Proposed DESH law aims to grant SEZs greater flexibility, but will it work?

Some experts see significant positives, other believe problems associated with older policy will persist

The government is attempting to overhaul the special economic zone (SEZ) policy by expanding the ambit of these exclusive zones to make them WTO-compliant and perform roles that go beyond export-orientation.

The new draft Development of Enterprise and Service Hubs (DESH) Bill seeks to set up ‘development hubs’ for promoting economic activity, generating employment, integrating with global supply and value chains and maintaining manufacturing and export competitiveness, developing infrastructure facilities, promoting investments, including in research and development (R&D).

The Bill, expected to be tabled in Parliament in the upcoming monsoon session, does not ignore exports. Such hubs will also include existing SEZs.

The proposed legislation, drafted by the commerce and industry ministry, also seeks to emphasise on promoting not only manufacturing but trading and services too. In SEZs, only specified services such as IT, ITeS are allowed. But now all services in alignment with GST laws will be allowed, which include liaison offices as well.

The Bill, which is the outcome of proposals made by an expert committee headed by Bharat Forge Chairman Baba Kalyani, does not seek to make it mandatory for the SEZs to have positive net foreign exchange earnings. It seeks to focus on single-window clearances. There will also not be any requirement to have specific demarcation for trading and warehousing activities, according to the draft Bill.

While there won't be any direct tax benefits as was given to SEZs which ran into trouble with WTO norms, some indirect tax benefits would be there. As cited above, these hubs will not be solely for exports, unlike the current SEZs. They would be allowed to sell in the domestic market with duties to be paid only on imported raw materials and inputs instead of final products.

The SEZ Act was passed by Parliament in 2005, with export promotion as a key objective. The aim was to develop these zones as strategic instruments to encourage investments, create employment opportunities and build quality infrastructure.

Economic regulations in such zones were set up in a way to attract foreign direct investment. Therefore, businesses in SEZs were given several economic advantages such as lower tariff and tax incentives.

However, several direct tax benefits provided to SEZs were withdrawn gradually. This resulted in lower investments due to lack of policy stability.

Therefore, the government decided to come up with a new law earlier this year, to replace the existing Act.

These development hubs can be set up by the Centre or state, or jointly by them or by any manufacturer of goods and services. After identifying the area, anyone who intends to set up such a hub will have to make an online proposal to the relevant regional board.

Experts said that in the current shape and form, it is difficult to gauge whether or not the proposed new law will be able to reduce the time taken to set up units in these hubs. “It takes roughly 4-6 months to set up a unit in an SEZ. It is difficult to say how much time it will take now till we see the rules,” an expert said.

They also said the government has realised that with increasing skilled manpower costs, there is a need to create low-cost manufacturing hubs and ensure India is price competitive in the international market. Therefore such hubs will be given some fiscal incentives, such as exemption from paying GST, customs duties and certain other levies. That said, such incentives continue to exist in the current regime as well.

A key differentiator between new and the old law is that under DESH, hubs will allow units to make optimal use of their idle infrastructure by delivering services to customers in India instead of hust focusing on exports, as was the case earlier. This is also something that industry has been demanding over the past decade or so.

Former chief statistician Pronab Sen said SEZs were for specific purposes, namely, exports and hence a package was given to them.

The question now is how these proposed hubs will be substantively different from regular industrial areas, Sen said.

"We have had industrial areas for donkey's years," he pointed out.

He added that industrial zones have certainly contributed to manufacturing but not as much as has been expected.

To a question on whether larger policy issues such as land acquisition would continue to hamper setting up of these hubs, Sen said this is a valid concern.

Also, these hubs might run into problems of the kind brought on by the earlier SEZ policy. For instance, there were court judgments that held that the government cannot have a differential labour policy for these zones, Sen said.

"So long as it is within the territorial limit of India, labour policies will apply to whatever name you call these zones. These were problems in SEZs as well. The government said they should not be treated as within the territorial boundary of India, courts said nothing doing. You can give whatever relaxations you like in terms of government policies, not in terms of labour laws. The labour problem will not get addressed by this," Sen pointed out.

WIll the proposed four labour codes help in this regard? For instance, the code on industrial relations will raise the requirement to over 300 workers from the current 100, for establishments to comply with these codes. This means establishments with up to 300 workers can go for hire and fire. Already, 12 states have implemented this by reforming their own labour laws.

To this, Sen wondered if 300 is a big enough number. "It depends on the kind of economic activities you are thinking of. If you are thinking about highly automotive, then 300 may be okay. But that is not what you want. What you want are large units employing lots of people. If you think about a garment factory, we are talking about 3,000-5,000 people," he said.

As cited above, the draft seeks to also emphasise on trading and services to overcome the idle capacity of the zone and better utilisation of area.

Rajiv Chugh, tax partner and leader for regulatory services, EY India, expected flexibility to services companies to go for a hybrid way of work -- work from home or from office -- under the rules.

He said the past two years have seen the  working environment evolve with service-sector companies reporting high productivity with employees working from home.

This has obviously resulted in reduced infrastructure structure requirements, since expansion can be accommodated by having employees work from anywhere, he said.

"In this backdrop, stakeholders are looking at the proposed DESH Act to allow hybrid way of working and fungibility of processing area. This will directly support developers of the zone to have exempt and non-exempt units co-exist,” said Chugh.

Harpreet Singh, partner indirect taxes at KPMG, said there are some significant positives in the draft DESH Bill vis-à-vis the current SEZ laws.

"Absence of the condition to have positive net foreign exchange earnings, inclusion of liaison office, no restriction for foreign exchange payments for purchases from DTA, aligning the definition of services with GST laws, not defining manufacture etc. are some of the key aspects that can provide much needed impetus to domestic manufacturing, ” he said.

When it was pointed out that many SEZs turned out to be real estate scams and the proposed Bill may reduce those irregularities, Sen said the situation would worsen in these hubs because at least there were limitations in terms of what one could do in the SEZ policy. 

SEZ Factsheet:

425: Number of formal approvals as on June 17, 2022

375: Number of notified SEZs as on June 17, 2022 

35: Number of in-principle approvals as on June 17, 2022 

268: The number of perational SEZs as on March 3, 2022 

101: The number of EZs denotified between April, 2008 and February, 2020 

Rs 6.46 trillion: Incremental investment brought in by SEZs between February, 2006 and March, 2022 

2.6 million persons: Incremental employment provided by SEZs between February, 2006 and March, 2022

Exports in first two months of 2022-23: $23.33 billion, representing growth of 30 per cent yoy.