India has been one of the fastest growing economies in the world for several years now. A closer look, however, highlights the huge potential waiting to be unshackled for it to grow much faster. One of the important factors that inhibit growth is the flat rate of industrial output. A major reason for this is the languishing growth of savings rate and less than adequate private sector investment.
Private investment flows depend on several parameters, primarily competitiveness factors such as cost of and access to land, power, labour and other infrastructure, as well as the regulatory framework in the economy. The taxation environment and access to capital also play a key role.
Companies look towards reinvesting profits for growth and to enhance value. One way in which reinvestment was given a boost in the past was the differential depreciation rates under the Income Tax Act and the Companies Act. This provided an avenue to the corporate sector to retain part of its profits and use it as promoter’s contribution for raising loans for capital investment without impairing the company’s ability to service its equity capital through payment of dividends. Reinvestment of monies led to higher depreciation provisions, allowing companies to become so called ‘zero tax’ companies under the Income Tax Act. The book profits of the company, however, remained adequate, as the methodology of providing depreciation under the Income Tax Act allowed companies to declare profits, and consequently service their capital. The two pillars of investment – equity and loan could thus be simultaneously accessed with the only incentive to avail of lower tax being reinvestment. This differential depreciation led to rapid growth of corporates and was available to all corporates irrespective of which sector or geographical location they were operating.
The outcry against ‘Zero Tax Companies’ and negative public perception led to introduction of Minimum Alternate Tax (MAT) in the year 1996. While presenting the union budget for the year 1996-97, the Finance Minister in his speech said, “I propose to introduce a Minimum Alternate Tax (MAT) on companies. In a case where the total income of the company, as computed under the Income Tax Act after availing all eligible deductions, is less than 30 per cent of the book profit, the total income of such a company shall be deemed to be 30 per cent of the book profit and shall be charged to tax accordingly.”
Introduction of MAT and subsequent hikes in the rate of MAT negated the benefits of the differential depreciation avenue for corporates, thus acting as a damper for reinvestment of corporate profits. Fiscal incentives to specific sectors (such as electronics) or geographical location (such as with the objective of backward area development) create market distortions. Existing units without access to these incentives face unequal competition. I am not in favour of such subsidies except where long term investments are required, such as, for infrastructure projects.
Enhancing capital investment into manufacturing sector and encouraging reinvestment are critical elements for industry and employment growth. There is a strong case to revisit MAT and retain differential depreciation. Unlike specific fiscal incentives, this does not create any market distortions. There is no loss either in government revenues because what is foregone in direct taxes is more than offset by the indirect taxes accruing by way of enhanced investment and production of goods, albeit with some time lag till investment is translated to production.
The associated area of Dividend Distribution Tax is also worth consideration. Here too there is a case for eliminating double taxation, thus providing stimulus to capital markets and private investment.
Development finance institutions (DFIs), like the erstwhile IFCI, IDBI and ICICI, have ceased to exist with India moving on to universal banking. The DFIs had access to relatively lower-cost, long-term monies, thus being able to match the needs of project finance and avoid the mismatch between short-term and long-term financing. There is an inherent conflict between project finance and monies required for working capital as there is always the danger of short-term funds being used for long-term financing and for the ever greening of project loans. This, in fact, could be one of the reasons why the problem of non-performing assets in our country has got accentuated. There is a strong case for reconsidering the formation of DFIs with clear cut demarcation between long-term lenders and short-term lenders.
The specific suggestion to eliminate MAT as a push to private investment does not in any way undermine other competitiveness factors for growth in investment including cost of land, power, labour and other infrastructure, or bringing back Investment Allowance. It is important to realign policies to create a supportive environment that promotes investment in the economy.
India has so far banked on a consumption led growth model. It is perhaps time for a two-pronged approach of consumption and investment led model.
(Mr Rajya Vardhan Kanoria, MBA (Honours) from IMD, Switzerland, and Advanced Management Programme from Wharton, USA, has four decades of experience in the chemicals, textiles and jute industries. He is the Chairman & Managing Director of Kanoria Chemicals & Industries Ltd.
He was President of Federation of Indian Chambers of Commerce and Industry during 2012-13. During 2007-08, he headed International Chamber of Commerce (India). He was Chairman, Confederation of Indian Textile Industry in the year 1994-95. He was the Chairman of Indian Jute Mills’ Association in 1983-94.
With his interest in social responsibility of business, Kanoria has not only spearheaded socially useful activities in the companies he heads, but has also contributed to other organisations, such as, Population Foundation of India of which he is Vice Chairman, and Operation Smile (now renamed as Mission Smile), where he was a Trustee.
Mr Kanoria serves on the board of several companies, including Nestle (India) and JK Paper. He is the recipient of Swiss Ambassador’s Award for Leadership and Business Ethics, 2013. He has also been bestowed with the Distinction of Commander of the Order of Leopold II by the King of Belgium for his contribution to the development of business ties between India and Belgium.)
First published in Business Digest in June 2019