Impact of Direct Tax Code on Special Economic Zones

Hey,

Today, I decided to take a break from normal accounting and decided to put forward a research on taxation. As many of us are aware that in a short period of time Direct Tax Code will be implemented instead of Income Tax Act,1956, I decided to put forward a research how such new Code will affect the Special Economic Zones.

Now, we all know Special Economic Zones are treated most times for the places situated out side India for Tax purposes. Be it Income Tax or Customs.

Income Tax Act:

Income Tax incentives for SEZ units

Tax exemption for SEZ units engaged in manufacture or providing services- A new section 10AA has been introduced in the IT Act by SEZ Act, 2005 which provides that the units in SEZ which start manufacturing or producing articles/ things or which start providing services on or after April 1, 2005 will be eligible for a deduction of 100 percent of export profits for the first five years from the year in which such manufacture/ provision of services commences and 50 percent of the export profits for the next five years. Further, for the next five years a deduction shall be allowed of upto 50 percent of the profit as is debited to the profit and loss account and credited to the Special Economic Zone Reinvestment Reserve Account (subject to conditions).

       Tax exemption for Offshore Banking units in SEZ- A deduction in respect of certain incomes would be allowed under the new section 80LA, to scheduled banks or foreign banks having an Offshore Banking unit in SEZ or to a unit of IFSC. The deduction shall be for 100 percent of income for five consecutive years beginning from the year in which permission/ registration has been obtained under the Banking Regulation Act or the SEBI Act or any other relevant law and 50 percent of income for next five years.

       Interest received by non-residents and not ordinary residents on deposits made with an Offshore Banking Unit on or after April 1, 2005 shall be exempt from tax.

       Exemption from Minimum Alternate Tax ("MAT")- Income arising or accruing on or after April 1, 2005 from any business carried on, or services rendered by SEZ unit would be exempt from MAT under section 115JB.

       Exemption from Capital Gains- Capital gains arising on transfer of assets (machinery, plant, building, land or any rights in buildings or land) on shifting of the industrial undertaking from an urban area to any SEZ would be exempt from capital gains tax. The exemption would be allowable if within one year before or three years after such transfer:

       Machinery or plant is purchased for the purposes of business of industrial undertaking in SEZ by the assessee.

       Assessee has acquired land or building or has constructed building for the purposes of business in SEZ.

       The original assets are shifted and establishment of the industrial undertaking is transferred to SEZ; and other specified expenses are incurred.

       The amount of exemption for capital gains would be restricted to the costs and expenses incurred in relation to all or any of the purposes mentioned above.

 Income Tax incentives for SEZ Developer

Tax holiday for SEZ developers- Section 80-IAB of  IT Act gives a deduction of 100 percent of profits derived from the business of developing SEZ (notified on or after April 1, 2005) would be available to developer of SEZ for any 10 consecutive years out of 15 years beginning from the year in which SEZ has been notified.

       Exemption under section 10(23G) that was available to infrastructure capital fund or a cooperative bank on interest and long term capital gains investment had been extended to investment made by SEZ developers qualifying for tax holiday under section 80-IAB. However, this exemption has been withdrawn with effect from assessment year 2007-08.

       Exemption from Dividend Distribution Tax ("DDT")- No DDT would be payable by a developer of SEZ on dividend declared, distributed or paid on or after April 1, 2005 out of current income.

       Exemption from MAT- Any income earned on or after April 1, 2005 by a SEZ developer would be exempt from MAT under section 115JB of the Act.

        

Now What DTC proposes?

DTC has proposed to bring a  shift in granting tax incentives to SEZ developers.DTC proposed to substitute the word Profit Based incentive prevalent under the existing provisions of the act with Expenditure/Investment based deductions for SEZs notified on or after April 1,2012.It has also provided for grandfathering of existing profit based deduction to SEZs notified on or after March 31,2012 for unexpired deduction period, However irrespective of the date of notification of their SEZs.SEZ developers will no longer enjoy the exemption from MAT liability and DDT under DTC.

SEZs notified on or before March 31, 2012:

1.    Profit based deductions under Sec.80 IAB of Income Tax Act would be grandfathered under DTC for the balance unexpired period out of prescribed 10 years.

2.    For computation of eligible profit, the methodology prescribed under schedule 12 of DTC Act is applicable.

3.    Capital expenditure as well as expenditure incurred prior to the commencement of business shall not be allowed.

4.    MAT and DDT exemptions shall not be allowed.

5.    Conditions under Sec.80 IAB for availing tax deductions shall continue to be applicable.

6.    SEZs notified on or after April1, 2012, SEZ developers shall be eligible for claiming Expenditure/Investment based deduction.

7.    Profits shall be gross earning less business expenditure in accordance with Schedule 12 of DTC.

8.    Capital Expenditure and expenditure incurred prior to commencement of business shall be allowable as business expenditure, except expenditure incurred on purchase/Acquisition of any land, or long term lease, goodwill, or financial instrument.

The total SEZ exports in the first quarter of this fiscal year (2010-11) has been at Rs. 58,685.46 crore which shows a growth of 68 percent over the corresponding year. The export in SEZ in the year 2009-10 has been at Rs. 2,20,711.39 crore which shows a growth of 121.40 percent.
As on June 30, an investment of Rs. 1,66,526 crore has been made in SEZs and direct employment for 5,50,323 persons have been generated.

• 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

On the other hand, for new SEZ units, there are no incentives available for units set up after the DTC comes into effect.

• Financial impact

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 profit linked 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 investment based incentive 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. The government is providing with the Income-Tax exemption to those SEZ units which will be operational by March 31, 2014  as provided in the present SEZ Act. And, the units which will become operational after March 2014 they are being provided with the investment-linked exemptions, it is difficult because the time period which has been provided to the SEZ units is insufficient. The units which will be operational by 2014 (which means the SEZ units which will become operational after 2012) they are getting two years time. However, a SEZ developer gets three years time for developing the SEZ units as per the SEZ Act and it can also be extended further.

Therefore, developers which have become or will become eligible to claim deduction between this period 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.
  
  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.

• If tax benefits are withdrawn, no new unit will come up in SEZs, adding that developers will lose huge investments made in land and infrastructure if companies do not set up units.

• From being tax free, to suddenly now be taxed at around 20 to 21% would surely hurt the smaller SEZs.

Conclusion:

It has been clear from above discussions that

The New Direct Tax Code, the survey shows overwhelming support for the code, with over three-fourth of respondents saying the code is simple and easy to understand, it will avoid litigation. The proposed reduction of tax rates, the end of incentives are other positives, although 72% respondents fear the new rules could lead to witch hunting, while MNC respondents are unhappy with the treaty override provision. Most of the aspects are positive. But you still have 20-25% of people who believe that there are negatives with respect to tax holidays, simplicity.In Short:

1. Efficiency with which fund is utilized will improve.
2. The tax collection will go up.
3. By not allowing credit of tax paid by way of minimum alternate tax, this tax is in the nature of     wealth tax and not on income at all;
4. This type of tax will clearly be an additional burden to loss making companies and will make their survival more difficult.

BIBLIOGRAPHY / WEBSITES:

1.     http://taxguru.in/direct-tax-code/sez-developers-step-up-demand-for-continued-income-tax-exemptions-seek-centre-states-intervention.html

2.     http://www.forum4finance.com/2010/07/08/sez-developers%E2%80%99-demands-continuation-of-tax-sops-under-revised-dtc/

3.      http://www.indianrealtynews.com/real-estate-india/sez-developers-concerned-over-adverse- impact-of-dtc.html

4.     http://www.premiuminvestments.in/cover-feature/53293p106/53255.html

5.     http://www.dnaindia.com/india/report_now-one-more-sez-wants-to-withdraw-from-gujarat_1565979

6.     http://www.suite101.com/content/impact-of-dtc-reforms-on-sezs-in-india-a356099

7.     http://www.inhouselawyer.co.uk/index.php/india/8302-impact-of-direct-tax-code-on-special-economic-zones

8.     http://www.business-standard.com/india/news/dtc-bill-to-impact-employment-investment-in-sezs-epces/107180/on

9.     http://catuts.com/minimum-alternate-tax-mat/

10.  governancenow.com/.../india-inc-wary-dtc-want-sez-sops-continue

11.  http://www.eximguru.com/exim/special_economic_zone_sez/ch_9_sez_incentives.aspx

12.  www.scribd.com/doc/38936751/Impact-of-DTC-on-SEZ

13.  http://www.projectsmonitor.com/SEZ/sezs-face-tax-hurdles-in-the-direct-taxes-code

14.  http://www.suite101.com/content/impact-of-direct-tax-code-dtc-reforms-in-india-a350221

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