BackWorked up over SEZ tax holiday
Worked up over SEZ tax holiday
Premium(Illustration : Jayachandran / Mint)
Fiscal incentives such as tax holiday benefits are often provided by the government with a view to achieve certain economic and social objectives, such as stimulating investments, generating employment opportunities, etc. However, it currently appears that with moderate corporate tax rates, the tax holiday benefits provided by the Income-tax Act, 1961, are progressively being reduced and/or phased out.
This article broadly analyses whether, as commonly perceived, a unit operating in an SEZ enjoys a complete tax holiday or whether there is an ambiguity in this regard.
As per section 10AA of the Act, a unit operating in an SEZ is eligible to claim 100% tax holiday for the first five years and a 50% tax holiday for the subsequent 10 years, subject to the satisfaction of certain conditions. However, as in the case of many provisions of the Act, the devil lies in interpreting the fine print of the specific provisions.
Section 10AA of the Act stipulates that the available deduction is the profits of the SEZ business multiplied by the export turnover divided by the total turnover of the business house, that is, including turnover of businesses outside the SEZ.
Logically, to be able to claim a total tax holiday, all the three components of the above formula should relate to the unit operating in the SEZ. However, the way the formula is literally stated in the section, there is scope for an interpretation adverse to the unit claiming the tax holiday and, more importantly, seemingly contrary to the intent of the government itself.
For example, say, an Indian company has two lines of business activities, one an export business undertaken from an SEZ and the second a local trading operation. Suppose the export turnover of the SEZ unit is Rs100 (which is also part of the total turnover of the company).
Assume that the domestic trading business also has a turnover of Rs100, taking the company’s total turnover to Rs200. If we assume that the SEZ unit earns a profit of Rs30, applying the prescribed formula in a strict manner, the tax holiday benefit of the SEZ unit would not be the entire Rs30, but would be limited to Rs15 (100/200 x 30).
The anomaly in the formula could result in substantial economic impact on the pricing, and consequently the profitability, of a business undertaken in an SEZ. The possible contentions that one could consider to argue that the total turnover in the denominator should be that of the particular unit and not of the entire business could be on the following basis.
The formula in the first part places emphasis on profits of the business of the undertaking, being the SEZ unit. Therefore, the reference to total turnover of the business carried on also must be to the business of the undertaking, being the SEZ unit. In other words, the “business" has to mean business of the SEZ unit. In this connection, the decision of the Madras high court in the case of CIT v. Madras Motors/M.M. Forgings Ltd. (257 ITR 60) could be relied on where in a similar context, under the erstwhile section 80HHC (3), it was held that the term “total turnover of the business carried on by the assessee" should be restricted to the turnover relating only to the unit undertaking the export business and should not include the turnover of other businesses of the assessee.
Further, a strict interpretation would lead to the tax authorities taking a view that it should be the total turnover of the business of the company in the aggregate and not just for the SEZ unit. The result in such a case leads to the absurdity of reducing the available tax holiday. There are judicial precedents which have held that where a plain literal interpretation of a statutory provision produces an unjust result that would never have been intended by the legislature, the court may modify the language used by the legislature so as to achieve the intention and produce a rational construction.
Though the above contentions could be raised, the same are contentious and hence, more likely than not to result in litigation.
A similar anomaly existed for computing the tax holiday benefits under section 10A of the Income-tax Act, that is, the denominator was stated to include the total turnover of the business carried on by the assessee.
The anomaly in the wording of section 10A was subsequently set to rest by the Finance Act, 2001, which replaced the term “total turnover of the business carried on by the assessee" with “total turnover of the business carried on by the undertaking". Accordingly, it becomes all the more imperative that such an amendment is made with retrospective effect to address the anomaly in section 10AA to avoid undue hardship.
An appropriate amendment and clarification by the revenue authorities with respect to such an unintended anomaly would be welcomed and would be a proactive measure to reduce undue hardship and avoidable litigation.
Ketan Dalal is executive director and Manish Desai is associate director, PricewaterhouseCoopers. Your comments and feedback are welcome at groundrules@livemint.
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