SEZs – Will they continue to be India’s tax havens?
Jayesh Kariya analyses the probable impact of the ‘The Direct Tax Code, Bill 2009’ as well as the new GST Code – both currently in the draft stage – on SEZ development in the country.
India was the first Asian country to recognize the potentials of export oriented zones and the linked incentives to enable multifold growth in infrastructure, stable economy regime and higher domestic and foreign investments. The first EPZ was set up in Kandla way back in 1965. To attract foreign investments, the Special Economic Zone (SEZ) Policy was announced in April 2000 followed by the SEZ Act in 2005 and the SEZ Rules in 2006. There have been significant delays in rolling out the scheme as well as making it more effective.
SEZ rules laid down simplified procedures for development, operation, and maintenance of SEZs – right from setting up units and conducting the business in SEZs to a single window clearance for all the matters relating to compliance, starting up and documentation at Central as well as State Government levels. The overwhelming response to the SEZ scheme is a known success story to all – manifested in terms of foreign investments, increased employment opportunities, increased urbanization and economic activities in the remote areas.
During 2008, like every growth story, SEZs felt the impact of economic recession and meltdown. Due to decline in investments, low demand and anti-outsourcing activities, denotifications of SEZs or withdrawals/holding of the projects in pipeline became the major issue for the sectors like real estate, the first victim fallen prey to the downfall.
As the global economy is depicting trends of revival, some silver lining was observed by the sector. The newly formed Government gave one more reason to rejoice and a step towards certainty. In the interim, the Indian Government had started offering major relief in form of duty benefits to SEZs; announced several notifications and circulars including guidelines on transfer to the subsidiary of the developer or an SPV, guidelines for clearance of cargo from ports located in SEZs, clarifying approving authority for DEPB and reducing stamp duty for SEZ transactions.
With the issuance of guidelines on Green SEZ, Power SEZ and Port based SEZs, the sector started experienced booster for better growth and tax positions. Clarity on various tax issues settled down the dust on the various open aspects. Amidst land grab issues, the model was slowly being accepted and implemented across the country.
But who knew that one blow will raze the SEZ regime to the ground and the so called “Tax Haven” will fall apart by the storm called “The Direct Tax Code, Bill 2009 (the ‘DTC’) as well as new GST Code. Both are in the draft stage and are likely to be introduced effective from April 2011.
Direct Tax Code vis-à-vis SEZs
The present regime of SEZ offers significant direct and indirect tax incentives both to the developer of SEZ as well as SEZ units making the regime virtually a “tax haven” on Indian soil. From direct tax stand point, the present regime provided profit linked incentives as well as exemptions from levy of MAT and DDT.
Whereas, the DTC proposes to introduce a scheme of tax incentives for specified eligible businesses, which is expenditure linked incentives as against the existing scheme of profit linked incentives.
As per Schedule Twelve of DTC, business of developing SEZs would be allowed a deduction which would be computed as ‘Gross income less business expenditure (including capital expenditure). If this result is negative, profits will be treated as ‘nil’; and the negative balance would be carried forward to the next year to be reduced from the gross income of the next year and so on.
Profits will arise only if the gross income exceeds business expenditure. Once this happens, such profits will be subject to normal corporate tax rate without any tax exemptions. Effectively, this is more in the nature of allowing capital expenditure in the year one, which otherwise would have been eligible over the life of the asset and consequently, there is no real tax incentive.
Nonetheless, as per section 282(2) (n) of the DTC, profit linked incentive available under the present Income-tax Act would be grandfathered in case of the SEZ developer who is eligible for such a deduction as on 31 March 2010. This means developers of SEZs notified prior to 31 March 2010 would continue to enjoy profit linked incentives under the Act even after the DTC comes into force; but the profits would need to be computed in accordance with the provisions of the DTC.
Some Vagueness in the DTC
The DTC has lead to certain ambiguities and concerns. The grandfathering clause is unclear; the cut off date for grandfathering to developers for profit linked incentives is of 31 March 2010 whereas the effective date of the DTC is 1 April 2011. So, what about the SEZs becoming notified and operational between 1 April 2010 and 31 March 2011? Also the eligibility benefits to co-developer of the SEZ notified before 31 March 2010 but appointed after the implementation of DTC is in doubt.
There is one more concern about the eligibility of benefits to the transferee of SEZ. In the present regime, tax holiday continues even in case of transfer of ‘operation and maintenance’ activities by SEZ developer to another developer; whereas the DTC does not grant such benefits. Further, DTC is silent on lapse of tax holiday or carry forward of unexpired period?
DTC is silent on deductions for SEZ units eligible for benefits under section 10AA of the Act – deductions are not available for new SEZ units nor is there any grandfathering provisions for SEZ units.
The new avatar of MAT is more draconian as it provides for payment of tax on gross assets basis (without any deductions for liabilities). This is a farfetched regime than MAT and would make SEZ projects unviable. This is effectively a Gross Assets Tax, worst than the wealth tax. This goes against the fundamental objective of shifting the incentives to expenditure linked incentives.
Similarly, exemption from payment of DDT hitherto available to SEZ developer has been withdrawn, which will effectively result in double whammy for the sector.
Impact of DTC
Any uncertainty or change in tax basis for SEZ sector will certainly be unfavourable to the business community and investors at large. Further, when gross assets based taxation is introduced, existing projects’ functioning gets negatively impacted. Similarly, investors return from such large infrastructure projects gets significantly impacted with such a sweeping change.
Tax deduction for SEZ Units has been an important basis to incentivise growth of SEZs. In the absence of such incentives for SEZ Units, it is not certain whether SEZs will witness a lot of demand. Additionally, the existing SEZ Units being denied benefit of the tax deduction, especially when most of the SEZ units have been setup just in the recent past, it does not augur well for the business.
Considering the commercial realities, SEZ projects are being undertaken in separate SPVs with one or more holding company. In case where there is a holding company structure, the gross assets tax would effectively result taxation of same assets twice once in the hands of the SPV and again in the hands of the holding company. Similarly, there could be a dual impact in respect of DDT unless the structure facilitates credit for DDT paid by the SPV.
Under the DTC, the leasing income would be characterized as “income from house property” as opposed to “business income”. As a result there would be limited deduction for various expenses incurred.
Various representations and recommendations are being made by the Commerce Ministry on keeping SEZs out of the ambit of DTC arguing that it could hit the development of such zones and ultimately exports. It is also expressed that while the proposed code contradicted provisions of the SEZ Act, ambiguities in the new proposal will make things worse and investors will shy away from taking investment decisions.
Representations are also being made to restore the benefits to make the SEZ regime viable and flourish. The Finance Ministry has taken these suggestions positively and is considering suggestions and representations made by various sections of the business community and other ministry. It appears that the Government has recognized the adverse impact of the DTC and would take appropriate measures to provide necessary boost to the sector in the present challenging times.
The proposal of bifurcating the benefit for processing and non processing areas in the first discussion paper of GST has created a controversy between the Commercial Ministry and the Finance Ministry.
It is good that the Government is taking the suggestions and representations with positive approach. Hopefully, Government should demonstrate this positive approach in its actions. More importantly, the Government should restore the benefits to SEZ developers and SEZ units to enable the SEZ regime to boost a faster economic government of the country.
Jayesh Kariya is with BSR & Associates, Chartered Accountants. He would like to thank his colleague Dipna Jobanputra in compiling this article.