Article

Finance Minister’s Bold Tax Cuts bring in Early Diwali!

20 Sep 2019

It was an action packed Friday for the stock markets after the Finance Minister Nirmala Sitharaman made some big announcements. Over the last four weeks, the Finance Minister had been making some incremental reforms and hence the markets were not too enthusiastic about any big bang changes. But she did take the markets by surprise by announcing a swift reduction in corporate taxes.

In one stroke of the pen, the Finance Minister took a huge risk on the revenue and deficit front with the hope that the resultant expansion in production and sales would more than compensate for the costs involved. Of course, there was an absolute thumbs-up from the stock markets as the Sensex scaled ~2000 points in a single day. It is hard to remember the last time when such a huge move in the markets was seen.

The big announcements from the Finance Minister

  • In case you are looking to simplify your tax management then you can opt for a flat 22% tax rate. The effective tax rate for such companies will be around 25.17%, inclusive of surcharges. Not worrying about exemptions and rebates, this makes a lot of sense for companies which avail limited exemptions. If a company opts for a flat rate of 22% without exemptions, they also do away with the multiple hassles of tax planning.

  • Not only for existing companies but the announcements were also big bang for new companies. If you set up a manufacturing operation between October 01st 2019 and before 2023, tax rate stand reduced to a concessional rate of 15%.

Monetary and valuation impact of the announcement by the FM

Tax cuts to 25% were originally promised by Arun Jaitley in his 2014 budget but was restricted to companies with turnover up to Rs.250 crore (later increased to Rs.400 crore). Here is what it means.

  • Companies who have complained about a complicated accounting and tax system can now relax. They now have a formula without the accounting hassles.

  • This right away releases funds worth Rs.145,000 crore which can be used productively for business expansion, necessary diversifications, new products, R&D and marketing expenses. This is likely to be highly productive and value accretive.

  • The big benefit could be for the start-ups and the Make in India program. The special 15% tax rate to set up new manufacturing facilities post October 2019 could trigger a virtuous investment cycle in the economy. This will also encourage a lot more of investments through the domestic and the FDI route.

Let us turn to valuations.

  • The tax cuts will release Rs.145,000 crore for Indian corporate sector in the form of surpluses in their business. Even if you consider an average P/E ratio of 20X for the market as a whole, additional value creation will be to the tune of nearly Rs.29 trillion. That leaves a potential upside in the market of 15-20%, which surely appears quite salivating at this point of time.

  • What is the downside risk? Firstly, there will be a revenue shortfall due to this tax break. Secondly, this will also result in higher yields on bonds if the government borrows to bridge the gap. That could mean higher cost of funding and higher cost of capital.

The only question is what happens to consumption? For that we will have to await the outcome of the GST Council meet late on Friday. But for now it is time for markets to celebrate.

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Finance Minister’s Bold Tax Cuts bring in Early Diwali!

20 Sep 2019

It was an action packed Friday for the stock markets after the Finance Minister Nirmala Sitharaman made some big announcements. Over the last four weeks, the Finance Minister had been making some incremental reforms and hence the markets were not too enthusiastic about any big bang changes. But she did take the markets by surprise by announcing a swift reduction in corporate taxes.

In one stroke of the pen, the Finance Minister took a huge risk on the revenue and deficit front with the hope that the resultant expansion in production and sales would more than compensate for the costs involved. Of course, there was an absolute thumbs-up from the stock markets as the Sensex scaled ~2000 points in a single day. It is hard to remember the last time when such a huge move in the markets was seen.

The big announcements from the Finance Minister

  • In case you are looking to simplify your tax management then you can opt for a flat 22% tax rate. The effective tax rate for such companies will be around 25.17%, inclusive of surcharges. Not worrying about exemptions and rebates, this makes a lot of sense for companies which avail limited exemptions. If a company opts for a flat rate of 22% without exemptions, they also do away with the multiple hassles of tax planning.

  • Not only for existing companies but the announcements were also big bang for new companies. If you set up a manufacturing operation between October 01st 2019 and before 2023, tax rate stand reduced to a concessional rate of 15%.

Monetary and valuation impact of the announcement by the FM

Tax cuts to 25% were originally promised by Arun Jaitley in his 2014 budget but was restricted to companies with turnover up to Rs.250 crore (later increased to Rs.400 crore). Here is what it means.

  • Companies who have complained about a complicated accounting and tax system can now relax. They now have a formula without the accounting hassles.

  • This right away releases funds worth Rs.145,000 crore which can be used productively for business expansion, necessary diversifications, new products, R&D and marketing expenses. This is likely to be highly productive and value accretive.

  • The big benefit could be for the start-ups and the Make in India program. The special 15% tax rate to set up new manufacturing facilities post October 2019 could trigger a virtuous investment cycle in the economy. This will also encourage a lot more of investments through the domestic and the FDI route.

Let us turn to valuations.

  • The tax cuts will release Rs.145,000 crore for Indian corporate sector in the form of surpluses in their business. Even if you consider an average P/E ratio of 20X for the market as a whole, additional value creation will be to the tune of nearly Rs.29 trillion. That leaves a potential upside in the market of 15-20%, which surely appears quite salivating at this point of time.

  • What is the downside risk? Firstly, there will be a revenue shortfall due to this tax break. Secondly, this will also result in higher yields on bonds if the government borrows to bridge the gap. That could mean higher cost of funding and higher cost of capital.

The only question is what happens to consumption? For that we will have to await the outcome of the GST Council meet late on Friday. But for now it is time for markets to celebrate.