Unlike China, the original concept of SEZs in India got diluted and it witnessed growth of numerous small scale SEZs, pre-dominantly in the IT/ ITeS space. Further, absence of a true Â´single windowÂ´ to operationalise SEZ coupled with the real estate cost impacted the growth of SEZs in India.
The concept of Special Economic Zone (SEZ) was introduced in India in the year 2000 to replicate the success achieved by China in leveraging this concept to incentivise and promote exports and attract investment. (Source: Government of India website SEZindia.nic.in and RBI Report of 22 September 2009 available on RBI website under reports) The objective was to establish large-scale conclaves which are deemed foreign territory, proviÂ¡ding duty or tax benefits as well as quality infrastructural facilities to an entrepreneur. It was expected that these conclaves will have large scale manufacturing hub-housing and warehousing facilities, manufacturers, supporting vendors, service providers, etc. and enjoy operational efficiencies.
However, unlike China, the original concept got diluted and it witnessed growth of numerous small scale SEZs, pre-dominantly in the IT/ ITeS space. Further, absence of a true Â´single windowÂ´ to operationalise SEZ coupled with the real estate cost impacted the growth of SEZs in India. Nevertheless, the contribution of SEZ to the Indian growth story cannot be undermined.
SEZ incentives and conditions
SEZ continues to hold relevance owing to the comparative tax or duty benefits it extends in terms of exemption from service tax, VAT, CST, research and development cess, certain levies, etc, which are generally not available to a normal business. Further, under the income-tax provisions, SEZ developers enjoy tax exemption on their income for 10 consecutive years (out of the first 15 years) and units operating in an SEZ are eligible for a deduction on their export profits over 15 years in a staggered manner (100 per cent for 5 years and 50 per cent for the next 10 years, subject to conditions). Further, other direct tax incentives included exemption from Minimum Alternate Tax (MAT) and Dividend Distribution Tax (DDT), which were subsequently revoked by the government. (Source: As per the Section 10AA, 80IAB of the Income tax Act, 1961)
With the objective of promoting fresh investment and employment, certain anti-abuse tests were incorporated in the tax provisions to ensure that the new business or unit claiming tax holiday is not formed by splitting up or reconstructing a business already in existence. Moreover, the new units should not be formed by way of transfer of significant amount of previously used machinery or plant, or by way of transfer of substantial number of employees from an existing business. (Use of old machinery up to 20% is however, allowed). (Source: As per the Section 10AA of the Income tax Act, 1961)
SEZs and Foreign Trade Policy: A Comparison
On the other hand, the schemes under Foreign Trade Policy (FTP) offer exemption or refund of customs duties, excise duty, and service tax on procurement of capital goods, inputs, and services required for export activity, be it manufacturing or services. The schemes are in the nature of pre-export benefits i.e. one avails the benefits of exemption upfront on procurement of capital goods and/or inputs for meeting a specified export obligation, e.g., Advance Authorization Scheme and Export Promotion Capital Goods Scheme (EPCG). Alternatively, there are schemes with post export benefits in the form of duty credit or refund of duty paid of a specified percentage computed on the value of exported goods or services, e.g., Duty Drawback, Merchandise Export Scheme, etc. The duty credit under some of these schemes can be used to pay customs duty, excise duty and service tax as well.
These schemes extend the exemption from specified duties or taxes as well, and can be used in a combination in specified cases. However, the challenges in terms of seeking issuance of authorisation for availing the benefit, tracking usage of goods and export status, meeting compliances, and procedural requirements under multiple regulations, including interacting with multiple authorities, is more than the offset benefits offered. Further, the benefits or their availability to specific business can be reviewed and potentially restricted.
In fact, the recent extension of post-export benefits under FTP to SEZ, makes them more attractive from tax or duty management perspective. The only potential disincentive vis-a-vis SEZ could be the requirement to relocate to a designated area and associated operational and logistics cost.
SEZs and Free Trade Agreements: A Comparison
Unlike benefits under FTP, the benefit under Free Trade Agreements (FTAs) is limited to concession from a specific component of customs duty (basic customs duty) on importation of specified goods, as agreed by the contracting countries. Thus, use of FTA only helps in mitigating the basic customs duty as it cannot be offset against output duty or tax liability.
However, the benefit is subject to meeting the value addition and other requirements, as specified in the rules of origin. Further, the contracting countries can periodically review the impact of FTAs on the domestic industry and may withdraw or restrict concession including resorting to other trade remedial measures like anti-dumping duty, etc.
Further, due to Â´invertedÂ´ duty structure in FTAs, the benefit in some cases gets nullified as the finished goods enjoy the benefit of exemption as well. The exporter at times uses FTAs to reduce the tax cost in the value chain for export operations, however, that too requires conformance to value addition requirement and may be limited to specified goods. FTAs can potentially score over SEZs in case of specific traded goods imported for domestic consumption, as clearances from SEZ to domestic market may not enjoy the exemption. However, these could be limited cases and cannot be termed as Â´disincentiveÂ´ for SEZ.
SEZ Story- Growth and Challenges
In the last decade or so, the SEZ story has grown significantly with approximately 199 out of 347 notified SEZs engaged in exports of approximately Rs 4,94 lakh crore in 2013-14. SEZ has attracted investment of Rs 3.22 lakh crore and direct employment to over 14,13,835 people. SEZs contribute to around 25 per cent of the countryÂ´s total exports. (Source: as per the statistics provided by Ministry of Commerce in their website.) The Indian SEZ story has had its share of challenges though. Maintaining that there must be a sunset provided on exemptions, the government had reinstated DDT and MAT on SEZ developers and MAT on SEZ units from 2011, citing loss of revenue and equity in taxation as the justification. Also, the revenue explained that MAT was an advance payment of tax and MAT credit could be carried forward for 10 years for set-off against regular tax payable in the subsequent years. However, besides the impact on cash flows, such argument does not stand steady for many SEZ companies which continue to be loss-making even after the expiry of the exemption period, leading to inability to avail and resultant lapse of the MAT credit.
Imposition of MAT and DDT had faced strong backlash by the investor community and had resulted in many developers surrendering and de-notifying their SEZ projects.
The Ministry of Commerce is cognisant of these challenges. The authorities recognise that the lack of true single window mechanism involving the state government authorities, infrastructure bottlenecks coupled with imposition of DDT and MAT in 2011 has impacted the realisation of true potential of SEZ. Despite several recommendations from the Ministry of Commerce on the restoration of exemptions, the amendments in the latest Finance Act 2015 were mute on the issue.
Yet in recent times, we have also seen some welcome clarifications on other issues by the Revenue, for instance, increase in the threshold for transfer of old Â´technical manpowerÂ´ to a new SEZ unit in the IT Enabled Services sector from 20 per cent to 50 per cent of the total technical manpower in the new unit.
With India riding high on the Â´Make in IndiaÂ´ wave to incentivise and work towards making the country a manufacturing hub, it is all the more important to address the current issues and challenges faced by SEZ units and developers. The wish list positively includes making SEZ a part of the Â´Make in IndiaÂ´ campaign thereby giving them a level playing field for catering to the domestic market, roll back of MAT and DDT, single window e-governance facilitation, etc. The government has also reiterated their commitment to boost SEZ and given the focus on SEZ in recent policy statements, it is unlikely that there is a question mark on the future of SEZs in India. Further, India is possibly on the verge of a major tax reform in the form of GST and a roadmap for the continued relevance of SEZ in the changed regime also needs to be looked out for in the future.
DISCLAIMER: This article has been authored by Naveen Aggarwal, Partner and Head of Tax (North), KPMG in India and Rahul Shukla, Technical Director – Indirect Tax, KPMG in India with inputs from Chetna Thapar, Manager – Tax, KPMG in India. The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in India.