SEZSunset Clause for SEZ?

INTRODUCTION TO SEZs

A Special Economic Zone (SEZ) refers to a limited geographical region set up by the government to incentivize fresh foreign direct investment (FDI) and enjoys relaxed economic laws. In the year 2000, the government had set a target of creating 100 million jobs and of achieving 25% of the country’s GDP from manufacturing by the year end 2022.  Thus, the government had set forth a SEZ policy as a part of its EXIM policy.

These economic zones are governed and regulated by the Special Economic Zones Act, 2005 which essentially converted pre-existing Export Processing Zones (EPZ) to now identify as SEZ’s. They are vital for employment generation in the country as well as increasing balance of trade is foreseeable. Exports generated from these zones in the last half a decade has reflected an exponential growth. In India there are 423 formally approved zones, attracting a total investment of approx. Rs. 5,37,657,67 Crore.

TYPES OF SEZs

SEZ covers a broad range of specific zone types which include:

1. Free-Trade Zones (FTZ)

This is an area usually organized around major seaports, airports and national frontiers within which goods are landed, handled, manufactured and re-exported but are not subjected to custom duties unless the goods are moved to consumers within the same country. These areas are deemed foreign territory.

The Government of India introduced a Free Trade and Warehousing Zones (FTWZ) Policy as a part of its Free Trade Policy 2004-2009, to increase infrastructure and attract employment in underdeveloped parts of the country. Arshiya International Ltd was India’s first fully functional FTWZ, set up in 2011. ​

2. Export Processing Zones (EPZ)

The concept of EPZs in India has been since the early 1970’s, the first one being Kandla Free Trade Zone (KAFTZ), in Kandla, Gujarat. They are clusters of aggressive economic activity, specially designed for the growth of Exports by way of tax rebates, fiscal incentives etc.

In addition to the upgradation of labour, advancement of technology and infrastructural development, EPZ promote FDI and channel foreign exchange for the country.

There exists three tier-management system wherein the first tier is headed by the Commerce Secretary, Ministry of Commerce. Second tier is headed by Additional Secretary, Board of Approvals, responsible for examination of proposals and new enterprises.

The three tiers are monitored by the Development Commissioner. 

3. Free Zones (FZ)

Free zone is an area adjoining a port that permits the duty-free entry of foreign goods intended for re-export. There are 12 major free ports in India.

4. Industrial Estates (IE)

It is developed over an area unto 1500 acres at a particular place for the growth of small scale sector wherein infrastructure such as roads, power and other utility services are provided to facilitate the growth of industries and to minimize adverse impact of economic development on the environment.​

5. Urban Enterprise Zones

They are similar to FTZ when it comes to tax incentives, except they are located closer to urban areas and attract skilled labour.​

ISSUES SURROUNDING THE SUNSET CLAUSE

Some crucial benefits available to SEZ’s include relaxed taxation laws, both indirect and direct tax exemptions; relaxed labour regulations i.e. no labour unionization is allowed and relaxed custom duties. Thus, SEZ’s have proved to be an attractive policy to foreign investors bringing FDI in the country.

However recurrent uncertainty in government policies, especially tax has been a burden. There has been a push towards establishing a Direct Tax Code (DTC) which is meant to replace the Income Tax Act (ITA), 1961 and all tax rebates granted under the umbrella of the existing taxation regime.

Under Section 10AA of the ITA, 100% income tax exemption is provided on export income for SEZ units for the first 5 years, 50% income tax exemption is provided for the next 5 years and 50% income tax exemption is provided for the ploughed back export profit for the subsequent 5 years if the unit has commenced operations from 1^st April, 2006 onwards and this tax holiday expires on 31^st March, 2020.

Central Board of Direct Taxes (CBDT) in an effort to phase out corporate tax exemptions had introduced sunset clauses to terminate Direct Tax benefits including weighted deductions on capital expenditure.

For example, laying and operating petroleum product pipelines, constructing hotels, warehousing facilities and even affordable housing starting March, 2017 for SEZ developers and April, 2020 for SEZ units but this move result into considerable loss of business for the country in terms of reduced forex earnings and create unutilized assets within SEZs unless the date of the Sunset Clause is extended.

Mr. P C Nambiar, the Chairman of Export Promotion Council for Export Oriented Units & SEZs (EPCES), has stated that:

“The frequent change in the regulations of SEZ incentives is the major concern for its development and the export industry. We submitted representation saying that sunset clause is not correct because our scheme is not mature enough. From 2006, the government has been cutting the schemes while expecting units to perform. How would this be possible with such constraints and unstable policy?”

BABA KALYANI REPORT ON SUNSET DATE

In June 2018, the Ministry of Commerce and Industry constituted a committee to study the existing SEZs in India and prepare a policy framework to adopt strategic policy measures which comply with WTO requirements and could help the country take advantage of global growth opportunities and simultaneously develop its own highly competitive manufacturing and service base.

The committee has proposed a shift in SEZs philosophy from trade-competitiveness to manufacturing-competitiveness, from being export-oriented to tilting towards broad-based Employment and Economic Growth orientation.

Thus, the objective would no longer be focused on exports rather it should be a catalyst of economic and employment growth, with the aid of quality infrastructure, ease of doing business and most notably the 3E’s namely; Employment and Economic Enclaves.  

The aforesaid objective aims to bring together all classes of investors that support economic activity for job creation and have investments targeted towards supporting the domestic demand.

RECOMMENDATIONS BY THE COMMITTEE

1. The Committee has pushed for a change in objectives; however it has maintained that in order to revitalize SEZ projects, wherein investors have agreed to undertake long term risks keeping in mind the original SEZ Policy, it is important to extend the Sunset Date.

An extension would not only help in fully utilizing the existing assets of SEZs but also in securing the investments made by developers as it will provide more time for revenue generation.

2. Compliance with WTO has been extensively discussed in the report and it has been noted that an extension of direct tax benefit to “services” have neither been objected to by WTO member countries nor violate international agreements.

Hence, continuation of income tax benefit on export revenue of “Services SEZs” need to be considered in line with those extended for International Financial Service Centre (IFSC).

3. The report has maintained that Sunset clause ought to be extended and greater flexibility needs to be provided to investors on the minimum numbers of years for lease.

The SEZ Act was notified by Central Government in 2005 and its Rules were framed in 2006 which stipulates that minimum period of lease of plot for setting-up SEZ should be 20 years.

If not for the Sunset Clause, an investor would reasonably expect tax exemptions to continue till 2026, thus for the sake of maintaining certainty for foreign investors looking forward to avail Direct Tax benefit on export proceeds and were relying on the SEZ Policy, an extension ought to be considered.

4. Currently, Minimum Alternate Tax (MAT) is levied at 20% and the Corporate Tax slab has been reduced to 24% for MSMEs. Thus, effectively there is a marginal benefit of approximately 4% being given to SEZs.

Additionally, the government has decided that a special IT levy of 15% for new manufacturing units, is to be instituted. Thus, since revenue department is not losing a substantial revenue for new manufacturing units, the sunset date for IT/ITES SEZs can easily be extended.

5. Unified regulator for IFSC.

6. Utilizing Multi Services SEZ IFSC for all the in-bound and out-bound investment of the country.

POST COVID-19 IMPACT

The impact of Covid-19 on Special Economic Zones has been immense. Due to restrictions on movement and other services, applications for new SEZs have been delayed and heavy investment on designated new zones may yield results only in 2021 due to disrupted and halted operations.

By virtue of an Ordinance dated 31.03.2020, the initial extension was from 31^st March, 2020 to 30^th June, 2020.

Further, the Ministry of Commerce vide Notification dated 24.06.2020 directed the CBDT to extend the income tax holiday for new units up to 3 additional months, i.e. till 30^th September, 2020.

For all the new units that begin operations in 2020-21, to receive the benefit of the sunset clause, a longer extension period will motivate heavy investment flow, employment and competitive foreign funds.

The Export Promotion Council for EoUs & SEZs along with the Commerce Ministry had pondered upon and discussed the possibility of extending the applicability of the sunset clause for SEZs for a period of another 5 years.

INTRODUCTION TO INTERNATIONAL FINANCIAL SERVICES CENTRE

An International Financial Services Centre (“IFSC”) deals with the flow of finance and financial products to serve its customers outside the jurisdiction of the country in the area where it is operational. In usual course, IFSC is an unlisted company operating in a Special Economic Zone and serves persons outside its economic original jurisdiction to extend the world economy to non-residents in the form of export services.

An IFSC can be set up in a SEZ as per Section 18(1) of the Special Economic Zones Act, 2005 which stipulates as hereunder:

“The Central Government may approve the setting up of an International Financial Service Centre in a Special Economic Zone and may prescribe the requirements for setting up and operation of such centre.

Provided that the Central Government shall approve only one International Financial Services Centre in a Special Economic Zone.”

IFSC provides varied services like fund-raising for companies and governments, asset and wealth management, global portfolio growth in terms of exports and foreign exchange, optimizing business opportunity across borders for intermediaries, facilitating mergers and acquisitions and other risk management functions.

India’s first IFSC, Gujarat International Finance Tec-City (GIFT City) was inaugurated in April, 2015 to promote infrastructure projects, technology, foreign investment, employment among other services. The Global Financial Centre in London and Singapore are the most successful till date.

SCOPE & POTENTIAL OF IFSC DEVELOPMENT

There has been a keen academic interest in the recent years towards developing IFSCs and in the event that the government does not extend the date for applicability of sunset clause for SEZs relating to tax holiday, there is a high probability that such interest may be transformed into a need-of-the-hour endeavor.

The massive scope for IFSCs can be attributed to the benefits it receives from different sectors. While it is remarked that overlapping regulatory norms have hindered growth so far, competitiveness on an international scale can still be achieved.

A. 2015 RBI Notification under Foreign Exchange Management Act, 1999

1. Any financial institution set up will be treated as a non-resident Indian;

2. Any financial institution set up shall conduct business in foreign currency with both residents & non-residents, as prescribed; and

3. Any financial institution set up will not be subject to other regulations applicable to a “unit” located in the IFSC.

B. Income-Tax Act, 1961 benefits

1. IFSC is subject to the same benefits and tax exemptions under the Sunset Clause Section 10AA, if it is set up within a SEZ before the expiry of such clauses; and

2. Under Section 80LA, an IFSC is granted 100% tax deduction for a period of 10 consecutive years within a block of 15 years if it is a Banking Unit.

C. Indirect tax benefits

1. High relaxation of Securities Transactions Tax (STT) & Commodities Transactions Tax (CTT);

2. Exemption from custom duties; if import of goods is to set up a Banking Unit; and

3. Exemption from GST; if there are services imported from other branches located in other parts of the world.

While the aforesaid do not appear to look like they can be leveraged against the high scale advantages of the income tax holiday provided currently to SEZs, the potential for expansion of IFSC is slowly being recognized. 

CHALLENGES TO THE INDUSTRY AND THE RECOMMENDATIONS

The extension on the applicability of direct tax holiday granted to SEZs has made the industry hopeful of a longer sunset period, perhaps until the end of the financial year if the government and CBDT are convinced.

However, in case the Sunset Clause expires next year and the effects of the Covid-19 pandemic do not ripple down, challenges and tough times lie ahead. They can be countered with solutions, albeit time consuming.

RECOMMENDATIONS

1. The first and foremost recommendation to the biggest hurdle of making operational already designated SEZs is to give them an opportunity to make good the heavy investment by extending the date of Sunset Clause for the SEZ units.

A longer period, in terms of extension, counted in years would be preferable for the Indian sector to grow enormously.

2. All the suggestions provided in the Baba Kalyani Committee Report need to be given due attention, particularly the ones relating to reducing MAT & CTT need to be implemented in concurrence with creating a dispute resolution structure for notified offences to create transparency and faith in the system.

3. The problem of long term risk taken by SEZs can also be countered by utilizing existing assets and securing developers investment through optimal revenue generation in case the tax holiday is extended till the end of this year. The recent CBDT notification seems to be leaning towards this mindset as well and the same needs to be continued.

4. The construction and development of IFSCs in India has to be given due notice by constituting an Expert Committee under the SEZ Act to look into the exact timeline and cost planning to benefit.

These special zones with regulations from different sectors and huge tax and banking relaxations prove that IFSCs will also succeed in raising the financial services export competitiveness of India in the global context.

CONCLUSION

Since it is the general consensus that the major reason for the export income generated by Indian SEZs is the tax holiday given to all such units, it is reasonable that the industry as well as the government is pushing for an extension of the Sunset Clause as provided in the Income Tax Act, 1961.

Indirect tax benefits also seem to have an effect on their growth and the designation of more than a hundred SEZs within one year is testimony to that fact. Nonetheless, with foreign investors looking at India for financial services export and fund management, IFSCs can be the new hotspot for the country to place itself on the global competitive index.

A push in the direction towards a regulatory legislation and body derived from within the SEZ Act itself, will help realize the potential for IFSCs.

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