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Tax Holiday Vs Lower Tax Rate: The Dilemma of Choice

The effective tax rate of 17.16% for manufacturing companies, is quite competitive or even better than the competing economies of Southeast Asia such as China, Thailand, Indonesia, Vietnam, Singapore and Hong Kong.

Photo Credit : Shutterstock

1467632208_3s7z8P_tax-shutterstock2.jpg

India is usually regarded as one of the countries that levieshigh corporate and indirect taxes. Although over the years, the Government reduced corporate tax to a base rate of 25% for companies whose turnover did not exceed Rs 4 billion in the previous fiscal year, India was still perceived to be a high tax levy country. 

In an unusual but a welcome move, the Indian Government, through an ordinance passed on 20September 2019, introduced a slew of tax and fiscal reliefs. The key amendments made through the ordinance being:   

  1. Reduction in the base corporate tax rate for Indian Companies from 30%/25% to 22% (thus reducing the effective tax rate from 34.94%/29.12% to 25.17% after surcharge and cess); provided such companies do not avail specified tax holidays/ incentives.  
  2. Reduced base corporate tax rate of 15% (effective rate of 17.01%) for domestic company engaged in manufacturing formed on or after 01 October 2019 and commences production on or before 31 March 2023. Manufacturing companies opting for the lower rate would not be entitled to avail specified tax holidays/ incentives. 
  3. Companies availing concessional rate will not be subjected to Minimum Alternate Tax (MAT), which is currently levied at a base rate of 18.5% on book profits. For companies continuing to pay corporate tax at existing rates, MAT rate is reduced from 18.5% to 15%. 

The applicability of a lower tax rate is subject to the following conditions: 

  1. In order to avail the reduced tax rate of 22%, the company will have to make an election on or before filing the tax return for the relevant year. In the case of new manufacturing companies, seeking reduced rate of 15%,they would need to make an election before filing the tax return for the year of incorporation. 
  2. Once the company opts for the lower tax regime, the company cannot switch back to the original regime. 
  3. Companies opting to be governed by the lower tax regime, would not be eligible to claim specified tax holidays, weighted deductions, accelerated depreciations and other specified incentives. 
  4. No set off would be allowed for any loss brought forward from the earlier years and attributable to any of the tax holidays/ incentives, etc. 
  5. Further, the Central Board of Direct Taxes (‘CBDT’), in the recentlyissued Circular No 29/2019 dated 02 October 2019,  clarified that companies wishing to opt for the lower tax regime, shall not be allowed to set off or carry forward unabsorbed MAT credit.  

In addition to the above conditions, there are certain additional conditions for a new manufacturing company opting to be taxed at base rate of 15%. 

Considerations for Evaluation

Claiming Tax Holiday

In case of a company desirous of opting for the lower tax rate of 22%, it would be imperative to analyse whether it is beneficial to continue under the prevalent tax regime (and continue to claim the tax holidays/ incentives for the remainder period) or opt for the lower tax regime (thus foregoing the said tax holidays/ incentives). Such companies also have an option to move to the lower tax rate of 22% in a subsequent year.

The impact of not availing tax holidays/ incentives and opting to be governed by the new tax regime has been tabulated as under:

(Amounts in INR)

Particulars

Old tax regime (turnover of entity below INR 400 Crores)

New tax regime – section 115BAA

Total taxable income before considering additional depreciation

(a)

10,00,000

10,00,000

Additional depreciation

(b)

1,00,000

NA

Total taxable income

(c) = (a) - (b)

9,00,000

10,00,000

Effective tax rate as per the normal provisions 

(d)

26%

25.168%

Total tax liability

(e) = (c) X (d)

2,34,000

2,51,680

Extra tax payable under the new tax regime


-

17,680


Although the tax rate under the new tax regime is beneficial, due to availing the additional depreciation, the total tax liability computed under the old tax regime is lower. 

Claiming MAT Credit 

While the recent CBDT Circularhas expressly made it clear that set off and carry forward of unutilised MAT credit shall not be allowed to companies opting for the lower tax regime, the legal fraternity is debating on validity of such clarification, since this is not a condition specified by the Ordinance. Given that the Ordinance is likely to find support of the Parliament when it is presented in the next session, it is very likely that suitable amendments to that effect will soon be introduced in the law on prohibiting setting off of MAT credit. 

An example depicting the impact of claiming MAT credit and applying the old tax regime as against the new tax regime is tabulated as under:

Particulars

Old tax regime (turnover of entity below INR 400 Crores)

New tax regime – section 115BAA

Total taxable income 

(a)

10,00,000

10,00,000

Effective tax rate as per the normal provisions 

(b)

26%

25.168%

Tax 

(c) = (a) X (b)

2,60,000

2,51,680

Book profits 

(d)

11,00,000

NA 

Tax as per MAT @ 15.6%

(e)

1,71,600

NA 

Tax payable 

Higher of 

(c) & (e)

2,60,000

2,51,680 

Set off of MAT credit brought forward 


(88,400)

NA

Total tax liability 


1,71,600

2,51,680

Extra tax payable under the new tax regime 


-

80,080



As can be seen from the above, although the effective tax rate under the new tax regime is beneficial by 0.832%, since the company in the above example has unutilised MAT credit, the total tax liability computed under the old tax regime is lower. 

Company vs LLP

Although the base tax rates have been reduced from 30%/25%, domestic companies are liable to pay dividend distribution taxes (‘DDT’) on the dividend payouts to shareholders, due to which, the tax costs till the time the money actually reaches the shareholder becomes substantial. In the case of anLLP, while the base tax rate is 30%, there is no DDT levied on distribution of profits to Partners. The chart below shows comparison of the cumulative tax impact:

Particulars

Domestic company

LLP

Section 115BAA

Section 115BAB

Profit before taxes 

100

100

100

Effective tax rate 

25.168%

17.16%

34.94%

Tax 

(25.17)

(17.16)

(34.94)

Profit after tax

74.83

82.84

65.06

Dividend distribution tax @ 20.56%

(15.38)

(17.03)

NA

Income available for distribution

59.45

65.81

65.06

Ultimate effective tax rate 

40.55%

34.19%

34.94%


As can be seen from the above, although the base tax levied on LLP is 30%, the effective tax rate after taking into consideration the dividend distribution tax may still be lower than the taxes that would be applicable for existing companies opting for the lower tax regime and desirous of distributing profits to its shareholders. However, in case of a manufacturing company, election of 15% rate may be marginally efficient. This however, may change in case impact of MAT, deduction claims, etc. are to be considered.

Further, where the dividends are distributed to resident shareholders, an additional tax of 10% is levied where the aggregate dividend income from domestic companies in the hands of the shareholder exceeds INR 10 lakhs. This now increases the tax costs, if profits were to be distributed to the shareholders. LLP in such case could appear as a more efficient form of business. A comparative chart reflecting the impact has been provided hereunder:

Particulars

Domestic company

LLP

Section 115BAA

Section 115BAB

Profit before taxes 

100

100

100

Effective tax rate 

25.168%

17.16%

34.94%

Tax 

(25.17)

(17.16)

(34.94)

Profit after tax

74.83

82.84

65.06

Dividend distribution tax @ 20.56%

(15.38)

(17.03)

NA

Income available for distribution

59.45

65.81

65.06

Tax in the hands of the shareholders

(8.47)

(9.38)

NA

Income post taxes paid 

50.98

56.44

65.06

Ultimate effective tax rate 

49.02%

43.56%

34.94%


In conclusion

The amendments announced by the government are a welcome move and will go a long way in attracting various multinational groups to shift their manufacturing base in India. The effective tax rate of 17.16% for manufacturing companies, is quite competitive or even better than the competing economies of Southeast Asia such as China, Thailand, Indonesia, Vietnam, Singapore and Hong Kong.

However, for the existing companies, before opting to be taxed under the new regime, it is imperative to undertake a time and benefit analysis – the taxpayer may be inclined to adopt the new tax rate only when it does not have adequate deductions under the other provisions of the IT Act.   

For new businesses, LLP may still be an attractive operational vehicle, considering the zero tax incidence on distribution of profits. However, challenges around investments, specially foreign investments and the corresponding foreign exchange regulations in an LLP need to be addressed before finalising this form of entity.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.


Tags assigned to this article:
tax planning tax rates

Jiger Saiyya

The author is Partner and Leader, Tax & Regulatory Services, BDO India

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