Conditional sales from SEZs to domestic market being expected in new Bill

Representational Image | Worker constucting a manufacturing unit in an SEZ in Gujarat

A new Bill, drafted to revamp India's struggling Special Economic Zones (SEZs), may allow conditional sales to the domestic market, lower taxes and partial denotification, sources said. The government is set to introduce the Development of Enterprise and Service Hubs (DESH) Bill in the ongoing monsoon session, it is learnt.

SEZs are notified geographic areas with separate business and trade laws. The government had pushed for an SEZ-led manufacturing development for nearly two decades to improve balance of trade, attract investments and create mass manufacturing jobs.

Financial incentives are granted to those setting up SEZs and cover a wider gamut of benefits—across taxation, customs and labour regulations—for investors.

However, the Commerce Department has pointed out that many SEZs are also operating at sub-par levels with the number of current units being much lower than the original expectation.

Case in point: Of the 370 notified SEZs, only 234 are operational, according to official statistics.

Meanwhile, SEZ exports fell to $102.3 billion in FY21, from $112.3 billion in FY20. Through DESH, the government hopes to revitalise these SEZs into mega manufacturing and services hubs, as well as spread out new development hubs across the country in a more even manner.

It also plans to change customs rules, slash taxes and liberalise rules to denotify unproductive or unoccupied SEZ lands, sources said.

Domestic sales

The updated rules are expected to allow the long-standing proposal from the Commerce Department that duties be reduced when goods are cleared by SEZs to domestic areas, considering that the same goods could be imported through the free trade agreement (FTA) route at nil rate, sources said.

Earlier, the department had proposed allowing SEZ units to sell goods in the domestic market at the lowest import duties.

According to the SEZ Act of 2005, supplies made from an SEZ to a domestic tariff area (DTA) should be treated as imports into India, and, hence, customs duties are to be paid by the importer on clearance of the goods.

This is because an SEZ is a specifically delineated duty-free enclave and is a deemed foreign territory for the purpose of trade operations, duties and tariffs. Currently, apart from customs duty, integrated goods and services tax (IGST) are paid by manufacturers in an SEZ when they sell to domestic players.

Despite this, out of the total export production of SEZs, the share of domestic sales has risen to a high of 21 percent in FY22, up from 18 percent in FY21 and 12 percent in FY20.

However, the Revenue Department had continued to reiterate its stand that permitting SEZs to sell goods in DTAs at zero duty—the rate at which most products are imported from India’s FTA partners—will cause significant revenue losses to the government, sources said.

Also, it will provide an unfair duty advantage to SEZ units as compared to domestic manufacturers based outside such enclaves, it had said.

Lower tax

Last year, the government adopted a sunset clause for SEZs, saying only those units that started production on or before June 30, 2020, would be granted a phased income-tax holiday for 15 years. Considering the impact of COVID-19 and lockdown restrictions across India, the government has extended the timeline for newly established units in SEZs to claim tax incentives to September 30, 2020, provided the letter of approval has been issued on or before March 31, 2020.

Back in 2019, the government had cut the minimum alternate tax (MAT) to 15 percent from 18.5 percent earlier, while also slashing the corporation tax rate to 22 percent from 30 percent. However, the Central Board of Direct Taxes (CBDT) also issued a detailed circular that MAT credit will not be available to a company that opts for a lower corporation tax rate.

As a result, SEZ developers have continued to push for an exemption from MAT, arguing that the provisions make SEZs an unfavourable investment sector. This is being strongly considered in DESH, officials said.

Other measures

Officials said plans were also afoot to identify which SEZs can be denotified. Last year, the government informed Parliament that between 2008 and March 2021 there had been 101 instances when SEZs were de-notified. The reasons given for these requests for de-notification include poor market response, lack of demand for space and change in the fiscal incentive regime for SEZs.

Approving job work for sectors like gems and jewellery and reviewing the minimum area requirement are also being planned. SEZ units are currently allowed to undertake job work for export on behalf of DTA units in certain sectors. This is subject to the condition that the finished goods are exported directly from SEZ units and export documents are made in the name of the DTA unit.