Home >Opinion >Views >Opinion | SEZs in India: In search of course-correction

Special Economic Zone (SEZ) is a geographic area in which the business and trade laws are different from the rest of the country. These tax havens are located within a country's territorial borders and the objective of developing SEZs include increasing balance of trade and attract newer inward-investments into the country, creation of newer jobs. Financial incentives are granted to those setting up SEZs and cover a wider gamut of benefits for investors across taxation, customs, labour regulations, etc. SEZ, as a concept, started in mid-1950s in countries with larger presence in industrial sectors. Ireland was one of the earliest adopters in setting up SEZ.

The concept of labour-arbitrage which started as a competitive advantage for nations to compete with each other for global trade, saw the 1970s develop labour-intensive manufacturing-focused SEZs. This trend started in East Asia and Latin America as labour was available and trained to stick to manufacturing processes. China opened up its first SEZ in 1979 in Shenzhen, thus kick starting the move of the communist nation to embrace capitalist investments and to seek foothold in the global trade. In the recent years, China has taken this a step ahead to assist African countries to set up SEZs with Chinese strategic investments and partnerships.

India & the genesis of its SEZs

Prior to the concept of SEZ, India relied on the Export Processing Zones (EPZs), which did not make a deep impact on foreign investors. The SEZ Act 2005 enabled fiscal benefits to projects that promote economic activity, brings in investments in infrastructure, generation of employment and export of products & services. Using this act, the then-existing EPZs had also been converted to SEZs. The SEZ Act 2005 provided for Direct & Indirect tax exemptions by the Central Govt. and SEZ Policies of States gave concessions / waivers from the levies of State Govt.

This is only national law that governs land, as rest of real estate laws across India are statesubjects otherwise. SEZs primarily are infrastructure projects and cannot be classified as real estate projects. For manufacturing SEZs, plotted development (including development of infrastructure of utilities) is necessary and for service-sector SEZs, ready-made office spaces are mandatory structures. The more popular SEZ category in India has been the service sector as fully-furnished office premises with 24 x 7 power supply for IT units, plots with utilities (power, water, sewage, gas & fuel facilities, telecommunications, ETPs, etc. were offered. Effectively, the tenant-IT/ITES units had negligible investment in capital assets, which suited their operations.

The SEZ Act does not mandate the SEZ promoters from any obligatory requirements in terms of employment generation or revenue collections. The only condition for the units functioning within processing area of SEZ is that they generate Net Foreign Exchange to be positive (i.e. earning forex) within 5 years of commencement of its operations.

An interesting labour-related aspect is that inside SEZs, no labour unions are allowed. That’s been a big positive for its users. Infact one of the state does not like this rule about having no labour union and hence there is no SEZ in that state. Despite having skilled and educated workforce, that state has lost out on IT / ITES talent employment generation.

A look at what’s SEZs delivered so far

SEZs across India have attracted investments of over 5.2 lakh crores and have current capacity utilisation of just over 50%; using this capacity, they employ nearly 20 lakh people (of which IT/ITES SEZs employ 80% of the head count). There are currently 355 SEZs of which 70% are IT / ITES focused. Not all of these IT / ITES units are focused in service exports. Many of these export products – IT software, electronic items, assembled parts such as Printed Circuit Boards, etc. In fact, SEZ’s account for over 26% the total exports of the country and the export value is over 7 lakh crores (Fiscal 2019).

SEZ - associated policy disconnects & outcomes

The levy of MAT and withdrawal of DDT exemption in 2012 were surely a surprise jerks that the SEZ developers faced. Another taxation issue that cropped up was the sudden introduction of the sunset date for termination of Direct Taxation benefits for SEZ developers in the year 2017 and SEZ units in the year 2020. This probably stemmed from the intention to implement the Direct Tax Code (DTC) and the consequent move to withdraw all concessions / rebates granted to entities under Income Tax Act (ITA) 1961. This not only hurt the developer community who had invested into SEZs but now pushes the envelope for the SEZ units, especially with the further expected economic slowdown and the need to be ultracompetitive to gain / hold onto global export businesses with competitive pricing. Also from global trade perspective, this move of withdrawal of taxation benefits from services SEZs has not been taken well. It has been upheld in WTO.

In the past few years, many of the ASEAN countries had tweaked their policies to attract global players to invest into their SEZs and have also worked on developmental set of their skilling initiatives. Consequently, Indian SEZs have lost some of their competitive advantages globally and hence need to have fresher policies.

Many units also migrated to other destinations including the Philippines, Vietnam, Thailand, Malaysia, China with local government support, taxation benefits. For example, SEZs in Indonesia and Costa Rica enjoy Income Tax exemption for 12 years. SEZs in Thailand are exempt from Corporate Tax for 13 years.

This loss of business for Indian SEZs results in reduced forex earnings and forced reduction in head count. Further fall in demand could lead to unutilised land and / or unoccupied built-up premises within SEZs. Exit of existing clients would further aggravate the issue of vacancy in SEZs thereby putting the existing investments in peril. These idle assets could create stressed-assets within the economy and increase the woes of the Banking sector. For a country that believes in climate change and its severity, the exit of IT/ITES businesses to other countries would also mean transfer of non-polluting industry from our country.

Many of these crucial elements have also been documented by the Baba Kalyani led committee, constituted by the Ministry of Commerce and Industry, to study the existing SEZ policy. This committee had submitted its recommendations in November 2018.

Baba Kalyani committee report

It had been set up with a broad objective to evaluate the SEZ policy towards making it WTO-compatible and to bring in global best practices to maximise capacity utilisation and to maximise potential output of the SEZs. The committee had a key suggestion to move the

SEZ philosophy from export-oriented to broad-based Employment and Economic Growth approach (Employment and Economic Enclaves-3Es).

The critical recommendations of this committee included :

• Extension of sunset clause beyond 2020 & retaining taxation benefits withdrawn earlier

• To develop integrated industrial and urban development

• Formulation of separate rules and procedures for manufacturing and service SEZs

• Infrastructure status to SEZs to improve access to finance and to enable longterm borrowing

• Enhance competitiveness by enabling ecosystem development by funding highspeed multi-modal connectivity, business services, and utility infrastructure.

• Procedural relaxations for developers and tenants to improve operational and exit issues.

• Broad-banding definition of services/allowing multiple services to come together

• Utilizing Multi Services SEZ and IFSC for all inbound and outbound investments

• The flexibility of long-term lease for developers and tenants

• Dispute resolution through arbitration and commercial courts

Suggested policy imperatives

Fiscal Incentives

• Considering the sensitivity of “Employment Generation" and “Forex Earnings", it is imperative to extend the sunset date for SEZ units. Example, SEZs created an employment of approx. 19 lakhs in 12 years and the further potential entails additional 19 lakhs in 6-8 years.

• Unemployment poses a serious issue for the educated youth of our country and our ballooning workforce with huge addition of graduates every year. Therefore, migration of business outside India needs to be halted with extension of sunset date for SEZs.

• Extension of Sunset Date would also help in utilizing the existing assets of SEZ and securing the investments made by developers (long term risk undertaken on the basis of original SEZ policy) by providing an opportunity for revenue generation, leading to revitalization of SEZ projects.

• Presently MAT is levied at 20% and the Corporate Tax slab has been reduced to 24% for small & medium enterprises. Thus, effectively the benefit given to SEZs would be marginal (4% approx.). Moreover, for new manufacturing units, the special IT levy of 15% has been instituted by GOI. Thus, since the Government does not lose a substantial revenue, the sunset date for IT/ITES SEZs may be extended.

• 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.

• The SEZ Act was notified by Central Government in 2005 and the Rules framed thereunder in 2006. The statute specifies that, minimum period of lease of land plot for setting-up SEZ should be 20 years. Abiding with this stipulation of the Government, the eligibility of SEZ for its continuation is till 2026. This is yet another reason for the SEZ sunset date (31/03/2020) for availing Direct Tax benefit on export proceeds to be given an extension at least for 6 years.

• Extending the financial benefits beyond 31/03/2020 would contribute in channelizing the exiting IT/ITES units from China to relocate in India.

• The revitalization of SEZs also ensures “spin-off" contribution to the Government treasury – income tax of SEZ employees and indirect tax collected by their increased expenditure (retail, housing, etc.)

• IT SEZs be given similar features as granted to GIFT SEZ; with a consideration that, both these SEZs operate through the ‘web-enabled’ interface and render services (Financial or IT) to their clients. Here the feature related to tax benefits. MAT is levied @ 9% to IFSC entities (GIFT project) and @ 20% for IT SEZ units. This discriminatory taxation for enclaves performing comparable activities should be eliminated and a uniform levy of 9% MAT need to applied for IFSC units and IT SEZ units (i.e. the services sector) Non-Fiscal Initiatives – Ease of Business

• Permission for Domestic units to operate from Non-Processing Area without availing indirect tax exemptions (industrial activity in addition to permissible social activities)

• Flexibility of utilization of Non-Processing Area (dual usage) by developers for creation of social infrastructure by removing existing usage restrictions vide notification dated 02/01/2015. (development to be governed by locational requirements)

• Broad-banding the Services definition (Rule 76 of SEZ Rules 2006) to include all the services permitted under the GST regulation.

• Change in Net Foreign Exchange (NFE) criterion of units for occupying office space

within the BUA of Processing Area and factoring the investment and employment parameters to determine qualification.

• Permission for reverse job-work to prevent idling of installed capacities & job loss during adverse economic conditions. (Sub-contracting activity on behalf of domestic units for sale in domestic market without tax benefits)

• Simplification of Exit Process is needed. SEZ denotification has to be approved by multiple entities and consumes approx. 10-12 months for completion of process.

• Services SEZ to be exempted from prior MOEF Approvals, if structures within the zone are pre-certified as “Green Buildings".

• Infrastructure status to be extended to all components developed within the SEZ (internal roads, utility networks, buildings, amenities, landscaped open spaces, service facilities, etc.) to enable alternate low-cost financing options.

• Digitization push for operational efficiency – Integration of e-platforms of all authorities (SEZ On-line system of MOC, GST Network of CBIT and ICEGATE system of Customs)

• E-Governance to be extended to SEZ project & Unit approval process of State & Central Governments and reduction of physical document submissions.

• Dispute resolution structure including dealing with notified offences which are suggested by Baba Kalyani Committee Report need to be implemented.

Summary

SEZs in India have proved to be a success story for the IT/ITES industry. Given the prowess of Indian workforce in the service sector, it is imperative to continue the government support for these hubs in terms of continued tax exemptions and fiscal concessions. To encourage growth of Services SEZs enabling generation of massive job opportunities to the huge educated population of the country, flexibilities in operations and easement of procedures in vital by ensuring necessary amendments to the existing SEZ policy. Implementing the suggestions made above would provide the necessary boost for economic recovery in the current recessionary scenario.

(The author is an independent markets commentator. The views expressed in this column are his own)

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