The credit worthiness of Indian corporate sector is set for an ample boost with the reduction in the corporate tax payable announced by Finance Minister Nirmala Sitharaman today on Friday. With this companies especially those facing tight liquidity conditions may get a greater legroom to service debt, which is likely to reflect in lower borrowing costs as well as higher free cash flows to service existing debt and invest in capex.
The friday announcement, the latest in the series of fiscal measures announced by the FM in the past weeks to fuel economic growth, will see reduction of corporate tax rate for companies that do not avail of any tax incentive to 22%, satisfying a long-standing plea for lower taxes from India Inc. After this change, the effective corporate tax rate (including surcharge) will be 25.17%.
For new manufacturing companies, they will have to pay an even lower corporate tax rate of 15% (17.01% inclusive of surcharge and cess). The government has also cut the minimum alternate tax (MAT) rate to 15% from 18.5% for companies that continue to avail exemptions and incentives.
A Mint analysis has shown that over the last 30 months, Indian companies’ ability to pay interest on loans has worsened. Now, industry experts say this trend in interest coverage ratios - a key metric to show creditworthiness - will in all likelihood begin to reverse. “The industry has been looking for taxes to be lowered so that they can be competitive internationally," MVS Seshagiri Rao, Joint MD and Group CFO, JSW Steel. “Manufacturing companies will start investing more now with the effective tax rates coming down and the extra amounts saved will be used for reinvestment in the business.
“The choice of whether an individual company chooses to forego incentives and pay higher tax rate will depend on their tax liabilities for each year, the net present value of long-term tax savings and their future investment plans," Rao added. “But in either case, we will definitely see cash savings from this move and the interest coverage ratios improving. This will particularly help medium and small companies in our value chain who are struggling with debt repayments and poor access to bank lending. A tax benefit of ₹1.45 lakh crore for the economy is a great stimulus."
The interest coverage ratio measures the ability of businesses to pay interest on their loans. Mint’s analysis of the top 500 companies listed on the BSE (excluding financial services firms and oil and gas firms) fell to a 13-quarter low in the June 2019 quarter, against the backdrop of slowing sales and profit growth. A lower cash outgo because of lower tax rate frees up cash and improves companies’ creditworthiness.
Vikas Halan, Senior Vice President, Corporate Finance Group, Moody's Investors Service, said, “The Government of India’s decision to reduce base corporation tax to 22% from 30% will boost net income of Indian corporates and is credit positive. Extent of final impact on credit profiles of Indian corporates will depend on whether they utilize the surplus earnings for reinvestment in business, debt reduction or high shareholder returns.
“While we have to wait for the details of the ordinance, so far it seems that the companies are not bound by any conditionality on how they use this 10 percentage points of tax savings. It will depend on what is the compelling business decision for each individual firm said Hitesh D Gajaria, Partner and Co-head of tax, KPMG India, said: . Those reeling under debt pressure with interest coverage ratios deteriorating will use this to repay loans. Others who have held back on capital-intensive projects will now see their debt-to-equity ratios of new projects improve as companies have higher internal accruals.
If companies decide to pay out dividends to shareholders, this will boost consumption. The economy is a living organism. If you incentivize one part, we will see the ripple effect go in various ways."