Union finance minister Arun Jaitley has his work cut out for him. Not only is the government’s overall revenue target likely to slip, the international corporate tax environment is also changing radically, unlike any time in the recent past, placing tax competition front and centre on the international agenda. With the passage of the tax reform package in the US which has sharply brought down the peak corporate income tax (CIT) rate from a high 39.6% to a low 21%, tax competition will be another new worry furrowing the finance minister’s brow in 2018.
The US reform dramatically reduces tax rates across the board, particularly for businesses, and promises to greatly simplify tax laws. Apart from the new low CIT rate of 21%, it also repeals the corporate alternative minimum tax, and provides for an indefinite carryforward of losses.
The proposals relating to business income taxation have the potential to start a huge international tax war, as the low headline corporate tax rate may spark competitive rate reductions across the world. This could have tremendous consequences for the investment environment in emerging economies, particularly in India.
The table below shows existing corporate income tax rates in selected economies, from competitors to the US such as the UK and China, to other emerging economies, including the BRICS, which range between 20-35%. The Organisation for Economic Co-operation and Development (OECD) average rate is about 25%. The US rate of 21% would be one of the most attractive tax rates on corporate income amongst all major economies, and certainly among the sought-after investment destinations. Investment decisions of multinational enterprises with the ability to locate operations in a destination of their choosing will surely favour the US, if this tax plan is implemented.
The impact on developing countries with weak investment climates – such as India – who need to attract foreign direct investment to their shores can be severe. India already offers huge tax incentives to multinational companies in a bid to attract investors, losing much-needed tax revenues. If drawn into a competitive tax war, India may need to make further concessions if it is to offset the reductions in tax rates in the US, putting further pressure on tax revenues.
The consequences to the investment-GDP ratio in India could be significant. Already, the gross fixed capital formation statistic continues to decline year after year. It has come down from a high of 37% of GDP in 2007-08 to 28.9% for Q2 of 2017-18 (as per the CSO Press Release of November 30, 2017). The Centre for Monitoring the Indian Economy (CMIE) reports that new investment proposals are likely to stabilise around Rs 8 trillion in 2017-18 which, would be about 60% of the new proposals made during 2016-17 and would be the lowest level since 2004-05. This would be the third consecutive year of a fall in new investments since they spiked momentarily in 2014-15, the difference is that the fall in 2017-18 would be sharper than in earlier years. In this context, a sharp reduction in corporate tax rates in a large, attractive investment destination like the US could have a further negative impact on India’s competitiveness. The economic uncertainty to the investment climate in India caused by demonetisation and the shabby design and implementation of the Goods and Services Tax (GST) does not help.