Nikhil Rohera, Executive Director, PwC, Mumbai, analyses the provisions of the
Direct Taxes Code and their likely impact on special economic zones in India.The introduction of
investment linked
incentive as a
substitute for profit
linked incentive is a
striking shift in the
government's thinking
of granting
incentives… However,
even with this shift in
incentive methodology,
there continues to be
a lack of clarity
in taxation
of SEZ units and
developers
Special Economic Zones
had gained serious popularity
with India Inc. over
the years due to numerous
fiscal concessions like
income tax holiday, exemption
from Minimum Alternate Tax
(MAT) and Dividend Distribution
Tax (DDT) and various
incentives under other indirect
tax laws.
Clearly, the admiration of
SEZs can be validated if one
looks at the investment in
SEZs which aggregated to Rs.1.5
lakh crore as on March 31,
2010, as compared to an
investment of only Rs.2,793 crore
as on March 31, 2006. In fact,
till date, over 575 formal
approvals have already been
granted by the Board since the
introduction of the SEZ rules.
During the year 2009-10, the
export turnover of the functional
SEZs was over Rs.2.2 lakh
crore, signalling a phenomenal
growth of over 121 per cent
from the previous year. There
was no doubt that the government's
SEZ policy was justifying
its existence.
In the midst of this upward
trend, the government came
out with a drastic change in the
direct tax law with the introduction
of draft Direct Taxes
Code (DTC) late last year.
Amongst others, the DTC proposes
to make radical changes
in the age-old income tax law
of the country by seeking to
withdraw profit linked incentives
and substituting it with
investment linked incentives.
Before analysing the provisions
of the DTC, it may be
worthwhile to look at the benefits
available to SEZ developers
and units under the existing
Income Tax Act, 1961.
Developers of SEZ are currently
entitled to a 100 per cent
deduction from taxable income
for a block of 10 years out of 15
years under section 80IAB. In
addition, a developer is also
exempted from MAT and DDT
applicability under the IT Act.
Likewise, under section
10AA, a SEZ unit is entitled to
100 per cent income tax
exemption on export income
for the first five years, 50 per
cent for the next five years, and
50 per cent of the ploughed
back export profit for the subsequent
five years. Further,
such units also enjoy exemption
from MAT under section
115JB of IT Act.
Tax incentives
Under the DTC, the developers
of new projects post the DTC
would be entitled to a tax
incentive, albeit on an investment
linked basis. For the
existing projects, the DTC provides
for grandfathering of
profit-based deduction for the
unexpired period. Interestingly,
however, there is no
mention of MAT or DDT
exemption under the DTC to
the developers.
On the other hand, for new
SEZ units, there are no incentives
available for units set up
after the DTC comes into
effect. For existing units, there
were no grandfathering
provisions in the original draft
of the DTC. However, the
recently released revised discussion
paper on DTC has
given some respite by clarifying
that grandfathering provisions
similar to developers
would be available even to
existing units.
Financial impact
As one can imagine, the introduction
of investment linked
incentive as a substitute for
profit linked incentive is a
striking shift in the government's
thinking of granting
incentives. The rationale quoted
by the Ministry of Finance
for such a move is that profitlinked
deductions are distortionary
in nature as they
create an incentive to inflate
profit as well as to transfer
profits from a taxable entity to
a non-taxable one. Under the
investment linked tax incentive,
the benefit would be
available to developers in the
form of upfront deduction of
capital expenditure (at par
with the treatment of revenue
expenditure), subject to certain
exceptions. The financial
impact of shift to investmentbased
incentive may, of
course, vary from one developer
to another depending upon
the investment and income
model of the developers.
However, even with this shift
in incentive methodology,
there continues to be a lack of
clarity in taxation of SEZ units
and developers. For example,
for the developers, the draft
DTC currently provides for
grandfathering of incentives if
the developer is eligible for
deduction under the present
section 80IAB for Assessment
Year 2010-11. In essence, the
cut-off date prescribed is April
1, 2010. Now, if the DTC proposes
to come into effect from
April 1, 2011, then ideally the
cut-off date should be at par
with this date. Therefore,
developers which have become
or will become eligible to claim
deduction between April 1,
2010, and March 31, 2011,
could face some difficulty in
claiming benefits as per the
present draft of the DTC.
Again, as far as units are concerned,
the revised discussion
paper on DTC simply states
that units already operating in
SEZs will be protected for the
unexpired period. However,
there is no guidance on the
meaning of the term 'operating'
thereby leaving some
room for doubt.
Clearly, the revised incentive
methodology as well as the
open tax issues are beginning
to have a bearing on the decision
of corporates seeking to
invest in SEZ. One must not
lose sight of the fact that the
government had heavily
promoted SEZs to Indian
economy with its most prominent
'tax free' character. However,
with a lack of basic clarity
on some income tax issues is
now causing a rethink from
several corporates.
Then there is the issue of living
up to one's promises. Take,
for example, those developers
who had proceeded to make
huge investments or commitments
on the basis of income
tax benefits. They now find
that while they may continue
to get an exemption even
under the DTC, albeit under a
changed methodology, no corresponding
benefits would be
available to new units. Since
new units may not be adequately
incentivised after the
DTC comes into force, the
developers may potentially be
left with developed land and
costly infrastructure with little
or no takers. This could significantly
impact the profitability
of several developers who are
yet to complete their projects.
Withdrawal of exemptions
Another area of concern under
the DTC for SEZ developers
and units is withdrawal of DDT
and MAT exemptions. As per
the present law, developers are
provided exemption from DDT
and MAT, whereas units are
exempt from MAT. While DTC
has stated that there would be
grandfathering for existing
developers and units, surprisingly,
there is no mention of
continuation of DDT or MAT
exemption. In the event, MAT
or DDT is to be levied upon
new developers and/or new
units; this would immediately
neutralise the incentive which
these corporates had otherwise
hoped to avail. To make matters
worse, there is no clarity
on availability of MAT credit in
the DTC regime, unlike in the
IT Act.
In fact, the above income tax
uncertainties are gaining such
force that it is prompting certain
developers to opt for
de-notification of their
approved SEZs. Undoubtedly,
this is not a desirable situation
for either side and has obviously
got the Ministry of Commerce
worried given that it was
the harbinger of the SEZ policy
in the country.
One hopes that some, if not
all, of the tax uncertainties
would be resolved before the
final enactment of the DTC.
A lot will now also depend
upon the revised text of the
DTC which is likely to be
tabled before the Parliament
shortly. This clarity is, of
course, very important considering
that the country's SEZ
regime is seeking to compete
with that of China's which
already has a robust tax
incentive regime for SEZs.
There is a lot at stake not only
for India Inc. but also for the
ministries involved and it will
be interesting to see if the
government is able to quickly
craft out a win-win solution for
various stakeholders.