The Hindu Business Line : Code blow for SEZs

It was with much fanfare that the Government launched the scheme for development of Special Economic Zones (SEZs) in 2005 with the object of accelerating economic development and promoting exports in certain special areas carved out for special treatment.

The Income-Tax Act was amended and Section 10A(1A) was inserted providing for 100 per cent exemption on export profits for five consecutive years, and thereafter 50 per cent exemption. Section 10AA was also inserted providing for similar exemption of profits in respect of an assessee being an entrepreneur referred to in Section 2 of the SEZ Act, 2005 from his unit.

Controversies arose about the scheme itself and critics were not wanting to suggest that the huge loss of revenue in terms of both direct and indirect taxes was not warranted and the exemption was distortionary.

At the same time, the law got clarified. SEZ developers were given the benefit of a 10-year, profit-based income-tax holiday. They were also exempted from Minimum Alternative Tax (MAT) and Dividend Distribution Tax (DDT). Exemption was available for 15 years.

Twelfth Schedule

The Direct Taxes Code provides that the profits of the business of developing SEZs shall be the gross incomes reduced by business expenditure under Sections 33 and 34. Careful scrutiny shows that no exemption is granted in respect of the gross assets tax sought to be introduced in lieu of MAT.

SEZs will henceforth be liable for 2 per cent gross assets tax even when they do not make profits. It is well known that the gestation periods for SEZ projects are long and profits will not be generated in the foreseeable future. Under the DTC, SEZ project is not recognised as an infrastructure project and no concession is allowed for payment of MAT.

It is well known that the DTC has altered profit-based incentives into investment-based deductions. Gross receipts of the SEZ will be reduced by capital expenditure and also revenue expenditure. In the first few years, there will be no tax liability. When the capital expenditure is absorbed in due course, and receipts exceed expenses, there will be tax liability. In any event, MAT will be applied, profit or loss.

Efficient units will be able to make profits sooner than later even before the 10-year period allowed under Section 80IAB of the I-T Act, 1961. They will be liable for 25 per cent corporate tax. There is no safe harbour rule in this regard. Those who have made large investment decisions in the hope of setting up a tax-free enclave in SEZ are in for a big disappointment.

Under the existing law, units in SEZ are entitled to 100 per cent tax exemption on export profits in the first five years, 50 per cent on export profits for the next five years and up to 50 per cent exemption on reinvested profits for the last five years. Profits of developers will be exempt 100 per cent for 10 years.

The Twelfth Schedule to the DTC will allow developers to recover capital and revenue expenditure only. Units in SEZs will be taxed on profits. The DTC will lead to a total switch over from profit-linked incentives to investment-linked incentives. This is not intended under the SEZ Act, 2005.

The SEZ Act was put in place in 2005 and Rules were promulgated in February 2006. There has been a surge in investments after the Act and Rules were promulgated. The Discussion Paper waxes eloquent on the distortionary effects of profit-based incentive and points out that such incentive is regressive in nature.

Since profit is the basis for exemption, there is no incentive for investment and upgradation during the period of tax holiday. Significant loss of revenue takes place. The Twelfth Schedule is silent on the promises made under the SEZ Act.

Promissory Estoppel

Can it be argued that the Government cannot go back on the promises made under the SEZ Act? The law is well settled that there can be no estoppel against any statute. Even though a concession is extended for a fixed period, the same can be withdrawn in public interest (STO vs Shree Durga Mills 1998 SCC 572). Public interest will override any consideration of private loss or gain. Government is free to change its stand and withdraw the exemption already granted.

The Kelkar Task Force has observed that the promise to confer tax benefits under Sections 10A, 10B, 80IA and 80IB for specified periods is by the legislature and there is no promissory estoppel either against the statute or against the legislature itself.

The Task Force had specifically recommended elimination of these provisions with immediate effect. It will be interesting to see whether the Commerce Ministry agrees with the provisions formulated under the DTC.

(The author is a former Chief Commissioner of Income-Tax.)

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