Power and energy sector likely to be worst hit by removal of tax exemptions

The government recently announced the phasing out tax exemptions and deductions extended to companies ahead of its plan to cut the headline corporate tax from 30 per cent to 25 per cent. It would be interesting to know how much these exemptions cost the government exchequer and which sectors benefits the most from them.

According to the statement of revenue  foregone issued at the time of Union Budget, the government lost Rs 58,000 crore of tax revenue in 2013/14 due to these exemptions compared to an estimated revenue loss of Rs 62,000 crore in 2014/15. The calculation was based on the effective tax rates of over 5.6 lakh companies.

The effective corporate tax in 2013/14 was 23.2 per cent compared to 22.4 per cent in the previous year. The effective tax rate for 2014/15 was not available. The current corporate tax rate is around 34 per cent after including surcharge and education cess.

Around 48,000 companies (out of the 5.6 lakh companies), which account for 42 per cent of the profits, paid tax at less than 25 per cent in 2013/14. Over 1.75 lakh companies, which accounted for 43 per cent of the total profit, paid tax at 25-33 per cent rate.

Manufacturing companies, which accounted for 48 per cent of the total profit in 2013/14, paid an average effective rate of 22 per cent, while the service sector companies paid tax at an average effective rate of 24 per cent.

The two most common exemptions availed by the companies include accelerated depreciation (Rs 34,000 crore) and deduction of export profits of units located in SEZs (Rs 17,000 crore)

Among the sectors which benefit the most from the exemptions and deductions are power & energy (effective tax of 15 per cent in 2013/14), petroleum and petrochemical (19 per cent), drugs and pharma (19.5 per cent), steel (18 per cent), paper (14 per cent) and sugar (16 per cent).

Other important sectors such as IT and IT-enabled services paid tax at 22-25 per cent, banks and NBFCs paid 24-26 per cent, auto and auto ancillary (24 per cent) and engineering goods (around 30 per cent).

A proposal issued by the government earlier laid out plans to phase out the exemptions. It plans to do away with the profit-linked, investment-linked and area-based deductions for both corporate and non-corporate tax payers. The government proposes to not modify the sunset date (the date after which tax exemptions and incentives cease to exist) for different sectors. For those exemptions with no sunset dates, they would cease to exist after 31 March 2017.

According to Nomura, over the course of the next four years, as the government lowers the corporate tax rate (to 25 from 30 per cent), but simultaneously removes the exemptions, the effective tax rate is due to rise to 25 per cent, which should boost corporate tax collection when fully implemented.

The proposed corporate tax rate as stated by the finance minister is 25 per cent which will effectively mean around 29 per cent (inclusive of surcharge and education cess).