SEZ - Tax Implications

SEZ - Tax Implications

v  Special Economic Zone

Special Economic Zone [“SEZ”] is a specified, delineated and duty-free geographical region that has different economic laws from those of the country in which it is situated. In some countries, such a region is even treated as a deemed foreign territory. A SEZ is a trade capacity development tool, with the goal to promote rapid economic growth by using tax and business incentives to attract foreign investment and technology. Today, there are approximately 3,000 SEZs operating in 120 countries, which account for over US$ 600 billion in exports and about 50 million jobs. By offering privileged terms, SEZs attract investment and foreign exchange, spur employment and boost the development of improved technologies and infrastructure. Most developing countries in the world have recognized the importance of facilitating international trade for the sustained growth of the economy and increased contribution to the GDP of the nation.

India is one of the first countries in Asia to recognize the effectiveness of the Export Processing Zone (EPZ) model in promoting exports. Asia’s first EPZ was set up in Kandla in 1965. In order to overcome the shortcomings experienced on account of the multiplicity of controls and clearances; absence of world-class infrastructure, and an unstable fiscal regime and with a view to attract larger foreign investments in India, the Special Economic Zones (SEZs) Policy was announced on 1^st  April, 2000. The prime objective was to enhance foreign investment and provide an internationally competitive and hassle free environment for exports. The idea was to promote exports from the country and realizing the need that level playing field must be made available to the domestic enterprises and manufacturers to be competitive globally.

To provide a stable economic environment for the promotion of export-import of goods in a quick, efficient and hassle-free manner, Government of India enacted the SEZ Act, 2005 which received the assent of the President of India on June 23, 2005. The SEZ Act and the SEZ Rules, 2006 [“SEZ Rules”] were notified on February 10, 2006. Before enactment of SEZ Act, 2005 there were 13 functional SEZs and about 61 SEZs, which have been approved and are under the process of establishment in India. As of now there are 173 functional SEZs & about 576 SEZs, which have been approved.

v  Facilities and Incentives to SEZ

The incentives and facilities offered to the units in SEZs for attracting investments into the SEZs, including foreign investment include:-

Ø  Duty free import/domestic procurement of goods for development, operation and maintenance of SEZ units;

Ø  100% Income Tax exemption on export income for SEZ units under Section 10AA of the Income Tax Act for first 5 years, 50% for next 5 years thereafter and 50% of the ploughed back export profit for next 5 years;

Ø  Exemption from minimum alternate tax under section 115JB of the Income Tax Act;

Ø  External commercial borrowing by SEZ units upto US $ 500 million in a year without any maturity restriction through recognized banking channels;

Ø  Exemption from Central Sales Tax;

Ø  Exemption from Service Tax;

Ø  Single window clearance for Central and State level approvals;

Ø  Exemption from State sales tax and other levies as extended by the respective State Governments;

Ø  Exemption from customs/excise duties for development of SEZs for authorized operations approved by the BOA.

Ø  Income Tax exemption on income derived from the business of development of the SEZ in a block of 10 years in 15 years under Section 80-IAB of the Income Tax Act.

Ø  Exemption from Central Sales Tax [CST].

Ø  Exemption from Service Tax [Section 7, 26 and Second Schedule of the SEZ Act].

v  Export performance of SEZ units

After liberalization of Indian economy, foreign trade has shown increasing trend. India is considered as an important player globally. Indian government has always strived to push up exports. SEZ has proven a potent tool to promote exports from India. Export performance from SEZ is tabulated below:-

v  Tax implications

By definition, SEZs are so-called “tax havens”. The SEZ Act, 2005 provides exemption from taxes, duties and cess leviable under various statutes listed in the First Schedule to the SEZ Act, 2005 in respect of any goods or services exported out of or imported into, or procured from the unit in a SEZ or Developer. Also, 100% FDI is freely allowed in manufacturing sector in SEZ units under automatic route, except arms and ammunition, explosive, atomic substance, narcotics and hazardous chemicals, distillation and brewing of alcoholic drinks and cigarettes, cigars and manufactured tobacco substitutes.

Tax implications to SEZ under various acts are listed below:-

1. Income tax –

The Developers of SEZ & units established under SEZ were not required to pay Minimum Alternate Tax [MAT] and Dividend Distribution Tax [DDT]. But Finance Act, 2012 amended section 115JB & section 115-O and w.e.f. 1^st April, 2012 MAT & DDT provisions have become applicable to SEZ developer & units of SEZ.  

[A]    Unit established under SEZ

Section 10AA deals with Special provisions in respect of newly established units in SEZ. This section applies to any undertaking, being a unit, which has begun or begins to manufacture or produce articles or things or provide any services during the previous year relevant to the assessment year commencing on or after 1st April, 2006, in any SEZ. It provides for a tax holiday in computing the total income of an assessee, being an entrepreneur, from his unit set up in a SEZ. The quantum of deduction under this section is:

Profits of the business of the undertaking × Export turnover ÷ Total turnover of the business carried on by the undertaking

                           i.       100% of profits and gains derived from the export of such articles or things or from services for a period of 5 consecutive assessment years beginning with the assessment year relevant to the previous year in which the Unit begins to manufacture or produce such articles or things or provide services, as the case may be, and

                         ii.      50% of such profits and gains for further 5 assessment years and

                       iii.       Thereafter, for the next 5 consecutive assessment years, so much of the amount not exceeding 50% of the profit as is debited to the profit and loss account of the previous year in respect of which the deduction is to be allowed and credited to a reserve account (to be called the "Special Economic Zone Re-investment Reserve Account") to be created and utilized for the purposes of the business of the assessee in the manner laid down.

But, no deduction under section 80-IA and 80-IB shall be allowed in relation to the profits and gains of the undertaking. Any unabsorbed depreciation under section 32(2) or business loss under section 72(1) or loss under the head “Capital gains” under section 74 of the undertaking, being the Unit shall be allowed to be carried forward and set off in the subsequent yeas.

Capital Gains on transfer of assets in case of shifting of an industrial undertaking from an urban area to an SEZ shall be exempt, provided that 1 year before, or 3 years after the transfer :

a.       Machinery / plant was purchased for the business of the industrial undertaking in the SEZ;

b.      Building or land was acquired or building was constructed in the SEZ;

c.       The original asset was shifted and the establishment was transferred to the SEZ;

d.      The assessee incurred such other expenses as are notified by the Central Government.

[B]            SEZ Developer

Section 80-IAB was introduced in Income tax act, 1961 whereby a deduction of 100% of profits derived from the business of developing SEZ (notified on or after April 1, 2005) would be available to developer of SEZ for any 10 consecutive years. The Assessee may opt for any 10 consecutive Assessment Years out of 15 Years beginning with the year in which SEZ has been notified by the Central Government. If a Developer has already claimed Deduction under Section 80 IA, he shall get the deduction under this Section only for the unexpired period. If a Developer transfers the operations & maintenance of SEZ to another Developer, the Transferee Developer gets the Deduction for remaining period.

2.Customs and Excise –

SEZ Units may import or procure from the domestic sources, duty free, all their requirements of capital goods, raw materials, consumables, spares, packing materials, office equipment, DG sets etc. for implementation of their projects in the SEZ without requiring any licence or specific approval. SEZ Units are free from the periodic examination by Customs of export and import cargo.

Goods imported/procured locally which are duty-free could or should be utilized within the approval period of 5 years. Domestic sales by SEZ Units will be exempt from Special Additional Duty [SAD]. Domestic sale of finished products, by-products is permitted on payment of applicable Customs duty. Domestic sale of rejects, waste and scrap is permitted on payment of applicable customs duty on the transaction value.

3. Service tax –

Exemption from service tax under Chapter V of the Finance Act, 1994 on taxable services provided to a Developer or Unit to carry on the authorized operations in a SEZ. It is as per Central Government’s notification 12/2013-ST, which stipulates upfront exemption. The service tax pertaining to common services used for authorized operations as well as domestic tariff area operations needs to be distributed as per rule 7 of CENVAT Credit Rules, 2004.

SEZ units with centralized registration can file common refund application. SEZ units and the developers are given the option to use the credit of input services as per the CENVAT credit rules instead of claiming refund. It has to file quarterly statement in Form A-3 containing the details of specified services received without payment of service tax.

4. Sales tax –

Exemption from Central sales tax on inter-state sale or purchase of goods is given to a Developer or Unit of SEZ. The respective State Governments may for the purpose of giving effect to the provisions of the SEZ Act, notify policies for Developers and SEZ Units and take suitable steps for the enactment of any law for granting exemption from state taxes, levies and duties to a Developer or an entrepreneur.

Rule 5(5) of SEZ Rules provides that before recommending any proposal for setting up of an SEZ, the State Government shall endeavor that the proposed SEZ Units and Developer get various incentives which inter alia include exemption from State and local taxes, levies and duties, including stamp duty, and taxes levied by local bodies on goods required for authorized operations by a Unit or Developer, and the goods sold by a Unit in the Domestic Tariff Area except the goods procured from domestic tariff area and sold as it is.

5. Securities Transaction Tax –

The SEZ Act provides for exemption from Securities Transaction Tax to non-residents in certain cases. Exemption under Section 10(38) of the Income tax may be available to a non-resident even in respect of securities transactions, which are exempt from Securities Transaction Tax under Section 26(1)(f) of the SEZ Act.

v  Conclusion

While the SEZ Act and SEZ Rules are steps in the right direction aimed at providing a momentum to growth in exports and employment, it is essential that the tax incentives provided for in the SEZ Act are fine-tuned with the present scheme of taxation. Demand was raised by businessmen to withdraw MAT & DDT which is currently applicable to SEZs. But Union budget, 2014 is silent on these issues. Central government in co-ordination with various departments shall think for streamlining taxation to SEZ so that many new businesses are encouraged to set up ventures.