Giving a safe passage to delinquent SEZs

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Giving a safe passage to delinquent SEZs

Friday, 24 November 2023 | Uttam Gupta

Giving a safe passage to delinquent SEZs

Development of Enterprise and Service Hubs (DESH) bill, gives a ‘safe passage’ to all those SEZ units that haven’t been able to fulfil their export commitments

The government is planning to make a few amendments to the Special Economic Zones (SEZ) Act 2005 in the winter session of Parliament, with a view to giving more operational flexibility to units in these tax-free enclaves, especially when it comes to sales in the domestic tariff area (DTA).

It had intended to overhaul the SEZ regime by bringing in the Development of Enterprise and Service Hubs Bill (DESH) announced in the budget for 2022-23. Since DESH is facing delays, the government is keen to address some of the concerns under the extant regime by making amendments.

The SEZs policy was launched in 2000 followed by the passage of the SEZs Act (2005) by Parliament in 2005. Intended to attract Foreign Direct Investment (FDI) for facilitating rapid economic growth, the Act sought to establish certain designated areas within the territory of India (call them enclaves) which are subject to different economic regulations than other regions within the country. 

An enclave is treated as a ‘territory outside the customs territory of India’ for the purpose of authorised operations in the SEZ. Such exclusive demarcation makes entities in these areas eligible for a host of fiscal incentives. An SEZ developer or a unit located therein gets a 100 per cent Income Tax (IT) exemption on export income for the first 5 years, 50 per cent for the next 5 years thereafter and 50 per cent of the ploughed back export profit for the next 5 years.

As for indirect taxes, because SEZs are considered to be located in a foreign territory, all transactions with them are classified as exports and imports - in the same way as transactions with a foreign country say, Germany. Their tax treatment flows from this fundamental premise. Thus, any supply of goods or services or both to a SEZ developer/unit is considered as export hence, zero-rated under GST which means these supplies are exempt from levy of GST. The SEZ units don’t also have to pay customs duties or other levies on imports like anti-dumping, countervailing safeguard duties etc.

The SEZ developers and units located therein are exempt from seeking licenses or other regulatory compliances for undertaking import/export (for instance, there is no routine examination by customs authorities of the cargos) which the enterprises in the Domestic Tariff Area (DTA) – an acronym for all units located within the territory of India other than SEZs – are normally subject to.

SEZs are equipped with state-of-the-art infrastructure, including well-planned industrial parks, reliable power supply, transportation networks (railways, highways, waterways etc) communication systems, and other necessary utilities.

Against this paraphernalia of support systems, the government imposes an obligation on SEZs to achieve Positive Net Foreign Exchange (NFE) to be calculated cumulatively for a period of five years from the commencement of production.

It has been over a decade since the SEZ policy was launched. But, the performance of these SEZs over the years has been at par with, or at best marginally better than sections of DTA units when it comes to boosting foreign exchange inflows. The 262 operational SEZs set up over this period (against 425 approved of which 376 have been notified) currently have only 5,576 operational units and account for less than 20 per cent of the country’s exports. More than 1 lakh acres of land within the current SEZs is still not occupied. The 2005 SEZ Act was brought in with the hope of making India a manufacturing powerhouse of the world, but it had very limited positive effects. Even as India’s service sector continues to show appreciable growth, the manufacturing sector has been lagging, This is evident from the fact that during 2022-23, out of total exports from SEZs at US$155.8 billion, services exports at US$94.2 billion were 60 per cent while merchandise exports at US$61.6 billion were 40 per cent.  

The objective of the DESH Bill is to “set up development hubs for promoting economic activity, generating employment, integrating with global supply and value chains and maintaining manufacturing and export competitiveness, developing infrastructure facilities, promoting investments, including in research and development (R&D)”.

These hubs will be further classified into enterprise and service hubs. While enterprise hubs will permit both manufacturing and service activities, service hubs will permit only service activities. The government plans to facilitate easier financing norms for activities in these hubs by giving them infrastructure status, at par with sectors such as roads, rail waterways, and airports.

Existing ports, airports, inland container depots (ICDs), land stations, etc., are proposed to be transformed into Development Hubs with a clear demarcation of processing and non-processing areas.

A comparison with the extant SEZ Act will show that there is nothing new in the DESH except replacing the word ‘SEZ’ with ‘hub’. It seems to be a case of ‘old wine in a new bottle’. What then has prompted the government to come up with DESH?

To understand this, let us look at a key proposal in the proposed amendments to the SEZ Act. This is to treat sales by SEZ units in the DTA akin to imports from countries with which India has bilateral free trade agreements (FTAs). Imports from FTA countries are subject to concessional/nil import tariffs. Currently, such sales are subject to the buyer paying the basic customs duty (import tariff) and Integrated Goods and Services Tax (IGST) applicable to the product concerned. besides other levies on imports like anti-dumping, countervailing and safeguard duties wherever applicable.

The existing provision is perfectly in order.

If the SEZ unit is unable to export and forced to sell in the domestic market, the very raison d'etre of giving it ‘tax free’ status disappears. Such sale in DTA has to be treated like any other sale and duty has to be paid. Charging concessional/nil duty – as proposed in the amendment – won’t be logical. 

Another provision in the new bill is expected to ensure tax rebates/refunds/financial subsidies to developers/companies in the hub, in a manner similar to the existing SEZs, but with no export compulsion NFE obligation. This too knocks at the foundation of giving the SEZ tax exemptions. If, the government doesn’t insist on export obligations from these units then, how are they different from other units?  

Tax-free status to SEZs with no export obligation will confer a fortuitous advantage on them. Instead of focusing on increasing exports, they will misuse tax exemptions for selling in the domestic market at the cost of units located in DTA that pay taxes. Another amendment in the SEZ Act seeks to make de-notification norms for SEZs easier. De-notification is basically an approval granted to developers to opt out of the SEZ scheme after being part of it. When SEZs are denotified, the developers have to refund all duties and tax benefits. More than 100 cases of de-notification have been approved by the government since 2008.

One wonders whether in the garb of simplifying the process of de-notification, the intent is to do away with the requirement of ‘refunding all duties and tax benefits.    

To conclude, it appears that the DESH bill/proposed amendments to the SEZ Act are intended to give SEZ developers and units located therein is to give a ‘safe passage’ to all those who haven’t been able to fulfil their export commitments as also to make life easier for others intending to invest in these zones/hubs.

(The writer is a policy analyst, views are personal)

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