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Economic Outlook

Clear the field for Special Economic Zones

Pallavi Bakhru is the director of Grant Thornton Advisory. Anshu Khanna is a chartered accountant

Sort out tax burdens and ambiguities in the law so that SEZs become ‘make in India’ hubs

In early 2000, when the India growth story was still struggling to be written, special economic zones (SEZs) were introduced to set up new infrastructure with the idea of creating jobs and giving an impetus to exports.

In 2005, the SEZ Act and Rules provided a policy framework with minimum regulations, simplified procedures and single window clearance at the State and central levels. SEZ developers and units were given major direct and indirect tax incentives, such as exemption from income tax for 15 years in a phased manner, service tax and central sales tax exemptions, and duty-free import of goods into an SEZ.

Initially, SEZ developers and units were exempt from the levy of Minimum Alternate Tax (MAT), with additional exemption from Dividend Distribution Tax (DDT) for developers. However, the exemptions were withdrawn by the Finance Act, 2011.

MAT is levied on book profits (currently at 18.5 per cent plus education cess and surcharge) of the SEZ unit/developer, without considering available income tax exemption.

Though MAT liability is creditable against future tax liability and is a timing difference, the amendment caused an uproar among SEZ units and developers who felt the key income tax benefit promised to the SEZs had been taken away.

It changed the cost benefit analysis which investors had undertaken prior to investing in the SEZ and it severely impacted their cash flows. The change in tax policy hampered India’s SEZ growth story by shattering investors’ confidence and hindering additional investment into the SEZs.

Lack of accountability

The flip-flops on applicability of tax laws to SEZs shows a lack of consistency on the part of the government.

Early last year, the NDA created history by winning with a thumping majority.

There were huge expectations from the finance minister. In the Budget speech for 2014-15, he said the government was committed to making them an effective tool for industrial production, economic growth, export promotion and employment generation.

This was followed by a statement from Prime Minister Narendra Modi on setting up a high-level team to revive stalled SEZs.

It appears that the intention of the government is to make SEZs a viable option and refuel them as engines of growth. This is demonstrated by certain actions.

What’s been done so far?

The Income Tax Act provides for tax deduction on the export profits of SEZ units subject to certain conditions, the key one being: “It is not formed by the splitting up/reconstruction of a business already in existence”.

The Central Board of Direct Taxes has clarified that it would not treat transfer/redeployment of technical manpower as splitting up or reconstruction subject to a ceiling of 50 per cent.

This has set to rest the debate on setting up an SEZ unit by splitting up existing business and provided much needed relief to services SEZs, where new units were being set up with some part of the existing manpower from other units.

The Commerce Ministry, in September 2014, announced its intent to revive SEZs by refocusing them as hubs for exports and manufacturing.

It also promised to lobby with the ministry of finance for lowering or complete doing away with taxes such as MAT and DDT applicable on SEZ developers and units.

What can be done?

The government can give a boost to the SEZ industry by reviewing the following incentives/mechanism in the forthcoming Budget: withdrawal of levy of MAT (need to go back to the original promise of tax exemption); withdrawal of levy of DDT on SEZ developers, and; revenue to follow Circular 14/2014 in spirit and not to litigate the issue of migration of employees so long as the 50 per cent rule is met.

Investing in an SEZ requires long-term planning and substantial capital outlay.

The absence of absolute clarity on the road ahead makes businesses sceptical of making fresh investments in this sector.

By providing a stable tax regime and reconsidering tax incentives, the government can give an impetus to SEZs.

The article appeared in the Hindu Business Line. The article can be found here.