Taxing chasm: Corporates fail to tally with statutory rates

The divergence between effective corporate tax rate and statutory tax rate resulting in an erosion in the tax base was a point well brought out by Kelkar in his report on direct taxes presented two years ago.

A sample of 2,585 companies in 2001-02 showed an effective tax rate of 21.9% against the statutory rate of 39.55%, even after factoring in the minimum alternate tax on zero tax companies. This has been amplified in the report by the task force on the implementation of the FRBM (see table). The Kelkar panel on direct taxes had also made out a case for aligning taxable income with book profits, saying that the divergence between the two undermines corporate governance.

To do this, tax incentives would need to be knocked off and depreciation allowances rationalized. The policy prescription has again been endorsed by the FRBM task force. The thrust of corporate tax reform is to reduce the general rate of depreciation for plant and machinery from 25% to 15%, abolish all tax incentives for new units and lower the corporate tax rate from 35.875% to 30%.

With cenvat credit fully allowed for capital goods in the first year, internal accruals from depreciation are projected to improve after the roll out of the state VAT. The task force reckons that the lowering of corporate tax rate would translate into increased retained earnings which can be used to finance modernisation plans.

It has also voted against fresh tax incentives and reviving sunset clauses – those with a predetermined date of expiry. A beginning has been made this year with the complete phase out of 80 HHC. At the same time, however, more relief has been provided through accelerated depreciation benefits in this budget to bolster manufacturing sector investments. A flip flop in policy measures would only make it tougher for the government to achieve the goal of fiscal policy consolidation committed under the FRBM is the subtle message.

The task force has, in fact, pitched for accepting its recommendations as a package. Two alternative sets of policy measures have been prescribed. If the government opts for the first one, units which start operations after September 1, 2004 will not be entitled to the graded tax holiday for goods and services exported from STPs etc (10 A and 10 B of the Income Tax Act) and incentives for backward area development and infrastructure (Section 80 IA and 80 IB).

Existing units will continue to get the benefits. It has also suggested scrapping the present distinction between unabsorbed depreciation and business losses and allowing such losses to be carried forward indefinitely. The idea is to encourage long gestation projects. Scrapping the 2.5% surcharge on corporate tax, retaining dividend distribution tax of 12.5% on companies and continuing the exemption of long-term capital gains on equity are dovetailed in the first package.