The Indian stock market bounced back sharply in September 2019 and the Nifty recovered most of its losses for the financial year. The strong recovery followed the Finance Minister’s announcement on the corporate tax rate. Henceforth, companies that choose not to avail of some specific exemptions under the Income Tax Act, will be taxed on their income at a net rate (including surcharge and cess) of 25.2%, down from an earlier 34.9%. Further, the FM announced that any new manufacturing company set up after 1 October 2019 and which commences production before 31 March 2023, would enjoy a corporate tax plus surcharge and cess rate of 17.0%.
What surprised everyone was the scale of the announcement and that too in the middle of the year (and not part of the annual finance budget). It was partly a response to the economic weakness and partly due to events unraveling globally. Due to the global trade war, especially between US and China, companies globally are looking for alternatives to China as a manufacturing base. Other countries like Vietnam, Thailand, Indonesia are competing to become the alternative locations and are providing suitable incentives. Even countries like USA have significantly reduced corporate tax rates. The reduction in tax rates in India, particularly the steep cut for new manufacturing companies, positions India favourably for global companies looking to diversify out of China as their global manufacturing base.
As we have been discussing in our various newsletters in the past, there has been a palpable slowdown in economic activity in India over the last year or so. The government needed to act decisively to bring the economy back on track and we are glad that it has done so structurally with the cut in corporate tax rates. The private sector investment cycle has been very subdued for some time and the tax cut will go a long way to revive the animal spirits in the economy.
India is a potentially a high growth economy and managing the twin objectives of high growth and low fiscal deficit can be challenging at times. There have been concerns raised about the impact the tax cuts would have on the fiscal deficit. Tax collections for the first 5 months of the year have been slow and the fiscal deficit target was looking a stretch. An accelerated private sector investment cycle, the resultant change in sentiment and possibly some higher receipts from PSU divestment may help narrow the fiscal gap. Given the current slowdown, we would actually encourage the government to let go of the fiscal deficit target as an obsession for some time. They should go further and release all overdue payments from the government and PSUs to their suppliers and other tax related refunds. This would greatly help in easing the working capital situation of businesses and could work as a great support to get the economy back on track. The government has already announced some measures in this regard and we
are hopeful of an improvement in the situation on the ground.
The greatest mathematical benefit of the cut in corporate tax rate is to companies who were paying higher taxes as a proportion of their Profit before Tax (PBT). We are happy to report that a large number of companies in our portfolio will benefit from the new lower tax rates. The Tax to PBT ratio is one of the criteria we use for determining a high quality company. Once again, our faith is reaffirmed in our philosophy of investing in high quality companies.