Tax sops to SEZs: Storm in a teacup?

DIRECT TAX

Lately, policy-makers and corporate bigwigs have been at the helm of hullabaloo in the wake of an evolving law and controversies surrounding it. This pertains to Special Economic Zones, a concept which traces its origin to countries like China and the UAE.

China's accomplishment and India's desire to replicate: China was an emulatory success story for Late Industry and Commerce Minister Murasoli Maran, who first championed the cause of SEZs for India Inc. Consequently, the concept made a formal entry via the EXIM policy and progressively climbed up the priority charts of successive governments.

In 2001, the share of the five SEZs in China's total exports was 10.4 per cent, in contrast to Indian SEZs' over 4 per cent. An overwhelming emphasis in China's SEZ enclaves was on infrastructure, simplified procedures and cost-effective environment.

China's astounding growth over the last three decades is largely attributed to SEZs, which contribute 45 per cent of total Chinese exports. A crucial factor has been the chemistry between China and Hong Kong, China being the manufacturing base and Hong Kong a trading hub. Simplified Customs regime provided tremendous operational ease. Low wage cost, flexible labour laws and lower compliance costs added to the advantage.

Tax sops promote investment?: Interestingly, the tax incentives package in India is a shade better than China. China provides tax sops up to 3 years. Generally, a concessional tax rate of 15 per cent (as against 33 per cent) is available for SEZs.

Our tax incentives may not be in line with the recommendations of the successive tax reforms committees, particularly the Chelliah Committee and the Kelkar Committee. The Kelkar panel was in favour of pruning and phasing out tax exemptions, while bringing down the overall tax rates. But it is silent on tax holidays to SEZs!

The Great Indian SEZ gold rush: SEZs were introduced in 2000 as part of the Foreign Trade Policy. Much of the ground work was done by the BJP-led coalition.

However, the current regime gave the requisite legislative tooth on June 23, 2005, by promulgating the Special Economic Zones Act, 2005. The BoA is expected to consider over 250 proposals with projected investment of $80 billion and employment potential of 1.8 million, according to Commerce Minister Kamal Nath.

Face-off between ministries: Tax holiday provisions provide for a 15-year staggered tax holiday to units within the SEZs and complete 10-year holiday to developers of SEZs.

The tax holiday provisions are similar to those provided to free trade zones, software technology parks etc. The obvious question is whether the SEZ regime implies backdoor entry for continuing with tax holidays, which otherwise expire in March 2009.

The tussle between the commerce and finance ministries, with one aggressively promoting and encouraging the SEZ scheme and the other against tax sops, stands to be resolved. The joint point statement by both ministers last week, presumably at the behest of the PM, is certainly a sigh of relief to project developers.

There were claims of a whopping $40 billion revenue losses by the finance minister, countered by the commerce minister's claim that SEZs would lead to a net tax gain of $25 billion by 2010. Lately, assurances from the North Block that SEZs shall not be viewed adversely have been welcomed.

Flight to greener pastures: The finance ministry's concerns stem from a probable arbitrage opportunity for existing businesses to relocate to SEZs. With the tax holiday sunset date approaching, it makes business sense either to develop a new SEZ or get tax holidays.

The SEZ tax holiday provision does not mirror provisions as applicable to STPs in relation to reconstruction of an existing business unit. Undoubtedly, tax holiday to SEZ is unclear and leaves room for liberal interpretations.

Reconstruction provisions impose rigid tests for tax holidays. The tests provide that the business should not have been formed by the splitting up or reconstruction of an existing business and by use of old plant or machinery previously used for any purpose.

It leads me to believe that migration of an existing business into an SEZ is possible. However, the intent of policy-makers to curb the misuse of the liberal provisions was furthered by amendments to the SEZ rules by introducing restrictive clauses on transfer of second-hand capital goods.

The current position is that at the approval stage, a unit shall be barred from bringing in second-hand capital goods. But the law is silent on transfer of existing contracts and employees. Hence the position is fraught with doubt on what exactly is the sanctity of a new unit to claim tax holiday. This is certainly unhealthy and does not promote the cause of transparency in fiscal legislation to promote investment. This also leaves the investor community bewildered.

Why the storm around tax holidays: I see the guidelines for getting approvals becoming progressively stringent. Proposals making a case for meaningful infrastructural development, employment generation and capital investment are likely to be approved. The government shall allow greater operational freedom to development commissioners.

The question that I wonder with a consultant's mind (and a businessman's heart) is whether in the wake of such rigorous checks and balances, will bonafide investors be subject to uncertainty?

The SEZ Act and its learned propounders propagate "single window clearance" as one of the prize facilities. Why then does this single window not guarantee to a bonafide investor the right to avail tax sops? Why is an enterprise looked upon with doubt and suspicion when it comes to tax benefits to which it is entitled?

Unlike in an STP situation, which is part of government's EXIM policy, SEZ is a law legislated by Parliament. I am not advocating that the Income-Tax Act should be ignored in so far as SEZs are concerned; it, however, needs to be streamlined to ensure that the policy objectives are met.

(Views expressed herein are personal views of the author)