Reviving The Indian SEZs

SEZs are industrial enclaves entitled with fiscal benefits and located within a country's  sovereign borders and have the objective of increasing balance of trade and attract newer inward-investments into the country along with creation of newer jobs. SEZ, as a concept, started in mid-1950s in countries with larger presence in industrial sectors. Ireland was one of the earliest adopters in setting up SEZ.

The concept of labour-arbitrage which started as a competitive advantage for nations to compete with each other for global trade, saw the 1970s develop labour-intensive manufacturing-focused SEZs.. China opened up its first SEZ in 1979 in Shenzhen, and thereafter took huge strides in institutionalizing mega-SEZs as economic power-houses.

India & its SEZs
Prior to the concept of SEZ, India relied on the Export Processing Zones (EPZs), which did not make a deep impact on foreign investors. The SEZ Act 2005 enabled private participation for infrastructure development and development of export-oriented hubs for products & services with large employment potential. The SEZ Act 2005 provided for Direct & Indirect tax exemptions by the Central Govt. and SEZ Policies of States gave concessions / waivers from the levies of State Govt.

For manufacturing SEZs, plotted development (including development of infrastructure of utilities) is necessary and for service-sector SEZs, ready-made office spaces are mandatory structures. The more popular SEZ category in India has been the service sector as fully-furnished  office premises with 24 x 7 power supply for IT units, plots with utilities (power, water, sewage, gas & fuel facilities, telecommunications, ETPs, etc.) were offered. Effectively, the tenant-IT/ITES units had negligible investment in capital assets, which suited their operations.

An interesting labour related aspect is that inside SEZs, no labour unions are allowed. That’s been a big positive for its users. Despite having skilled and educated workforce,  states insisting for trade unions have lost out on IT / ITES talent employment generation.

SEZs across India have attracted investments of over Rs 5.2 lakh crores so far and have current capacity utilisation of just over 50%; using this capacity, they employ nearly 20 lakh people (of which IT/ITES SEZs employ 80% of the head count). There are currently 355 SEZs of which 70% are IT / ITES focused. Not all of these IT / ITES units are focused in service exports. Many of these export products – IT software, electronic items, assembled parts such as Printed Circuit Boards, etc. Infact, SEZ’s account for over 26% the total exports of the country and the export value is over Rs 7 lakh crores (Fiscal 2019).

SEZ - policy disconnects 
The levy of MAT and withdrawal of DDT exemption in 2012 was surely a shock that the SEZ developers faced. Another taxation issue that cropped up was the sudden introduction of the sunset date for termination of Direct Taxation benefits for SEZ developers in the year 2017 and SEZ units in the year 2020. This probably stemmed from the intention to implement the Direct Tax Code (DTC) and the consequent move to withdraw all concessions / rebates granted to entities under Income Tax Act (ITA) 1961. This not only hurt the developer community who had invested into SEZs but now pushes the envelope for the SEZ units, especially with the further expected economic slowdown and the need to be ultra-competitive to gain / hold onto global export businesses with competitive pricing. Also from global trade perspective, this move of withdrawal of taxation benefits from services SEZs has not been taken well and the complaints about it have been upheld in WTO.

In the past few years, many of the ASEAN countries had tweaked their taxation & fiscal policies to attract global players to invest into their SEZs and have also worked on developmental set of their skilling initiatives. Consequently Indian SEZs have lost some of their competitive advantages globally and hence need to have fresher policies. Many units also migrated to other destinations including Philippines, Vietnam, Thailand, Malaysia, China with local government support, taxation benefits. (For eg, SEZs in Indonesia & Costa Rica enjoy Income Tax exemption for 12 years. SEZs in Thailand are exempted from Corporate Tax for 13 years.)

This loss of business for Indian SEZs results in reduced forex earnings and forced-reduction in head count. Further fall in demand could lead to unutilised land and / or unoccupied built-up premises within SEZs. Exit of existing clients would further aggravate the issue of vacancy in SEZs thereby putting the existing investments in peril. These idle assets could create stressed-assets within the economy and increase the woes of the Banking sector. For a country that believes in climate change and its severity, the exit of IT/ITES businesses to other countries would also mean transfer of non-polluting industry from our country.

Many of these crucial elements have also been documented by the Baba Kalyani led committee, constituted by the Ministry of Commerce and Industry, to study the existing SEZ policy. This committee had submitted its recommendations in November 2018.

Baba Kalyani committee report - In brief
It had been set up with a broad objective to evaluate the SEZ policy towards making it WTO-compatible and to bring in global best practices to maximise capacity utilisation and to maximise  potential output of the SEZs. The committee had a key suggestion to move the SEZ philosophy from export-oriented to broad-based Employment and Economic Growth approach (Employment and Economic Enclaves-3Es).

The critical recommendations of this committee included :

Extension of sunset  date of 31/03/2020 and retaining taxation benefits as per SEZ Act 2005
Formulation of separate rules and procedures for manufacturing and service SEZs

Infrastructure status to SEZs to improve access to finance and to enable long-term borrowing
Enhance competitiveness by enabling ecosystem development by funding high-speed multi-modal connectivity, business services, and utility infrastructure

Procedural relaxations for developers and tenants to improve operational and exit issues
Broad-banding definition of services/allowing multiple services to come together

The flexibility of long-term lease for developers and tenants

Dispute resolution through arbitration and commercial courts

The SEZs in India have proved to be a success story for the IT/ITES industry. Given the prowess of Indian workforce in the Service Sector, it is imperative to continue the Government support for these hubs in terms of continued tax exemptions and fiscal concessions. To encourage growth of Services SEZs enabling generation of massive job opportunities to the huge educated population of the country, flexibilities in operations and easement of procedures in vital by ensuring necessary amendments to the existing SEZ policy. Implementing the suggestions made above would provide the necessary boost for economic recovery in the current recessionary scenario.

In this context, some of the suggested policy tweaks are:

Fiscal Incentives
Considering the sensitivity of “Employment Generation” and “Forex Earnings”,  it is imperative to extend the sunset date for SEZ units. ( E.g. SEZs created an employment of approx. 19 lakhs in 12 years and the further potential entails additional 19 lakhs in 6-8 years.)

Extension of direct tax benefit to “Services” have neither been objected to by WTO member countries nor violate international agreements. Hence, continuation of income tax benefit on export revenue of “Services SEZs” need to be considered.

IT SEZs be given similar features as granted to GIFT SEZ; with a consideration that, both these SEZs operate through the ‘web-enabled’ interface and render services (Financial or IT) to their clients. Here the feature related to tax benefits. MAT is levied @ 9% to IFSC entities (GIFT project) and @ 20% for other SEZ units.

Ease of Business
Permission for Domestic units to operate from Non-Processing Area without availing indirect tax exemptions (industrial activity in addition to permissible social activities)

Change in Net Foreign Exchange (NFE) criterion of units for occupying office space within the BUA of Processing Area and factoring-in the investment and employment parameters to determine qualification

Flexibility of utilization of Non-Processing Area (dual usage) by developers for creation of social infrastructure by removing existing usage restrictions (development to be governed by locational requirements).

Broad-banding the services definition (Rule 76 of SEZ Rules 2006) to include all the services permitted under GST Regulation.

Permission for reverse job-work. (Sub-contracting activity on behalf of domestic units for sale in domestic market without tax benefits)

Simplification of Exit Process is needed. Currently the SEZ denotification has to be approved by multiple entities and takes over 10 months to complete.

Implementing the suggestions made above would provide the necessary boost for economic recovery in the current recessionary scenario and to sustain the concept of SEZ and to rebuild it to its potential.