New Delhi: Instead of paying advance tax, some companies could be using the money in the commercial credit market because current interest rates are much higher than the penalty for deferred tax payments.
This might be partly responsible for the slowdown in growth rate for corporate tax collections, finance ministry’s revenue department officials argue.
Advance taxes paid by companies between April and September were Rs60,785 crore, up by 21% compared with a growth rate of around 40% in the recent past. In 2007-08 and 2006-07, advance taxes paid by companies grew annually by 40% and 42%, respectively.
Advance taxes are paid four times in a fiscal year—in June, September, December and March—based on a company’s estimate of the year’s profit. The Income-tax (I-T) Act has since September 2003 levied simple interest of 1% a month on companies that default or defer advance tax under sections 234B and 234C.
Also See Alternative cost of paying advance tax (Graphic)
The current liquidity crunch has hardened interest rates on short-term debt such as commercial paper, providing an arbitrage opportunity between commercial interest rates and penalty interest fixed by the I-T Act for deferment or default of advance tax, said senior revenue officials, who did not want to be identified.
In mid-September, interest rates on the highest rated commercial paper of 90 days and 180 days was 11.51% and 11.70%, respectively. In the inter-corporate deposit markets, say money market participants, the rates are a good 4-5% higher and largely determined by the immediate need for money by a company.
Around 15 September, the deadline for the second quarter’s advance tax payments by companies, the annualized return on the safest available short-term debt was almost 10 percentage points higher than the annual penalty for deferred advance tax.
The finance chief of a public sector oil refiner said the interest rate trend in the last couple of months made the finance ministry’s hypothesis plausible. “It (arbitrage) is quite possible when penalty interest is 12% (a year),” he said, on condition of anonymity.
However, the hypothesis was met with scepticism among some independent experts. “The scenario for most companies is (that) costs on a project basis are going up,” said Sudhir Kapadia, partner at management consultancy Ernst and Young. As some companies might not have the pricing power to pass on higher input costs to their clients, advance tax based on the year’s profit projections might have dropped, he said.
“Companies also have a legitimate anxiety to not overpay,” Kapadia said, giving another reason why tax collections might have come down when uncertainty dominates the economic outlook.
A tax consultant with one of the big four audit and professional services firms—PricewaterhouseCoopers, Ernst and Young, KPMG and Deloitte Touche Tohmatsu—was sceptical about the finance ministry’s hypothesis.
The current uncertainty across most economies would discourage companies from exploiting arbitrage opportunities, another consultant from one of the big four said. Neither wanted to be identified.
A six-month commercial paper today might slip suddenly in rating by the time it matures in the current economic scenario, the second consultant said. Therefore, companies today run a relatively bigger risk of delayed repayments, which would discourage exploiting loopholes in the law, he added.