Regulation glitch takes sheen off special economic zones

After withdrawal of tax sops, they have ceased to be a success story for manufacturers

Sriperumbudur in Tamil Nadu has been a nursery of sorts for the Special Economic Zones (SEZs) in India. More multinational companies have set up their manufacturing base in and around these zones in Sriperumbudur, about 40 km south of Chennai, than in any other place in the country. In a way, this town was the country's first brush with Make in India.

Ironically, Sriperumbudur has also seen more companies shutting down than in any other place. The first big name to shut shop was Motorola. That was a beginning. Nokia followed suit. So did Siemens, Ericsson, Foxconn (in its first India foray) and Flextronics.

"The sentiment died out over the last four years. There wasn't just one reason but it all summed up as complaints about the tough Indian regulatory regime," says R Sridhar, partner with Leapridge Advisers, a boutique chartered accountancy firm that walked with quite a few of these companies when they arrived in Chennai.

According to the Union commerce ministry, some of these closures happened due to the withdrawal of tax sops. For instance, exemption from levy of minimum alternate tax (MAT) was withdrawn in April 2012. Developers claimed the impact was greater since the withdrawal was made retrospective with effect from 2005.

Sridhar, however, doesn't think the winding down of MAT exemptions was the killer. Neither does Icrier, the New Delhi-based think tank which has just released a report on the role of this tax on the fortunes of SEZ.

The report prepared by Icrier for the commerce ministry has, instead, shown that after MAT was imposed on the SEZ developers and units, the pace of entrants to the zones has not flagged. The number of operational SEZs has increased from 153 to 202 in the three years since 2012 when the tax exemption was removed. The number of new units registered in this period has been 1,650. "Thus, MAT does not seem to have adversely affected the registration of units in SEZs."

Arpita Mukherjee, lead author of the Icrier report, has identified a larger problem. Even as the number of zones rose, she says the growth rate of SEZ exports "flattened out compared to the rest of the economy". It rather declined in 2013-14 when exports from the rest of the economy witnessed a healthy growth of 12 per cent year-on-year, she adds. There were several reasons for exports fall, including the downturn of the world economy. The others were delays in getting clearances from state governments (especially environment clearances), lack of interest among the units due to global slowdown and difficulties in catering to the domestic market from SEZs. And, as the performance of the zones suffered, except the commerce ministry, no government agency continued to believe in the efficacy of the SEZ plan.

  Exports from Sriperumbudur had risen steadily during the initial years, registering a growth rate of 92 per cent in 2007-08 and 121 per cent in 2009-10. "But, in subsequent years, the growth rate slowed to around 15 per cent in 2011-12; the rate was negative in 2014-15." The report was released at a time when the commerce ministry was pushing the finance ministry to restore the tax sop.

"The removal of the MAT benefit was a loss of confidence for such manufacturers. Since we cannot give an inch of land, these tax benefits were the only tangible ones the government could offer," said Guruprasad Mohapatra, joint secretary in the commerce ministry.

The Gujarat-cadre Indian Administrative Service officer heads the SEZ division in the commerce department. He argues tax arbitrage that some investors were accused of by shifting their taxable units to the zones was a phenomenon of the services sector. The argument should not be used to punish the units that set up fresh manufacturing investments in the zones, he says. In a survey among 145 units operating in the SEZs, Mukherjee and her team found 70 per cent saying the tax holiday was a 'very important' reason for locating themselves in an SEZ. More than information technology firms manufacturing units ranked the tax sop higher.

Data show that although the on-off policy towards SEZs impacted the pace of investment in the zones, it had a limited impact. The total cumulative investment in SEZs increased to Rs 297 lakh crore by 2013-14. And, annual investment in them in real terms rose consistently till 2010-11. In 2011-12, money flowed out from the zones but it quickly recovered. By 2013-14, annual investment has gone past the peak of 2009-10. As a percentage of total investment into the economy, it is still minuscule at only three per cent. Most of that investment is into infotech-based SEZs; even as Sriperumbudur has slipped, within Chennai SEZs at Tarama, Tril Info Park promoted by the Tata Group flourished. Next door DLF Info City at Porur is also very busy.

So, do the zones need a MAT set-off? Looking around Sriperumbudur, it is obvious that for manufacturers, SEZs have ceased to be a success story. Mohapatra thinks perceptions could change if MAT exemptions are revived, even if it is offered with a sunset clause. Yet, as Niti Aayog member Bibek Debroy said last week, tax exemptions are difficult to remove once they are introduced. "Everyone claims he has a good reason to get one even if the other doesn't".