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Corporate tax: What's the impact?

March 01, 2005

Let us take a look at the impact of the lowering of corporate income tax in the Budget proposals on Monday by analysing the performance of the Quantum Universe of 300 companies in the last four quarters. This includes the tax paid, the effective tax rates and what is the upside.

Before going any further, consider the Budget proposals first:

  1. For domestic companies, the corporate income tax rate will be 30 per cent, plus a surcharge of 10 per cent.

  2. The rate of depreciation is fixed at 15 per cent for general machinery and plant with the initial depreciation rate to be increased to 20 per cent. Requirement of 10 per cent increase in installed capacity for availing of the benefit of initial depreciation to be removed.

  3. The benefits that are usually enjoyed collectively by the employees and cannot be attributed to individual employees shall be taxed in the hands of the employer.

    The tax to be called 'Fringe Benefits Tax' at 30 per cent on an appropriately defined base. Transport services for workers and staff and canteen services in office or factory to be outside the tax net.

The upside
The graph here highlights the effective tax rate of the Quantum Universe of 300 companies in the last four quarters. The following are some key observations:

  1. Against the actual tax rate of 37.5 per cent (including the surcharge and the cess), the effective tax rate of the 300 companies under consideration was 28.8 per cent (based on the trailing twelve months basis).

  2. Even if one were to exclude the loss making companies from this list, the effective tax rate is marginally lower at 28.1 per cent.

Now, given the fact that corporate income tax has been reduced from 35 per cent to 30 per cent, for simplistic purpose, if one were to reduce the effective tax rate to 23.1 per cent (28.1 per cent minus 5.0 per cent), net profit increases by as much as 7 per cent.

Effective tax rate (%)
The highest...*The lowest...*
Tata Infomedia48.9 Zensar1.9
Color-chem53.4 Caprihans2.0
EIH 53.8 Sun Pharma3.3
Parry's Confectionary54.5 Mastek3.5
VST Ind56.3 Sterlite Ind3.5
Mukta Arts61.5 Rallis3.8
Essar Oil67.1 HCL Tech4.0
VIP77.1 Hexaware4.2
Guj. Fertilisers84.4 VisualSoft4.8
Dr Reddy's88.6 Birla Corp5.2
*Trailing twelve months

The downside…
Following are some of the factors that could subdue the upside to net profit.

  1. Surcharge has been increased from 8 per cent to 10 per cent.

  2. Depreciation rates have been changed. Based on our interaction with two companies, the finer points have to be considered before capturing the upside or the downside.

  3. Fringe Benefit Tax has been introduced at 30 per cent, though select amenities to employees like canteen and transportation services have been excluded. This will further reduce the benefit at the hands of the corporates.

  4. The reduction in corporate income tax is not applicable to foreign companies. In fact, the increase in surcharge will actually add to the tax liability.

On the balance, we believe that in the BSE 'A' group, most of the companies has aggressive capital expenditure plans in the next three to five years.

This reduction in corporate tax and modifications in the depreciation rates is likely to be earnings accretive in nature and to that extent, we will have to upgrade earnings of most of the companies under our research coverage.


Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.




Budget 2005-06: Complete Coverage | More Specials

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