Home / ANALYSIS / Business / SEZs in the realm of DTC 2010

recently launched Vadodara SEZ. Pic courtesy: Synefra Engineering & Construction Ltd

Jayesh Kariya and Nirmal Nagda, Chartered Accountants, analyse the key changes and its likely impact on the stake holders of SEZs with regards to Direct Tax Code 2010

The SEZ scheme has always been touted as attractive in terms of its objectives and plethora of incentives it offers. However in the past, the scheme has lacked stability due to gaps in select regulatory and implementation aspects. Overtime the authorities have made commendable efforts to refine the SEZ scheme and have introduced several amendments and instructions to streamline the entire SEZ mechanism for investors across categories.

A key amendment being rectification of formula anomaly for calculation of export profits while calculating the Income-tax incentive available to an SEZ unit. However, the frequent amendments have also created a negative impact on the stakeholders i.e. the investors never know when the law will get amended and their interests (or planning) would be put on stake.

SEZs have come a long way - from June 2005, when the SEZ Act was notified, to August 2010, when the revised Direct Taxes Bill, 2010 (DTC, 2010) has been tabled in the Parliament. Several substantial changes have been proposed in the DTC, 2010 with respect to the direct tax incentives available to developers and units partaking in SEZ activity.

The Income-tax Act, 1961 (the Act) provided 100% tax deduction to an SEZ developer for a period of 10 consecutive assessment years from the date of notification of an SEZ. This deduction was made available for developing an SEZ. Further, similar benefit was also made available to a Co-developer and transferee developer (for the balance number of years) in case of transfer of responsibility of maintaining and operating an SEZ.

The availability of MAT and DDT exemption also proved attractive for SEZ developers and their investors, since it meant complete tax free income (and consequential higher cash flows and IRRs) to the developer and investors, unlike many other infrastructure and capital intensive projects.

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The DTC Bill, 2009 proposed to change the scheme of direct tax incentive available to an SEZ developer from profit linked incentive to investment linked incentive. It also provided for a transition provision to the effect that all SEZ notified on or before 31 March 2011, shall be entitled to profit linked incentive, though calculated in accordance with the provisions of the DTC Bill, 2009. Further, the MAT and DDT exemptions were also proposed to be rolled back. These proposals saw a series of representation and the general expectation was that SEZ developers will be exempted from following investment linked incentives and will continue to avail the incentives as contained in the Act.

The DTC Bill, 2010 has, on an overall basis, proved to be a dampener. Though, it proposes to extend the applicable year for grandfathering the profit based tax incentives available to an SEZ developer from 31 March 2011 to 31 March 2012, it has left the other proposals of DTC Bill 2009 unaffected. In other words, the SEZ developers will no longer be eligible for MAT and DDT exemptions (including the DDT relief available to the Shareholders when they in turn declare dividends (i.e. reducing the dividends on which the DDT has been paid)), if the DTC Bill 2010 becomes the law. The proposals could have the following negative implications:

• Investment linked incentive could mean a little attraction to low capital intensive projects, particularly for IT-ITES sector (since they require lesser investments as compared to others), which to a large extent have been the back bone of the SEZ scheme and the India growth story.

•  With exemption from MAT and DDT proposed to be rolled back, the tax cost for an investor, till the point it receives dividend, would be 30.5% as compared to a current tax free scenario. This is a big impact and could virtually throw most of the IRR projections of SEZ projects out of gear.

• Another finer angle is the manner in which the profits of the SEZ developer would be calculated. It is stated that the cost of land, including long term lease will not be considered as an eligible capital expenditure. This means, that an SEZ developer will never be able to claim a tax relief of the land cost, which was hitherto possible under the computation of income from business. The proposal could severely impact the large SEZs (including those promoted by the Semi - State Government institutions), which follow a model of leasing plots and only play a role of infrastructure provider.

• The exemption which was in past available to a Venture Capital Fund / Company from investments into SEZ, which many felt would be made available in the DTC Bill 2010, has not been provided. The impact on Venture Capital Fund / Company, from investments into SEZ will have to be analysed.