Compared to IT, financials, energy, consumer staples and materials such as metals has scope for notable upgrades in earnings. (Photo: Abhijit Bhatlekar/Mint)
Compared to IT, financials, energy, consumer staples and materials such as metals has scope for notable upgrades in earnings. (Photo: Abhijit Bhatlekar/Mint)

For IT companies, tax rate cuts won’t make much of a difference in FY20

  • The actual tax incidence varies across IT companies depending on their exposure to tax exemption zones
  • Effective tax rates of most large IT companies are already low or close to the new tax rates announced by the government

Mumbai: Information Technology (IT) stocks were bystanders in Monday’s market rally, declining an average 2%. Investors are cautious. The benefit of the cut in corporate tax rate to 22% will be negligible or modest at best for IT companies in the current fiscal.

Not without reason. IT services companies enjoy tax exemptions on revenues from special economic zones (SEZs). So the effective tax rates of most large IT companies are already low or close to the new tax rates announced by the government. “Benefit in FY2020E will be modest to negligible since many avail of tax exemption on SEZ profits in India," Kotak Institutional Equities said in a note.

Graphic by Satish Kumar/Mint
Graphic by Satish Kumar/Mint

Further, amid growing concerns about sustainability of a pick-up in revenue growth rates and the material scope for earnings upgrades in other sectors from the corporate tax cut, the Street is making a tactical shift in preferences. “We lower (view on technology stocks) to equal weight tactically by taking weights from both TCS Ltd and Infosys Ltd; investors may pivot to domestic sectors," Jefferies India Pvt. Ltd said in a note. Compared to IT, financials, energy, consumer staples and materials such as metals has scope for notable upgrades in earnings, Jefferies India’s calculations show.

Analysts fear that the growing headwinds to economic growth in the US and Europe may weigh on technology spends, which in turn will weigh on revenue growth rates.

The actual tax incidence varies across IT companies depending on their exposure to tax exemption zones. Due to low presence in SEZs, smaller companies generally pay higher tax. Even then, the benefits are seen to be marginal.

Another sectoral index that traded in losses on the National Stock Exchange was the NSE Pharma index. Domestic pharmaceutical companies, like IT companies, receive several tax incentives such as deductions on investments in research and development. Manufacturing plants in designated industrial zones are taxed at concessional rates. Therefore, the effective tax rates for several pharma companies are already low.

Meanwhile, it does not mean that corporate tax rate cut will go in vain for the IT sector. Tax benefits from SEZs fade over time. Typically profits generated from SEZs are exempt from taxation in the initial five years with benefits receding in subsequent years. The latest reduction in corporate tax will cap the tax liability, pointed out analysts at Kotak Institutional Equities. So even as benefits from SEZs recede, thanks to reduction in corporate tax rate, there will be no abrupt rise in taxes for IT companies. “The benefit (from corporate tax rate cut) will be material in the medium term once the SEZ benefit fades away," analysts at Kotak said.

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