Impact of fiscal incentives on corporate financial decisions

Abstract

The Government from time to time comes up with certain fiscal incentives to affect the behaviour of the private sector to achieve the desired goal. In this thesis we have made an attempt to study the impact of two such incentives development rebate and backward area capital subsidy on corporate financial decisions. Under the development rebate scheme, assesses were, allowed to deduct from their taxable income, a specified percentage of cost of new plant and machinery installed. To get this tax benefit the assesses had to transfer a sum equivalent to seventy-five per cent of the rebate claimed t a reserve account. The amount so transferred had to be kept in the business for a period of at least eight years. Under the backward area capital subsidy scheme an amount equal to fifteen per cent of cost of fixed assets subject to a maximum of fifteen lakh rupees is given as an outright subsidy for units which located their industry in a notified backward area. In this thesis we looked into: 1. The impact of development rebate on the following financial decisions: i. Private corporate investment ii. Private corporate dividend iii. Private corporate borrowing 2. The interrelation of the above decisions and the impact of development rebate on the corporate financial systems. 3. The impact of backward area subsidy on: i. Project selection ii. Project location. We undertook a cross sectional study of three industries - Electric equipment and cables, Chemical and Pharmaceutical for the period 1968 to 1973. We used multiple regression technique to find the relation between development rebate and each of the financial decisions. A simultaneous’ system of equations was formulated and two stage least square techniques were used to study the interrelation between the corporate financial decisions. Project reports of units that had moved into backward area were analysed to look into the influence of backward area subsidy. We also attempted to ascertain the factors - behind and the role of subsidy in the locational choice of a few units through a questionnaire. Discussions were held with officials of financial institutions - state and apex to understand how they have incorporated this subsidy in project appraisal. On the basis of the above study the following conclusions were arrived at: 1. The development rebate had significant impact on the investment and borrowing decisions in the pharmaceutical industry during the period studied. In case of chemicals and electrical, the impact was not as significant as in pharmaceutical industry. 2. The development rebate had significant negative effect on dividend in the chemical industry in the earlier years. Whereas in the electrical industry, the impact was found only in later years of study. 3. The interrelation between investment, borrowing and dividend decisions were established in the case of chemical industry only. 4. The impact of development rebate extends over a period of time and hence evaluation has to be made on the basis of total impact of development rebate over a period of time. In the case of chemical industry, the investment generated over two years did not exceed the amount foregone by way of the rebate. 5. The backward area subsidy did not seem to have had any impact on project selection especially for those projects which are financed by financial institutions. 6. The influence of backward area subsidy on project location was also very weak. Further, operational problems of the above incentives and alternate policy measures to achieve the desired goal are also discussed in the thesis.