manufacturing sector," IHS Markit added.