Finance Minister Nirmala Sitharaman announced that the effective corporate tax will be cut to 22 percent without exemptions.

This comes at a time when the country was facing an economic slowdown with the GDP growth in the June quarter being the slowest in the past six years.

The Indian government on Friday announced its most decisive step yet in combating a five-quarter slowdown, which has taken the country’s gross domestic product growth rate down from 8 percent to a six-year low of 5 percent.

After initially relying on monetary policy and improved credit flow as ways to push up GDP growth, the government appears to have finally come around to the view that a fiscal push was essential to boost growth and sentiment.

Ceteris Paribus, the revenue loss of Rs 1.45 lakh crore estimated by the government will push up the fiscal deficit to near about 4 percent. However, should there be some spending cuts or additional revenue generated through asset sales, the impact on the fiscal deficit could be lower.

What the government is attempting is fiscal pump-priming of the economy, undertaken last in India after the global financial crisis. The difference, though, is that the current government has chosen the route of corporate tax rate cuts, in the hope of encouraging investments. In contrast, the 2008-09 fiscal package was aimed at increasing spending and boosting consumption.

As such, any benefits of the corporate tax rate cuts to the economy will flow through corporations rather than directly to consumers.

According to data provided by the government, the effective tax rate for companies with a turnover of more than Rs 400 crore shall be 25.17 percent (inclusive of surcharge and cess) versus 34.9 percent earlier. These tax savings, if they materialise, will translate into higher profitability for corporations with varying magnitudes.

The global average corporate tax rate is 23.79 percent and the OECD average is 23.38 percent, KPMG data shows. Averages for North America, Europe and Asia are 26.75 percent, 19.37 percent and 21.09 percent. India’s new tax rates sit comfortably with these.

For the current year, KPMG data shows that the statutory tax rate in Myanmar is 25 per cent, in Malaysia, it is 24 per cent, in Indonesia and Korea 25 per cent and Sri Lanka 28 per cent. Even Chinese companies cough up more – they pay a tax of 25 per cent and Brazil 34 per cent.

There are two main takeaways from the above tax cut:

Firstly, Sitharaman has reduced statutory corporate tax rates from 30% to 22%. This ‘22%’ is actually 25.17%, after adding surcharges and levies. But, because effective tax rates vary from sector to sector, this reduction doesn’t have the same effect across India Inc. For some companies (like auto firms or banks) the relief is greater, while for others it’s lesser.

Secondly, Sitharaman has introduced what is a dual-track system of taxation. In her press conference, she noted that the 22% tax rate would apply only to domestic companies that chose not to avail of the various exemptions that are available to them. This means companies can choose to avail of the lower 22% rate or choose to stick with what they have and keep the exemptions.

Will these tax cuts have an effect on new investment?

The other major tax announcement that Sitharaman made was that new manufacturing companies, which start operations after October 1, 2019, will only have to pay an even lower corporate tax rate of 15%.

New manufacturing companies will have to pay an even lower corporate tax rate of 15%, which translates to a little over 17% after taking into account levies and surcharge.

This is a major step in terms of attracting new investment. Foreign companies wanting to relocate to India with fresh investment will pay only 15% corporate tax now. At a time when the US-China trade war is making multinational companies re-think their investment strategies, this is a huge incentive for global companies to come to India. This also puts the Indian tax regime at the same level as many East Asian countries including Singapore. 

On the other hand, more clarification is needed, as The Wire’s M.K Venu has pointed out. Does the 15% tax rate for new manufacturing companies also applyto the existing corporations that decide to launch new investments with their subsidiaries? And if so, will this undermine the move to lower the headline corporate tax rate from 30% to 22%? 

Will it perk up India Inc, which has been feeling gloomy over the last few months?

India’s stock markets are in rapture. The 30-share benchmark Sensex is up by over 1,800 points, the biggest single-day gain in over a decade.

This is also the first big, non-incremental tax reform by Narendra Modi government in five years. Most analysts expect that corporate earnings will improve by 10% to 15% in the next year, especially for those companies that don’t avail of too many exemptions. This should improve business sentiment and hopefully help the Indian economy attract new investment.

By announcing a reduction, Nirmala Sitharaman is also fulfilling a promise made by Arun Jaitley back in 2015-16. In that year’s budget speech, the late BJP leader vowed that the Narendra Modi government would reduce the corporate tax rate of 30% to 25% in phases.

Will it reverse the economic slowdown and set right India’s growth trajectory?

This is less clear. India’s economy currently has a problem on the demand-side – consumers are reluctant to buy everything from biscuits to cars.