In a significant setback to businesses operating in special economic zones (SEZs), the Karnataka High Court (HC) in its recent judgment dismissed writ petitions filed by SEZ developers and operators challenging the constitutional validity of amendments to levy minimum alternate tax (MAT) and dividend distribution tax (DDT), introduced by the Finance Act of 2011.
Before delving into the principles enunciated by the HC, it will be useful to recapitulate the background of the SEZ law. The SEZ scheme was introduced in 2000 with an ambitious and directional change of Foreign Trade Policy to provide an internationally competitive hassle-free environment for foreign exchange earners, promoting FDI and augmenting employment opportunities in line with the successful Chinese experience. To provide impetus and instill confidence on stability of SEZ regime, the Ministry of Commerce proposed enactment of the Special Economic Zone Act, 2005, which saw a safe passage in Parliament, in June 2005.
The SEZ law proposed modifications to direct and indirect tax enactments, including exemptions from the application of MAT and DDT. The law was largely labelled as successful from an FDI and employment generation standpoint, though, criticised for institutionalisation of the land acquisition process and fiscal incentives standpoint. The fiscal giveaways were a constant source of stress between the commerce and finance ministries, given the rising tax revenue foregone leading the latter to mull over withdrawal of exemptions. The proposal to move away from all forms of profit-driven incentives and sunset clause for SEZs was evident in the first draft of the Direct Tax Code (DTC) as early as 2009. In the government, there was a growing suspicion that SEZs were set up solely as a device to exploit tax benefits and were defeating an overarching objective for infrastructure-driven zones. While most believed that government would not backtrack on tax benefits before the DTC sets in, the Finance Bill, 2011, introduced a sunset clause withdrawing exemptions for MAT and DDT.
The writ petitions were filed challenging the constitutional validity of sunset clause as being arbitrary, beyond legislative competence and violative of fundamental rights (Article 14) of the Constitution. The doctrine of promissory estoppel and legitimate expectation were invoked to buttress the petition. It was contended that an express promise for exemption from MAT and DDT incentive prompted investors to opt for the SEZ scheme and its abrupt withdrawal has led to injustice and breach of promise by government.
The HC in exercising its power of judicial review (Article 226) under the Constitution is expected to limit itself to testing the validity of the statute on the touchstone of established principles since strictly speaking, it is not the job of the judiciary to question the wisdom of law makers, unless the law is arbitrary. The HC reiterating that a law made by the Parliament can be struck down solely on grounds of legislative competence and violation of fundamental rights has given its stamp of approval for withdrawal of incentives. Dismissing the writs, the HC reasoned that as a settled principle, there could be no perpetual tax exemption and amendments were aimed at removing discrimination between SEZ and non-SEZ companies. Adverting to the application of doctrine of the promissory estoppel in matters of legislation, the HC reiterated a settled position that there is no promissory estoppel against statute.
In light of the constitutional principles given that Indian courts show restraint in invalidating a legislation, one would find little fault with the reasoning, though the HC's observation on discriminations seems to have backfired on the SEZ and is surprising.The controversy surrounding tax exemptions to SEZs seems more on stability of policy framework than on legal issues, though the SC will have a final say on legality of the amendment. A valid law made in line with the constitutional mandate cannot be struck down merely by resorting to the doctrine of promissory estoppel. As such legislature can never be precluded from exercising its legislative power by resorting to the doctrine of legitimate expectations. However, as a matter of policy, the legislature should have shown empathy and vision before withdrawal. Investors feel nervous on stability of policy and short-changed in such situations having acted on the promise of tax incentives and committed investments.
Though it's not appropriate to entirely attribute slowdown of SEZ investments to tax policy change (investments fell from average of Rs 40,000 crore up to 2010 to 176 in the first half of 2011), the timing for change in law could not have been worse. A big question to ponder over is, if fall in SEZ investment can be addressed by partly restoring MAT and DDT.
Author is chairman of BMR Advisors. Views are entirely personal. Contribution by Rahul Yadav
