IT: No immediate impact

Most companies in the information technology space will not be enthused by the corporate tax rate cuts announced by Finance Minister Nirmala Sitharaman. There are two reasons. Many companies have an effective corporate tax rate below 25.17 per cent (including surcharge and cess) and they get the benefit of profit-based deductions for exporting their services from special economic zones in India.

Also, IT and software companies that build their own intellectual property get a weighted deduction under the income-tax laws on the R&D expenses that they have incurred to build their IP.

Now, such companies might have to pay minimum alternate tax (MAT) calculated on their book profits.

The Finance Minister has slashed MAT from 18.5 per cent to 15 per cent. That puts the effective tax rate, including surcharge, for companies paying MAT at 17.5 per cent compared with 21.6 per cent earlier.

This means that IT companies that get tax deductions on their export revenues earned from operating in SEZs, and pay MAT, wouldn’t want to opt out of claiming these deductions. They would also have to forego the weighted deduction on R&D that brings down the effective corporate tax rate.

Besides, if they opt for the lower effective corporate tax rate of 25.2 per cent, they will have to take a one-time charge of any MAT credit that might be in their books.

In 2018-19, out of the top-tier IT companies in the S&P BSE IT Index, only Infosys (26 per cent) had an effective tax rate of over 25 per cent at the standalone level, while TCS (21.3 per cent), HCL Technologies (23.7 per cent), Wipro (23.02 per cent) and Tech Mahindra (19.6 per cent) had effective tax rates below 25.2 per cent.

Even most mid-tier IT companies such as Mphasis (20.5 per cent), Hexaware (22.3 per cent), Mindtree (24.9 per cent), L&T Infotech (21.7 per cent) and L&T Technology Services (24.2 per cent), had effective tax rates below 25.2 per cent.

In all, IT companies won’t be rushing to opt out of their export-based tax incentives until the benefit of paying lower taxes on export revenues runs out.

FMCG: Higher profitability

With major players such as Hindustan Unilever, Nestle, Britannia, GSK Consumer and Colgate-Palmolive suffering an effective tax of 32-36 per cent, the FMCG segment could be a beneficiary of the new 25.17 per cent tax rate.

At the same time, home-grown companies such as Dabur, Jyothy Labs, Godrej Consumer, Bajaj Consumer and Marico may not choose to move to the new regime, considering that their effective tax rates are either on a par with or lower than 25.17 per cent.

Overall, for shareholders in FMCG stocks, this move could result in the 2018-19 profits of listed FMCG players, on an aggregate, inching up by 9 per cent.

However, FMCG companies can choose to retain a portion of the benefits to increase advertising spends and/or pass it on as price cuts to boost demand. In the quarter-ended June 2019, for instance, major FMCG companies clocked single-digit growth in sales due to poor volumes.

Autos: Lower tax for majors

Going by the 2018-19 numbers, Hero MotoCorp, TVS Motors and Maruti Suzuki and Eicher Motors have an effective tax rate of 29-33 per cent and could benefit from the reduced rates. However, the rates of Mahindra & Mahindra and Ashok Leyland, are much lower. Taking M&M ‘s reported tax expenses (standalone) for 2018-19, the effective tax rate is only at 24.17 per cent (21.3 per cent, considering the current year's tax expense alone).

The company also has a MAT credit of ₹1,116.35 crore in its books as on March 31, 2019. Ashok Leyland’s effective tax rate, given the reported tax expense for 2018-19, is 20.6 per cent (15.14 per cent taking the current year's expense alone). The company has availed itself of benefit to the extent of ₹233 crore on tax concessions and tax holidays in 2018-19 and has MAT credit on its books.

In such cases, companies may choose to continue under the current regime till the tax holiday/concessions exist. Since MAT also continues at a reduced rate of 15 per cent, these companies can choose to pay tax as per normal rates or as per MAT, whichever is higher — as has been the case until now. MAT credit can also be set off against the tax liability in future years.

Among auto ancillaries, MNC players such as SKF India, Goodyear and Bosch that have high effective tax rates of 33-36 per cent could be major beneficiaries. Put together, listed companies in the auto and auto ancillaries space may see a 3-5 per cent addition to their profits of 2018-19, if they choose to avail themselves of the 25.17 per cent tax rate.

Cement, Infra, Capital Goods: Building a strong base

For infrastructure companies, the effective tax rates in FY19, after taking into account all eligible exemptions and tax holidays, work out to 27-35 per cent of their standalone PBT. For companies such as Engineers India, Ircon International, Ashoka Buildcon and RITES, availing themselves of the lower tax rate of 25.17 per cent could translate to a 14-18 per cent jump in earnings, going forward. Whereas, giants such as Larsen & Toubro and IRB Infra developers could witness only a 2 and 5 per cent rise in PAT led by tax savings.

Among the pure construction players, NCC, Welspun and Sadhbav Engg could benefit. Certain companies have effective tax rates of less than 25 per cent, which can be on account of payment of minimum alternate tax, or availing themselves of benefits of differential depreciation on fixed assets under the IT Act. The effects of the amendments announced will hence have to be evaluated on a case-to-case basis.

For instance, Dilip Buildcon has an effective tax rate of 16 per cent in FY19 on account of MAT provisions (inferred from the annual report). Hence, the lowered MAT rates could bring down its effective tax rate further, and the company would also get the existing MAT credit entitlement.

On the other hand, Adani Port and SEZ now enjoy an effective tax rate of 21 per cent, after availing itself of deductions under Section 80IAB of the Income Tax Act for 10 years, with effect from FY07-08. This apart, it has several subsidiaries and joint ventures that can get tax holiday benefits under Section 80IA.

The company is also likely to benefit from the grandfathering of taxes on buyback, as the management had made a public announcement of the share buyback of ₹1,960 crore on June 4, 2019.

Among the cement manufacturers, the effective tax rate in FY19 for most companies (on a standalone basis) is less than 25 per cent — they may refrain from foregoing their exemptions and deductions. This includes large players like Ultratech and Shree Cement. However, there could be savings in PAT in the range of 11-15 per cent for Himadri, Deccan and India Cements if they opt for the subsidised rates, as their current effective tax rate is more than 25.17 per cent.

Steel : Mixed impact

The impact of the lower corporate tax on the steel industry is expected to be mixed, at least in the near future.

The tax incidence on companies such as Tata Steel, Kalyani Steels and Jindal Stainless Hisar in FY19 was 39 per cent, 33 per cent and 37 per cent, respectively. Note that these are the tax rates after taking into account the tax exemptions that the companies are eligible for. Thus, these companies stand to gain in a big way if they opt for the reduced tax rate of 22 per cent (25.17 per cent including surcharge and cess).

Companies such as JSW Steel and Tata Metaliks with effective tax rates of 20 per cent and 22 per cent, respectively, may not opt for the reduced tax rate immediately. Meanwhile, SAIL, Jindal Steel and Uttam Galva had zero current tax for FY19. This could be either due to companies making losses in FY19 or accumulated losses from previous years, setting off the year’s profits. If the new reduced tax rate is opted, setting-off of losses will not be possible, making it unattractive. However, in the long run, when the companies turn profitable or become eligible to pay MAT, they can opt for the new tax rates, which could reduce their tax outgo.

Real estate: Better plot

The move to reduce corporate tax seems largely positive for real-estate companies reeling under pressure due to tight liquidity in the market. For most realty companies, the effective tax rate is higher than 25.17 per cent (including cess and surcharge), based on standalone profit before tax. For instance, for Oberoi Realty and Ashiana Housing, the current tax rate is 29 per cent, while for Kolte-Patil, it works out to around 45 per cent.

These companies, if they adopt the new corporate tax regime, could improve their earnings, even if they forego their exemptions and MAT credit.

If players pass on the benefit to home buyers, it could spur demand in the market.

But for companies such as Sunteck Realty and Prestige Estate Properties, for which the effective current year tax rates work out to less than 5 per cent, and Brigade Enterprises and Sobha with 23 per cent rate, continuing with the existing tax structure may be better.

Oil & Gas: Largely positive

For the oil and gas sector, the cut in corporate tax rate seems largely positive. Going by their FY19 standalone financials, the effective tax rate for most companies in the sector is higher than the 25.17 per cent rate (including surcharge and cess) that will apply to them now. For instance, in FY19, the current tax provision of city gas distributors Indraprastha Gas and Mahanagar Gas was about 31 per cent of their profit before tax.

The effective tax rate for the PSU hydrocarbon explorers, ONGC and Oil India, and gas transmitter GAIL (India) was 27-28 per cent, while it was about 29 per cent for PSU refiner HPCL. The highest tax rate — about 32 per cent — was borne by Gujarat-based gas transmitter GSPL. For the above companies, the new tax rate of 22 per cent plus surcharge of 10 per cent and cess of 4 per cent — totalling 25.17 per cent — should translate into lower tax outgo. Even if these companies have to give up some investment-based tax exemptions and credit of minimum alternate tax carried forward from earlier years, they should be better off under the new tax rate regime.

On the other hand, there are a few companies such as Reliance Industries, PSU refiners Indian Oil and BPCL, and gas importer Petronet LNG that may not benefit from the new tax rate. In FY19, the current tax provision of Reliance Industries, Indian Oil and BPCL was about 20 per cent of their profit before tax — this is lower than the new effective tax rate of 25.17 per cent.

It is the same case for Petronet LNG, which had an effective tax rate of about 24 per cent last year. For these companies, it may be worthwhile continuing with their existing tax structure, taking the benefits, if any, of investment-based tax exemptions, and carried forward MAT credit and carried forward loss.

In the case of Reliance Industries, for instance, while the applicable tax rate in FY19 was 34.94 per cent, it was able to reduce the effective rate (excluding deferred tax adjustments) to about 20 per cent, thanks to exempted income, and additional allowances net of MAT credit.

The company may likely find it more beneficial to continue with this arrangement until the tax breaks that keep the effective tax low are exhausted.

Later, it could shift to the new regime with the effective tax rate of 25.17 per cent.

Equity: Big stimulus for India Inc

Finance Minister Nirmala Sitharaman opened the liquidity tap for corporates on Friday by announcing a sharp tax cut and leaving more money in their hands for capacity expansion. The statutory tax rate for corporates has been lowered to 22 per cent from 30 per cent. This benefit, though, is only for companies that wish to give up their tax exemptions. Given that most tax incentives and exemptions have been phased out over the past few years, companies may prefer to forego the few they enjoy now, and opt to be taxed at the lower rate of 22 per cent.

New manufacturing companies incorporated after October 1, 2019, can benefit from an even lower rate of 15 per cent tax if they don’t claim the tax benefits they are eligible for. India Inc will also get relief on MAT (Minimum Alternate Tax). The Finance Minister has reduced MAT to 15 per cent from 18.5 per cent. This would benefit companies located in SEZ developers, infrastructure, cement companies, companies with units in specified locations in the North-East and exporters. There is also relief on buyback tax.

The 20 per cent tax on buybacks by corporates, which was announced in the Budget on July 5, 2019, would not apply to companies that announced them before the Budget day. According to data from nseinfobase.com, companies, including Sasken Technologies, Greaves Cotton, Welspun Corp, Star Cement and Eris Lifesciences, whose issues are on the way, but were announced before July 5, and for companies such as Infosys, which had buybacks ongoing in July, will benefit from the change. Wipro is also set to benefit as it announced its buyback on June 5.

Companies that pay corporate taxes under the new rates of 15 and 22 per cent will be charged a flat surcharge of 10 per cent, irrespective of their taxable income. The companies that choose the existing regime, availing exemptions and deductions, will have to pay a surcharge only if their total income exceeds ₹1 crore. The rates of surcharge for them will continue to be at 7 per cent and 12 per cent, for total income between ₹1 crore and ₹10 crore and more than ₹10 crore, respectively.

The stock market on Friday cheered the Finance Minister’s move to cut taxes. While companies that are currently paying lower rates due to various deductions and exemptions, such as many information technology players, are unlikely to shift to the new regime, there are many companies across sectors that are likely to see their tax incidence move lower, thus translating to higher profits. If the lower tax incidence is passed on to customers in the form of price cuts, it can help spur demand.

Effective tax rate went in past

Ever since the late Finance Minister Arun Jaitley kick-started the process of a phased reduction in corporate tax in 2016-17 and elimination of exemptions, the effective tax rate for India Inc has only gone up.

This is because, while smaller companies were given the benefit of a lower tax rate each year, the phasing out of some tax deductions began impacting the tax outgo of larger companies.

Further, in 2015-16, the Finance Minister also increased the surcharge on corporate tax. That year, for companies with income of up to ₹10 crore, the surcharge was increased to 7 per cent from 5 per cent, and for firms with income above ₹10 crore, it was increased to 12 per cent from 10 per cent. Thus, the effective tax rate in 2017-18 came to 29.49 per cent; it was 23.22 per cent in 2013-14. This increase — evident in the numbers of the past one year — was due to larger companies coughing up more.

In 2017-18, the effective tax rate for companies making profit of more than ₹500 crore was 26.3 per cent; in 2016-17, it was 23.94 per cent. The effective tax rate for smaller companies making profit of ₹1-10 crore came down to 27.38 per cent from 29.2 per cent. So far, withdrawal of tax exemptions has made the effective tax rate of larger companies move higher. It is from here on that these companies will start benefiting.

Now, all companies that are willing to give up their tax incentives can pay taxes at a fairly lower rate of 22 per cent.

Among the lowest globally

India is now among the countries that have a low corporate tax rate, and can compete better globally. For the current year, KPMG data show that the statutory tax rate in Myanmar is 25 per cent; in Malaysia, it is 24 per cent; 25 per cent in Indonesia and Korea and 28 per cent in Sri Lanka. Even Chinese companies cough up more — as they pay a tax of 25 per cent — and in Brazil, it is 34 per cent.

The global average corporate tax rate is 23.79 now, and the Asian average is 21.09 per cent. That said, the current move to cut taxes is going to make a hole in the government’s tax kitty. Last year, as per the Budget estimates, the revenue foregone by the Centre on various tax incentives was ₹1.08-lakh crore. Now, with tax cuts, there will be an additional revenue loss of ₹1.45-lakh crore.

Bonds: What’s in store

Bond investors who have been basking in the double-digit return glory over the past year may be in for a bumpy ride ahead. While Finance Minister Nirmala Sitharaman’s corporate tax rate cut has cheered India Inc and the equity market, the move is a dampener for bond markets.

This is because the revenue loss of ₹1.45-lakh crore owing to the cut will throw the Centre’s fiscal deficit target off track. The RBI’s surplus transfer to the Centre, at best, makes up for the existing shortfall in income tax and GST collections. While higher proceeds from disinvestment and some tax buoyancy (towards the end of the fiscal), on account of the growth-boosting measures, can aid revenues, for now, the ₹1.45-lakh crore revenue loss appears to have left a big hole in the Centre’s kitty. The fiscal deficit target could well move up to 4 per cent (from the projected 3.3 per cent), implying additional borrowings.

Fiscal math

Based on the Controller General of Accounts’ (CGA) provisional figures for FY19 (in which income tax grew by a modest 7 per cent), the estimated growth in income tax collections for FY20 works out to 23 per cent. For April-July, CGA data suggest that the growth in net income tax was just about 6 per cent. There is also a significant shortfall in GST collections.

The surplus transfer by the RBI as recommended by the Bimal Jalan Committee has offered a much-needed respite to the Centre in the current fiscal. Excluding the ₹28,000-crore interim dividend already paid by the RBI to the Centre last fiscal, the net transfer in the current financial year amounts to ₹1,48,051 crore. But while optically, the surplus transfer appears to be a massive figure, essentially, it is about ₹60,000 crore above what was estimated in the Budget. Hence, this additional bonanza can help make good the shortfall in tax revenues.

On the disinvestment front, the Centre has set a target of ₹1.05-lakh crore (above the ₹85,000 crore achieved the previous year), which may be achievable. But given that the Centre has been missing its target on spectrum, it is unlikely to meet its estimate of ₹50,500 crore for FY20.

On balance, before the corporate tax rate cut, the Centre could have still pulled off the 3.3 per cent (risk of missing GDP growth assumptions though remained). The substantial ₹1.45-lakh crore revenue foregone on account of the corporate tax rate cut is an additional burden for the Centre that can take its fiscal deficit target to 4 per cent levels.

The joker in the pack is still the underlying growth in the economy. While the real GDP growth has fallen from 8 per cent last year to 5 per cent this fiscal in the April-June quarter, the sharp fall in nominal GDP growth from 12.6 per cent to 8 per cent during this period is worrisome.

The Centre’s fiscal deficit target assumes a 11 per cent growth in nominal GDP growth for FY20 (from the Central Statistics Office’s FY19 estimates), which is a tall task. If growth falters further, the fiscal deficit target can even move beyond 4 per cent levels.

Demand-supply dynamics

The biggest overhang for Indian bond markets has been the huge gross market borrowings by the Centre pegged at a high ₹7.1-lakh crore in the current fiscal (from ₹5.71-lakh crore last year). But given that the borrowing calendar has been front-loaded, the market was factoring in the easing of supply of bonds in the second half of the fiscal.

For the April-September 2019 period, issuance of government securities amounts to ₹4.42-lakh crore; the balance ₹2.68-lakh crore of gross borrowings will come in the second half. But the supply of bonds in the second half could go up now. The stimulus announced by the Centre would lead to additional borrowings, which implies more supply of bonds and higher yields (bond prices and yields are inversely related).

Going ahead with the foreign sovereign bond issuance could be a saving grace. The ₹70,000-odd crore of foreign sovereign bonds pegged in by most economists can help lower bond yields in the domestic market.

Where yields are headed

Even though the RBI cut its policy repo rate by a notable 35 basis points in its August policy, Indian bond yields have only inched up. From 6.3 per cent levels in the beginning of August, the yield on 10-year government bonds has increased to 6.6 per cent levels, already factoring in expectations of a fiscal stimulus from the Centre. Post the FM’s move on corporate tax rate, the yield has moved up by another 20 basis points.

Given that expectations of fiscal slippage has been factored into bond yields to some extent, bond yields could remain range-bound in the near term, until there is more clarity on foreign sovereign bond issuance, GST collections and the disinvestment agenda. Expectations of the RBI cutting rates further, given the sanguine inflation trends, may also cap the upside in bond yields. That said, notable rise in yields cannot be ruled out in the coming months, given the significant slip on fiscal deficit and volatile rupee.

What for bond investors

Given the uncertainty around various factors impacting bond yields, investors must cap their expectations and tread with caution. Long-term gilt funds as a category has delivered 15-16 per cent returns over the past year, thanks to the sharp rise in bond prices. A rise in yield (fall in prices) hereon can impact returns.

Hence, investors should avoid duration and credit risk in their portfolio. A chunk of your debt fund investments should be in short-term debt funds that carry less volatility in returns. Short- and medium-duration debt funds having a duration of up to 3-4 years are ideal for investors with medium risk appetite. Opt for corporate bond funds that invest a chunk of their assets in high-rated debt instruments.

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