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    Proposed US corporate tax rate hike may not dent IT companies’ demand strength: CLSA

    Proposed US corporate tax rate hike may not dent IT companies’ demand strength: CLSA

    Proposed US corporate tax rate hike may not dent IT companies’ demand strength: CLSA
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    By CNBCTV18.com  IST (Published)

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    The brokerage remains bullish on large-cap IT firms and prefers Infosys, HCL, and Tech Mahindra in the sector.

    Brokerage firm CLSA, in a recent report, stated that the proposal by the Biden administration to raise corporate tax rates in the United States (US) from the present 21 percent to 28 percent is unlikely to impact Indian IT companies. The brokerage remains bullish on large-cap IT firms and prefers Infosys, HCL, and Tech Mahindra in the sector.
    Drawing comparisons with the 2017 tax cut imposed by the Trump administration, CLSA said that even then it had a limited direct impact on the revenue growth of Indian IT companies.
    The brokerage note states: “While their valuations did move up in 2018, we believe there were other contributing factors. Our initial read of the 2021 tax reforms indicates the proposed hike is unlikely to dent demand strength and that it should be broadly neutral for the effective tax rates of Indian IT companies and, thus, have minimal impact on sector valuations. We remain positive on the sector with a bias for large caps.”
    It further added that the 2017 tax cut, along with the Jobs Act, lowered the corporate income tax rate in the US from 35 percent to 21 percent. “It also imposed Base Erosion Anti-Abuse Tax (BEAT) on payments for work outsourced to related parties outside the US,” the note read.
    While the BEAT tax posed a challenge for companies with a subsidiary model in the US, they were able to restructure client contracts and limit the impact.
    However, the lower tax outgo did not lead to an increase IT spending or higher offshoring. While the growth in overall IT spending by US companies was stable at 3.3 percent to 3.4 percent between 2017 and 2019, spending on offshore IT services grew a tad slower at 6.3 percent to 6 percent in 2018 and 2019, respectively, versus 7.8 percent and 7 percent in 2016 and 2017, respectively.
    So, what’s different this time? The CLSA note observes, “We see a limited impact of the proposed increase in the US corporate tax rate on the demand trajectory. If at all, it could lead to increased outsourcing and offshoring, as corporates explore ways to manage their cash-flow.”
    However, the proposal to deny deductions for ‘offshore’ jobs could pose a risk, states the note.
    “We believe near-term, valuations and stock movement in the sector will continue to be driven by the strength of deal momentum (the upside to revenue forecasts) and the ability of individual companies to defend margins (from potential supply-side risks),” the CLSA report added.
    On the sector outperformance over 2018, it stated that there were multiple drivers.
    “After consecutive years of underperformance (16 and 10 percent in 2017 and 2016, respectively), Nifty IT Index outperformed the broader market by 21 percent over 2018. The revival of investor interest in the sector was led by factors like a pick-up in deal momentum, management commentary of the bottoming-out of the drag in the key verticals, and rupee depreciation. Also, valuations were attractive and both TCS and Infosys increased capital return to shareholders,” noted the report.
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