SPECIAL ECONOMIC ZONES – NO MORE SPECIAL

[Dr. Sanjiv Agarwal]

Special Economic Zones (SEZs) which contribute over 30 % of country’s exports have been adversely hit by Budget 2011 proposals as the SEZs have been brought under Minimum Alternate Tax (MAT) by 20.1 percent (including cess ) and dividend  distribution tax (DDT) at 16.22 percent (including cess). SEZs were hitherto exempt from both these taxes. The units as well as developer, both will be liable to MAT and DDT a year ahead of Direct Tax Code (DTC) which is intended to be in place in April 2012. However, some relief has been given to SEZs by way of exemptions from service tax to taxable services provided within SEZ and simplification of the refund procedures . 

 As per the budget proposals in 2011 budget, special economic zones will be subject to levy of minimum alternate tax (MAT) under section 115JB of Income Tax Act which will now be 0.5 percent higher @ 18.5 percent on book profits. This will be levied on both, SEZ developer as well as units in SEZ. MAT was not applicable to either as per the exemptions available . Thus from next assessment year. AY 2012-13, units operational in SEZ and developer of SEZ, both will have to shell out a tax called MAT @ 18.5% which will effectively be 20.1% including cess. . The idea of MAT is to tax companies which do not pay income tax or pay very little tax. The logic for MAT is to bring SEZs and units at par with other corporate entities in terms of sharing tax liabilities. This however, will work as a ‘retrograde’ and goes against the spirit of promotion of SEZs in the country.     

 The second bombshell on SEZs has been levy of Dividend Distribution Tax (DDT) which was not applicable to SEZ developers until now. The DDT shall be levied from 1^st June 2011 on dividends distributed by SEZ developers @ 15 percent plus cess, ie, 16.22 percent . 

Under the existing provisions of section 10AA of the Income-tax Act, a deduction of hundred percent, is allowed in respect of profits and gains derived by a unit located in a Special Economic Zone (SEZ) from the export of articles or things or services for the first five consecutive assessment years; of fifty percent, for further five assessment years; and thereafter, of fifty percent, of the ploughed back export profit for the next five years. Further, under section 80-IAB of the Income-tax Act, a deduction of hundred percent, is allowed in respect of profits and gains derived by an undertaking from the business of development of an SEZ notified on or after 1^st April, 2005 from the total income for any ten consecutive assessment years out of fifteen years beginning from the year in which the SEZ is notified by the Central Government. 

Under the exiting provisions of section 115JB (6), an exemption is allowed from payment of minimum alternate tax (MAT) on book profit in respect of the income accrued or arising on or after 1^st April, 2005 from any business carried on, or services rendered, by an entrepreneur or a Developer, in a Unit or Special Economic Zone (SEZ), as the case may be.

under the existing provisions of section 115-O(6), an exemption is allowed from payment of tax on distributed profits [Dividend Distribution Tax (DDT)] in respect of the total income of an undertaking or enterprise engaged in developing or developing and operating or developing, operating and maintaining a Special Economic Zone for any assessment year on any amount declared, distributed or paid by such Developer or enterprise, by way of dividends (Whether interior, or otherwise) on or after 1^st April, 2005 out of its current income. Such distributed income is also exempt from tax under section 10(34) of the Act.

The above provisions were inserted in the Income-tax Act by the Special Economic Zones Act, 2005 (SEZ Act) with effect from 10^th February, 2006.      

While section 10 AA of Income Tax Act 1961, exempt profits of SEZs to the extent of 100 % in first five years, 50% in next five years and 50% of plough back of export profits for next five years, we have now taxes in the form of MAT and DDT which are also taxes on income. Not only this , SEZ Act 2005 provides for total exemption of all taxes and levies for SEZ developers and units in SEZ. Infact investments in SEZ were made by business entities keeping tax incentive in mind. These units will now suffer profitability squeeze and liquidity crunch to the extent of tax out go which is going to be substantial. The units in SEZ are generally new generation companies which include high degree of innovation, research, technology, information technology, IPR and knowledge resources.

With applicability of minimum alternate tax and dividend distribution, there will be not much difference between SEZ units and other units and SEZs will loose their attraction and competitive edge.  While proposed Direct Tax Code (DTC) talks of levying MAT on SEZs and units therein @ 20%, DTC is still  a year  away and Government instead of waiting for DTC to come, has levied tax in the form of DTT and MAT, despite there bring exemption available to SEZs  under section 10 AA of Income Tax Act, 1961. 

The Budget proposal ahead of time (as proposed in DTC ) on MAT is certainty against the spirit of law itself which grants exemption in one section (10AA) and levies tax in another section (115JB). The Government of the day could have waited till the report of Parliamentary Committee examining the DTC proposals. The Government’s proposal is also against the principle of promissory estoppel.

SEZs were set up and promoted in order to upgrade the industrial infrastructure in the country and to have specialized and sectoral Zones to sharpen competitive edge of Indian entrepreneurs. Having promised certain incentives, backing out mid way is nothing less than betrayal at its best and governance at its worst.

So far as service tax is concerned, SEZs were allowed exemption from levy of service tax on input services vide Notification No 9/2009-ST dated 3.3.2009 which was latter amended by Notification No 15/2009-ST dated 20.5.2009 to fully exempt services received in the SEZ for authorized operations and other services were subjected to exemption via refund route. The exemption for input services has been simplified with new Notification No 17/2011-ST dated 1.3.2011 superseding the earlier scheme. Accordingly, exemption to SEZs and units in SEZ   has been made easier to implement. The exemption would operate for services provided, services received and tax payable under reverse charge mechanism by both developer as well as units of SEZ. The exemption is for tax as well as cess. For the purpose of wholly consumed within SEZ, taxable services have been categorized  as per classification for the purpose of export of services. All services received by Units in a SEZ which does not has any domestic operation will be considered as wholly consumed and no service tax shall be payable on such services. On common services, meant for SEZ as well as domestic operations, refund could be available on pro-ratalevisbasis on turnover.