SEZ policy set for overhaul after polls

SEZ policy set for overhaul after polls
The Financial Express, May 4, 2009, Page 1

Arun S, New Delhi

Irrespective of whichever party or coalition comes to power at the Centre, the investment-magnet Special Economic Zone (SEZ) policy will be in for some major changes. Anticipating this, the commerce ministry has begun an exercise to gather suggestions from developers, units and stakeholders to improve the functioning of these tax-free enclaves. On the basis of the feedback, the government will also hold an inter-ministerial meeting to sort out policy and operational issues.

A lot is at stake as these zones have so far attracted over Rs 90,000-crore investments and given direct employment to around 2.3-lakh people — as per data culled from the ministry. Despite global slowdown, exports from SEZs had recorded 33% growth to touch Rs 89,000 crore last fiscal, much above the growth of shipments from the rest of the country at 3.4%. SEZ exports also formed close to 10.8% of India’s total exports. So far, around 572 SEZ projects have received formal approval, of which 282 have formally been notified.

Bibek Debroy, economist, working with the Centre for Policy Research in New Delhi, said the changes need not involve a new legislation to rewrite the Special Economic Zones Act of 2005. “A lot of the changes could be of rules. But it is certain that the policy would be reworked, as one of the first things the new government would undertake”.

The performance of the SEZs will help the new government contend with the problems of land grab, that some of them have been accused of.

While the UPA has not mentioned SEZ in its manifesto, Debroy said as the composition of the coalition is expected to change, a fresh examination of SEZs is fairly certain.

The BJP, in its manifesto, has clearly criticised the SEZ policy saying these tax-free enclaves “spells disaster for the farm sector.” The party said if voted to power, it would amend existing laws to rectify anomalies pertaining to land acquisition. The CPI(M) manifesto says it will amend the SEZ Act and rules to eliminate the tax concessions and regulate land use and labour policies in the zones.

Simultaneously, the commerce ministry is examining another set of issues that have emerged for the developers that could seriously impact the viability of the zones. One of the aspects that has put the government in a spot is the impact of the 20-odd free trade agreements, that India has inked or is negotiating with different trading partner countries and regions, on SEZs and units in the domestic tariff area (or DTA—the area outside the tax-free zones subjected to normal taxes and duties).

Under FTA rules, imports of agreed products from partner countries to India enjoy nil or negligible duties. But the DTA units importing from SEZ (SEZ is a tax-free zone and a foreign territory for tax purposes) has to pay the full range of duties (basic customs duty, additional customs duty/excise duty, education/ higher education cess)on the imports.

This would encourage DTA units to import from FTA countries instead of from SEZ units. It would indirectly mean that the government is encouraging manufacturing in FTA partner countries and not in SEZs in the country, especially at a time when domestic demand is much higher than in markets abroad.

Therefore, the government might resolve the problem by at least temporarily doing away with duties for DTA units while importing from SEZ units, on the condition that the goods will be exported. If the DTA unit adds value to the product and ships it abroad, the value addition also should be taken into account while determining the duty component. On their part, the SEZs will continue to pay income tax on the profits from sales to DTA units.

Another problem that the government is facing is income tax on intra/inter-SEZ transactions or the tax paid by vendors within an SEZ unit while supplying to the main manufacturing unit in the SEZ.

For instance, in an SEZ of a major telecom company, the vendors within the SEZ unit have no incentive to sell their wares to that telecom company, as they have to pay income tax on the profit from transaction.

This is because intra/inter-SEZ transactions are not considered physical export/import.

While on the other hand, the vendor gets tax benefits on his profits for exporting his ware outside the country. This makes it better for the vendor to house his unit in the DTA rather than in the SEZ. Also, the telecom company can get duty-free benefits if it imports the components or parts from outside the country.

This not only discourages intra/inter-SEZ transaction but also prevents the ‘just-in-time’ supply chain from vendors to the main company. The just-in-time concept saves time and money as well as encourage vendors to set up shops near the main company - promoting manufacturing and generating employment in India.

Therefore, in order to have more vendors set up shop in an SEZ, the government is now considering a proposal to make the main exporter in the SEZ (in this case the telecom company) give a certificate detailing the proportionate benefits that the vendor should get for contributing the components of their export. However, intra/inter-SEZ transactions are deemed exports and therefore does notattract duties.

The third aspect is regarding treating certain services, consumed within the SEZ and earning foreign exchange, as exports and according it tax benefits. For instance, medical, education and hospitality services to foreign nationals in SEZs as well as maintenance, repair and operation (MRO) services in aviation units in SEZs earn valuable foreign exchange is not considered deemed export now as they are not physical exports. Medical tourism, education, hospitality and MRO are growing sectors in India due to the affordability in services and its quality.

Regarding the huge tax and revenue losses, earlier cited by the finance ministry, these were proved to be notional by the commerce ministry. This is because, without these benefits, India would not have got that particular investment and would not have resulted in multiplier effects of employment generation and exports. The revenue losses are therefore compensated by this additional economic activity.

But at a time when every country is competing with each other to attract foreign investors, if India loses that investment, it will also lose the subsequent benefits of economic activity forever, industry sources said.

Also, at a time when port-based SEZs too are coming up, the commerce ministry is deliberating on whether to accord tax-benefits to new ports that are built inside the new SEZs or provide the same to the ones situated outside too to ensure a level playing field.

Besides the government is expected to ask the Reserve Bank of India to notify an empowered group of ministers recommendation that SEZs should be classified as infrastructure projects. “Despite the EGoM decision, the RBI has not notified the same,” said L B Singhal, director general, Export Promotion Council for Export Oriented Units and SEZs.

Singhal said the central bank’s stand is denying SEZ developers the ability to access external commercial borrowings and cheaper domestic credit. RBI treats SEZs as commercial realty projects and lending rates for such projects are considerably higher than core sector projects. As per the SEZ policy, these zones are social, commercial and industrial infrastructure projects, Singhal said. Lack of funds have forced developers to delay in the implementation of their SEZ projects and in some cases even surrender some of these projects.

—Tomorrow: More IT SEZs by non-IT developers to drop out