MUMBAI: Many companies have stopped expansion plans and are reaching out to tax experts after the corporate tax for new companies has been pegged at 15%. The reason being that instead of investing directly, if a separate entity is formed for the same investment, there could be a tax arbitrage of about 10%.Last Friday, FM Nirmala Sitharaman had announced the lowest corporate tax rate for new manufacturing units that begin production before March 31, 2023. The effective tax rate for such companies could be around 17%, including surcharge.Tax experts said most companies that have expansion plans, including the ones in pharma and engineering sectors, are evaluating setting up new entities to take advantage of the lower tax structure.“A 10% tax arbitrage is huge for any business, and several companies would be looking at creating new fully owned legal entities from where dividend can be received and dividend distribution tax ( DDT ) can be set off so there is no leakage of tax. As far as reconstructing of business is concerned, there is a Supreme Court order that defines what constitutes reconstructing of business and companies will have to create structures that don’t flout these norms,” said Dinesh Kanabar, CEO of tax consultancy Dhruva Advisors.The current regulations say that the new investment cannot be “restructuring”, but allow fresh capital expenditure through a new legal entity. Companies will have to deal with cash management, dividend distribution tax, increased compliance among other things if they form new companies to get the 15% tax benefit.Many major companies are weighing this option but the inclination to save tax seems to be overpowering other considerations for now, said industry insiders.A major pharma company, for instance, that was looking to set up a new unit has just halted its plans. It is now planning to set up a 100%-owned subsidiary that would be done as a new entity from where the investment will be made.Industry trackers said some conditions will have to be met so that the taxman doesn’t harass companies in the coming years, if this route has to be explored.“While companies can avail 15% tax rate by making capital expenditure through a new legal entity, they have to be mindful that this is not a restructuring and even the new company shouldn’t have borrowed money from existing entity or even customers can’t be moved to the new company. Apart from that, several other factors like cash management, DDT and business cycles in the sector and the amount of time to break even will have to be taken into consideration as well,” said Girish Vanvari, founder, Transaction Square.Another pharma company — that was looking to expand its facility to manufacture a new drug and had almost finalised the project before the announcement came in — has now reached out to its tax consultants. It is considering whether the same investment can be carried out through a separate legal entity.However, if this has to be done, the company needs a robust tax structure and will have to meet all the preconditions set by the government.One of the conditions that companies will have to take care of is that they do not use the same plant and machinery in the new entity. Not only that, the new entity cannot have more than 20% of existing employees and will have to look out for new customers as well.“Many companies are contemplating that they create new legal entities, but they will have to buy new plant and machinery and find new clients or customers, otherwise it can be categorised as restructuring of business. Also, there is no revenue loss for tax department if investment is done through new entities as that seems to be the objective of the government for this regulation,” said Amit Singhania, partner, Shardul Amarchand Mangaldas.Insiders point out that there is a fear that some companies may sell off their existing assets only to be bought by the new entity, but that will come under the taxman’s scrutiny. Industry experts said the taxman can even use General Anti Avoidance Rule (GAAR), an anti-avoidance rule, to make sure companies do not evade tax. “The 15% or 17% tax rate is the best rate that a company can avail. Companies going for this route should also be mindful of GAAR as it will have to demonstrate that the new legal entity is not merely a front of the old company,” said Kanabar.A person with direct knowledge of the matter said some of the major manufacturing companies, including those in the auto sector, are also exploring this route. Many auto companies may set up new facilities for their upcoming new products as well. “However, this route could first be explored for smaller investments mainly for auto components,” the person said.