India Inc. is slipping into a deep morass of collapsing profitability and falling investments growth driven by excessive capacity and rising tax incidence.
Audited financial statements of over 20,000 companies show that almost every measure of their profitability hit their nadir in 2017-18. Profitability has been declining steadily and steeply for nearly a decade, i.e. since 2007-08. Margins over sales have declined just as much as returns on investments.
Net profit after tax as stated by companies was 2.3 percent of total income in 2017-18. If we adjust these stated profits and the corresponding income transactions that pertain to prior periods or those that were extraordinary in nature then the margin was even lower at 2.1 percent.
Taxes make a bigger claim on the top line of companies than profits. While profits account for a little over 2 percent of the top line, direct and indirect taxes account for three times as much. Taxes took away 6.5 percent of the top line. Since 2014-15, while the share of profits in total income has been falling, the share of taxes has been rising.
This increase in the share of taxes in recent years is a change from the earlier trend when taxes as a proportion of total income were steadily falling. It is likely that the steady increase in excise duty on petroleum products charged by the government to mop off the gains from falling petroleum prices has caused this increase in indirect taxes by companies.
Although the government has reduced corporate tax rates for relatively smaller companies recently, the overall corporate tax incidence has been rising. The reduction in rates, first introduced in 2017-18, has had no impact on the overall corporate tax incidence on company profits.
Corporate direct tax as a percent of the profit before tax more than doubled from 23.8 percent in 2005-06 to 55.4 percent in 2017-18.
Year-on-year direct tax collection growth rates have remained positive even in years in which aggregate corporate profits declined. Since 1991-92, there were seven years in which profit growth was negative, but tax collection growth was negative in only three of these.
One major reason why the overall corporate tax incidence has gone up so sharply is that the share of the losses at PBT level, of the loss-making companies in aggregate PBT of all companies has been rising.
Loss-making companies account for about a third of all the companies in the sample. This share is reasonably stable. But, the amount of losses of these companies has been rising steadily such that it has been wiping out larger amounts of the profits made by the rest. Losses of the loss-making companies accounted for 9.7 percent of the profits of the profit-making companies during 2004-05 through 2007-08. A decade later, 2014-15 through 2017-18, they accounted for 39 percent of the profits of profit making companies.
As the share of loss-making companies rises, the aggregate profits get depressed. And in proportion, the taxes paid largely by the profit-making companies appear increasingly larger.
Nevertheless, corporate tax incidence has risen even for the profit-making companies alone. It rose from an average of 22.4 percent during 2004-05 through 2007-08 to 26.8 percent a decade later, i.e. in the most recent four years.
High taxation and poor profitability have hit the corporate sector when they seem to be facing a demand constraint. This is seen in the steady fall in both, the asset utilisation ratio and the labour utilisation ratio of the corporate sector.
The asset utilisation ratio (total income as a multiple of total assets) declined from around 0.5 during the second half of the 2000s to less than 0.4 during 2015-16 through 2017-18. At the same time, the labour utilisation ratio (total income as a multiple of total employee compensation) declined from 14 to 11.
This fall in asset utilisation, rise in taxation and fall in profit margins have led to fall in returns on assets. In 2017-18, net returns over total assets at 0.8 percent, net return over net worth at 3.6 percent and net returns over capital employed at 1.5 percent were all at their lowest levels since 1990-91.
India Inc. has reacted to these adverse business conditions. They have pulled back on investments. First, they pulled out monies from companies. The dividend payout ratio in 2017-18 was 78 percent – the highest since 1990-91. And second, they stalled investments. This shows up in a net fixed assets growth of only 6 percent in 2017-18. This is close to the last period of rock-bottom assets growth during the early 2000s.
The sample of companies analysed above include finance and non-finance companies, listed and unlisted companies and small and big companies. In 2017-18, these companies collectively accounted for around 55 percent of the total corporate tax collections by the union government. Over the past 10 years, on an average these accounted for 57 percent of the total taxes.
Early results for 2018-19, based on about a thousand companies that account for 48.7 percent of total corporate taxes do not suggest any turnaround from the story painted above. As the sample for 2018-19 increases, we will report the story as it unfolds.
For now, the falling profitability and assets growth do not bode very well for the corporate sector and the Indian economy.