Background
India introduced Special Economic Zones (SEZ) Policy in 2006 in an attempt to emulate the successful use of SEZs by China for boosting economic activity and exports. However, since then the policy has not had the desired impact. The reasons cited by critics are mainly around aspects such as lack of creation of complimentary infrastructure, flip flops in the tax regime for SEZs (sudden introduction of MAT/ introduction of sunset clause for income-tax holiday /removal of DDT exemption) and other issues like problems with land acquisition at optimal locations etc. Additionally, there has been industry representations on several topics aimed at improving the flexibility and ease of doing business in an SEZ.
In order to align the SEZ Rules, 2006 with the GST laws as well as for removal of various difficulties faced, a Committee was constituted by the Department of Commerce, Ministry of Commerce and Industry to review the SEZ Rules, 2006 and to make necessary recommendations. Committee’s recommendations were released for public comments and various representations were filed by industry for the betterment of such rules. After considering the representations, the much awaited amendments to SEZ rules were finally released on 19 September 2018. In view of the phasing out of income-tax tax holiday by March 2020, it was important to take certain steps to protect the future of SEZs. We take a look at whether these changes take care of important aspects which would improve flow of investments back into an otherwise apparently unimpressive outlook for SEZs in India.
Welcome changes
1. Minimum area
One of the welcome changes include removal of minimum area required (10 hectares) for setting up Bio-technology and Health Sector (excluding hospitals) SEZs subject to the zones meeting the minimum built-up processing area requirements as per category of city. Earlier, this relaxation was limited to IT/ ITeS SEZ only. This may propel Bio-technology and Health Sector companies moving to SEZ and it may fuel growth of exports in these sectors. Further it may help reorganisations amongst the developers in this space.
2. Merger of units
Further, merger of two or more units of the same company falling within the same SEZ is also now permitted subject to certain conditions. In this regard, the block period for calculation of positive Net Foreign Exchange Earnings (‘NFE’) of the merged unit shall be from the date of commencement of production of the older Unit and income tax exemption (section 10AA) period shall also be considered from the date of start of operation of the older Unit. Thus, while merger may reduce the effective period of tax holiday for the newly set-up SEZ unit, companies may consider the merger option if there is no significant gap in the date of set-up of two units for the purposes of meeting positive NFE, avoid multiplicity of compliances and to achieve operational flexibility. To avoid ambiguities and potential litigation, suitable amendments in the section 10AA or through an appropriate CBDT circular may follow.
In the past, few cases of expansion of a SEZ unit into a different SEZ falling under jurisdiction of same Development Commissioner were allowed based on specific facts of the case. On similar lines, perhaps merger of two units could have also been permitted with appropriate safeguards irrespective of its location provided the same falls under jurisdiction of the same Development Commissioner.
While Instruction No 89 dated 17 May 2018 had permitted merger/demergers and other specified reorganizations of SEZ developers with prior approval of Board of Approval (‘BoA’) and subject to certain conditions, the same does not find place in the amendments to SEZ rules.
Developers may seek to reorganise suitably by exercising the flexibility provided in terms of Instruction 89 dated 17 May 2018 for restructuring of the SEZs in order to accommodate expansion requests of their tenants because there would be no income-tax incentive for setting up new units after March 2020. Enabling rules would have been welcome.
3. Other positive changes
- Simplifying the procedure for claiming drawbacks whereby instead of the earlier requirement of submitting the ARE-1, exporters now need to submit only the bill of export. However, the requirement of physical endorsement by the authorized officer could have alternatively been better dealt with in today’s digital/ online world.
- A consolidated application seeking permission for setting up of a Unit and other clearances is to be made to the DC in Form F in one copy only instead of five copies earlier.
- SEZ is now permitted to procure goods from DTA for setting up and maintenance of educational institutions, hospitals, hotels and other facilities in non-processing area.
- The proposed harsh provisions relating to non-renewal of letter of approvals (‘LoA’) in case of delay in filing renewal application has been dropped and instead a mechanism of condonation of delay has been provided.
Restrictive changes
1. Computation of Net Foreign Exchange Earning (‘NFE’)
There are some restrictive amendment relates to methodology for calculation of Net Foreign Exchange Earning (‘NFE’). Following are the key changes and its repercussions on the economy:
- Exclusion of trading from income for computation of NFE - While the intention appears to discourage mis-utilization/ mis-reporting in the consumer goods sector based on the recently observed cases for sale to DTA units, the amendment would impact even genuine companies who as a part of their overall manufacturing activity also engage in complementary trading activity either to provide complete solution to client or as a part of after sales/repairs activity.
- Exclusion of Supply made to bonded warehouses or FTWZ where payment is received in foreign currency - there may be instances where the SEZ unit supplies to a bonded warehouse for subsequent export out of India. Accordingly, an exception should have been created for allowing supplies to bonded warehouses for subsequent export if consideration is received in foreign currency.
- Exclusion of Supply of goods and services to DTA where is payment received in foreign currency - the restriction is contrary to the benefit provided for allowing subcontracting on behalf of DTA units. Such a move would also hamper the idle / surplus capacity of SEZ units.
- Inclusion of indigenous procurements in costs for computation of NFE – in the absence of any clarification indigenous procurements in INR terms also appears to have been covered. The aim of the regulations is to earn foreign exchange hence indigenous / domestic procurement of inputs should not have been included in the amounts to be reduced in NFE calculation.
2. Work from home
As per earlier issued instructions, subject to certain conditions, work from home facility was available to the employees of Information Technology (IT)/ Information Technology Enabled Services (ITeS) units situated in SEZ. However, as per the amended rules, the said facility is permitted only for employees being de-capacitated, employees travelling and off-site employees. The amendment raises a question as to whether the relaxation of work from home for all employees of IT/ITeS units as per aforesaid Instructions have now been reversed. It does not seem to be the intention in light of the stated objective which is to incorporate old instructions in the Rules. Suitable clarifications may be needed.
Unmet expectations of the industry
Similar to merger of the SEZ units, SEZ developers were also expecting that merger of two SEZs owned by the same developer should be permitted for ease of operations. However, the same has not been specifically included in the amended rules. Currently such merger would have to be applied for and would be subject to a fact specific discretionary approvals of the SEZ Board of approvals.
Currently companies are facing challenges in obtaining LoA and Bond-cum-Letter of Undertaking since Unit Approval Committee (UAC) does not meet very frequently (typically once a month). Industry was expecting concrete action in terms of changing to online application and approval process. But this does not find place in the priorities of the Government.
As per one of the changes, exemptions from payment of duty or drawbacks and other concessions available to SEZ unit for the goods and services required for setting up and maintenance of factory building, now shall also be available to the contractors including subcontractors appointed by such unit. However, the scope of above facility should have been widened to the complete supply chain involved in the transaction for any infrastructure work of the SEZ to incentivize the development work. Also, currently, the facility is available only if all transactional documents mention name of the SEZ unit. Some flexibility could have been provided in relation to documentation aspects as to whom the product is billed / shipped provided it is meant for exclusive consumption by SEZ.
For removal of various difficulties, Committee had suggested that the inter-ministerial BoA be accorded powers to grant exemption, relaxation or relief to units and developers from certain rules to promote these zones. However, this welcome suggestion does not find place in the amendments. Similarly, a recommendation of establishment of a SEZ Rules Interpretation Committee to help in ease of operations has not been implemented.
Conclusion
Comprehensive amendments to SEZ rules is a welcome step to the extent to which changes are made for alignment with GST laws and certain rationalization measures towards ease of operating in SEZ and provisions allowing merger of SEZ units. However, the intent of a law should be to encourage economic activity apart from promotion of exports. And on this count the changes fall short of industry expectations. Precluding SEZ units from trading activity or making supplies to DTA (due to exclusion from NFE computation) may not have the desired effect. Work from home policy may also need further clarification.
With the phasing out of income tax holiday for SEZ Units by March, 2020 the continued availability of indirect tax benefits and regulatory freedom to SEZ units is need of the hour to protect future of SEZs.
Background
India introduced Special Economic
Zones (SEZ) Policy in 2006 in an attempt to emulate the successful
use of SEZs by China for boosting economic activity and exports.
However, since then the policy has not had the desired impact. The
reasons cited by critics are mainly around aspects such as lack of
creation of complimentary infrastructure, flip flops in the tax
regime for SEZs (sudden introduction of MAT/ introduction of sunset
clause for income-tax holiday /removal of DDT exemption) and other
issues like problems with land acquisition at optimal locations
etc. Additionally, there has been industry representations on
several topics aimed at improving the flexibility and ease of doing
business in an SEZ.
In order to align the SEZ Rules,
2006 with the GST laws as well as for removal of various
difficulties faced, a Committee was constituted by the Department
of Commerce, Ministry of Commerce and Industry to review the SEZ
Rules, 2006 and to make necessary recommendations. Committee’s
recommendations were released for public comments and various
representations were filed by industry for the betterment of such
rules. After considering the representations, the much awaited
amendments to SEZ rules were finally released on 19 September 2018.
In view of the phasing out of income-tax tax holiday by
March 2020, it was important to take certain steps to protect
the future of SEZs. We take a look at whether these changes take
care of important aspects which would improve flow of investments
back into an otherwise apparently unimpressive outlook for SEZs in
India.
Welcome
changes
1.
Minimum area
One of the welcome changes include
removal of minimum area required (10 hectares) for setting up
Bio-technology and Health Sector (excluding hospitals) SEZs subject
to the zones meeting the minimum built-up processing area
requirements as per category of city.
...
Earlier, this relaxation was limited to IT/ ITeS SEZ only. This
may propel Bio-technology and Health Sector companies moving to SEZ
and it may fuel growth of exports in these sectors. Further it may
help reorganisations amongst the developers in this
space.
2.
Merger of units
Further, merger of two or more
units of the same company falling within the same SEZ is also now
permitted subject to certain conditions. In this regard, the block
period for calculation of positive Net Foreign Exchange Earnings
(‘NFE’) of the merged unit shall be from the date of commencement
of production of the older Unit and income tax exemption (section
10AA) period shall also be considered from the date of start of
operation of the older Unit. Thus, while merger may reduce the
effective period of tax holiday for the newly set-up SEZ unit,
companies may consider the merger option if there is no significant
gap in the date of set-up of two units for the purposes of meeting
positive NFE, avoid multiplicity of compliances and to achieve
operational flexibility. To avoid ambiguities and potential
litigation, suitable amendments in the section 10AA or through an
appropriate CBDT circular may follow.
In the past, few cases of expansion of a SEZ unit into a different
SEZ falling under jurisdiction of same Development Commissioner
were allowed based on specific facts of the case. On similar lines,
perhaps merger of two units could have also been permitted with
appropriate safeguards irrespective of its location provided the
same falls under jurisdiction of the same Development
Commissioner.
While Instruction No 89 dated 17 May 2018 had permitted
merger/demergers and other specified reorganizations of SEZ
developers with prior approval of Board of Approval (‘BoA’) and
subject to certain conditions, the same does not find place in the
amendments to SEZ rules.
...
Developers may seek to reorganise
suitably by exercising the flexibility provided in terms of
Instruction 89 dated 17 May 2018 for restructuring of the SEZs in
order to accommodate expansion requests of their tenants because
there would be no income-tax incentive for setting up new units
after March 2020. Enabling rules would have been welcome.
3. Other positive
changes
- Simplifying the procedure for claiming drawbacks whereby
instead of the earlier requirement of submitting the ARE-1,
exporters now need to submit only the bill of export. However, the
requirement of physical endorsement by the authorized officer could
have alternatively been better dealt with in today’s digital/
online world.
- A consolidated application seeking permission for setting up of
a Unit and other clearances is to be made to the DC in Form F in
one copy only instead of five copies earlier.
- SEZ is now permitted to procure goods from DTA for setting up
and maintenance of educational institutions, hospitals, hotels and
other facilities in non-processing area.
- The proposed harsh provisions relating to non-renewal of letter
of approvals (‘LoA’) in case of delay in filing renewal application
has been dropped and instead a mechanism of condonation of delay
has been provided.
Restrictive
changes
1. Computation of Net
Foreign Exchange Earning (‘NFE’)
There are some restrictive
amendment relates to methodology for calculation of Net Foreign
Exchange Earning (‘NFE’). Following are the key changes and its
repercussions on the economy:
- Exclusion of trading from income for computation of NFE - While
the intention appears to discourage mis-utilization/ mis-reporting
in the consumer goods sector based on the recently observed cases
for sale to DTA units, the amendment would impact even genuine
companies who as a part of their overall manufacturing activity
also engage in complementary trading activity either to provide
complete solution to client or as a part of after sales/repairs
activity.
...
Exclusion of Supply made to bonded warehouses or FTWZ where
payment is received in foreign currency - there may be instances
where the SEZ unit supplies to a bonded warehouse for subsequent
export out of India. Accordingly, an exception should have been
created for allowing supplies to bonded warehouses for subsequent
export if consideration is received in foreign currency.
Exclusion of Supply of goods and services to DTA where is
payment received in foreign currency - the restriction is contrary
to the benefit provided for allowing subcontracting on behalf of
DTA units. Such a move would also hamper the idle / surplus
capacity of SEZ units.
Inclusion of indigenous procurements in costs for computation
of NFE – in the absence of any clarification indigenous
procurements in INR terms also appears to have been covered.
The aim of the regulations is to earn foreign exchange hence
indigenous / domestic procurement of inputs should not have been
included in the amounts to be reduced in NFE
calculation.
2. Work
from home
As per earlier issued instructions,
subject to certain conditions, work from home facility was
available to the employees of Information Technology (IT)/
Information Technology Enabled Services (ITeS) units situated in
SEZ. However, as per the amended rules, the said facility is
permitted only for employees being de-capacitated, employees
travelling and off-site employees. The amendment raises a question
as to whether the relaxation of work from home for all employees of
IT/ITeS units as per aforesaid Instructions have now been reversed.
It does not seem to be the intention in light of the stated
objective which is to incorporate old instructions in the
Rules.
...
Suitable clarifications may be needed.
Unmet expectations of the
industry
Similar to merger of the SEZ units,
SEZ developers were also expecting that merger of two SEZs owned by
the same developer should be permitted for ease of operations.
However, the same has not been specifically included in the amended
rules. Currently such merger would have to be applied for and would
be subject to a fact specific discretionary approvals of the SEZ
Board of approvals.
Currently companies are facing
challenges in obtaining LoA and Bond-cum-Letter of Undertaking
since Unit Approval Committee (UAC) does not meet very frequently
(typically once a month). Industry was expecting concrete action in
terms of changing to online application and approval process. But
this does not find place in the priorities of the Government.
As per one of the changes,
exemptions from payment of duty or drawbacks and other concessions
available to SEZ unit for the goods and services required for
setting up and maintenance of factory building, now shall also be
available to the contractors including subcontractors appointed by
such unit. However, the scope of above facility should have
been widened to the complete supply chain involved in the
transaction for any infrastructure work of the SEZ to incentivize
the development work. Also, currently, the facility is
available only if all transactional documents mention name of the
SEZ unit. Some flexibility could have been provided in relation to
documentation aspects as to whom the product is billed / shipped
provided it is meant for exclusive consumption by SEZ.
For removal of various difficulties, Committee had suggested that
the inter-ministerial BoA be accorded powers to grant exemption,
relaxation or relief to units and developers from certain rules to
promote these zones.
...
However, this welcome suggestion does not find place in the
amendments. Similarly, a recommendation of establishment of a SEZ
Rules Interpretation Committee to help in ease of operations has
not been implemented.
Conclusion
Comprehensive amendments to SEZ rules is a welcome step to the
extent to which changes are made for alignment with GST laws and
certain rationalization measures towards ease of operating in SEZ
and provisions allowing merger of SEZ units. However, the
intent of a law should be to encourage economic activity apart from
promotion of exports. And on this count the changes fall short of
industry expectations. Precluding SEZ units from trading activity
or making supplies to DTA (due to exclusion from NFE computation)
may not have the desired effect. Work from home policy may also
need further clarification.
With the phasing out of income tax holiday for SEZ Units by March,
2020 the continued availability of indirect tax benefits and
regulatory freedom to SEZ units is need of the hour to protect
future of SEZs.