Income Tax 31 Jan,2020
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Special Economic Zones (SEZs) – Case for extending the income-tax holiday
Vinita AbhyankarManager with Deloitte Haskins & Sells LLP.
Utkarsh TrivediDirector with Deloitte Haskins and Sells LLP
Rajesh Gandhi Partner with Deloitte Haskins & Sells LLP

Special Economic Zones (SEZs) were introduced to India in the year 2000 to boost economic growth, promote export of goods and services, promote domestic and foreign investment and generate employment. SEZs have come a long way since then. At present1, 238 SEZs are operational and 5,168 units have been approved in the SEZs, employing over 2 million people. The total investment2 in SEZs is USD 74.52 billion and the exports in financial year 2019-20 (up to 30 September 2019) are USD 54.56 billion.

To attract investment, SEZs have been given a host of incentives, which include, amongst others, a 100 percent income-tax exemption on export income for first five years, 50 percent for five years thereafter, and 50 percent of the export profit reinvested in the business for the next five years. This tax exemption is slated to expire from 1 April 2020 owing to the sunset clause provided in the domestic tax law.

Should the SEZ income-tax holiday be extended?

SEZs, which emerged as major export hubs in the country, started losing their sheen after the imposition of the Minimum Alternate Tax (MAT) and with the introduction of the sunset clause.

Recently, a committee was constituted under industrialist Baba Kalyani (Chairman/ Managing Director of Bharat Forge Ltd.), to evaluate the existing SEZ policy, make it relevant to exporters in the current economic scenario, suggest course correction if any and make the policy WTO compliant. The committee recommended several measures such as renaming of SEZs to employment and economic enclaves (EECs), incentives linked with investments, employment, technology and value addition, simplification of processes, extension of a sunset clause, swift resolution of disputes through arbitration, flexibility in the dual-usage norms for non-processing areas in SEZs and extension of MSME schemes to these zones. The Ministry of Commerce and Industry is said to be examining the recommendations and discussing with stakeholders to find a way to implement the same. Extension of the sunset clause will help revive investment in SEZs and boost India's 'Make in India' propaganda.

Another reason to extend the sunset clause for SEZs is that a number of such zones are still left with idle capacity and an extension will boost further investments and also help address the slowdown in SEZs, especially in manufacturing sector.

What happens if the SEZ income-tax holiday is not extended?

Units set-up prior to 1 April 2020 will continue to enjoy the income-tax holiday in a phased manner for the remaining period of 15 years. Such companies, will be liable to a reduced rate of MAT of 15 percent. After expiry of the tax holiday, such companies can opt to be taxed at a concessional tax rate of 22 percent (plus surcharge and cess) and not utilise MAT credit or be taxed at 25 percent3 (plus surcharge and cess) and claim unutilised MAT credit. Units set-up / commencing operations post 1 April 2020 can continue to avail indirect tax benefits but will not be eligible for the income-tax holiday. Companies setting up such units can opt to be taxed at a concessional rate of 22 percent (plus surcharge and cess) without applying MAT. In case of units set up by Limited Liability Partnerships (LLPs), such LLPs will be taxed at 30 percent (plus surcharge and cess) after the expiry of tax holiday period or if the unit becomes operational on or after 1 April 2020. Companies having SEZ units (whether claiming SEZ income-tax holiday or otherwise) will have to evaluate which tax regime should be adopted.

Impact on companies if tax holiday is not extended

The impact on tax rate and cash tax outflow for a company in case the SEZ income-tax holiday is not extended is explained with the help of an illustration below:

A new company sets-up a unit in a SEZ after 1 April 2020 to provide services. The tax rate and cash tax outflow in a two scenarios (i) assuming the tax holiday is extended (ii) assuming tax holiday is not extended, is given below.

Particulars SEZ tax holiday is available SEZ tax holiday is not available
Years 1 – 5 Years 6 – 15 Years 1 - 5 Years 6 - 15
Normal tax 0% 13% - 17.5%* 25.17% 25.17%
Minimum Alternative Tax (MAT) 17.47% 17.47% Not applicable Not applicable
MAT credit entitlement (Amount of MAT paid over normal tax) 17.47% 0-2.5% Not applicable Not applicable
Cash tax outflow 17.47% 17.47% 25.17% 25.17%
Effective tax rate (ignoring the impact of MAT credit) 17.47% 17.47% 25.17% 25.17%

*50% of the income will be taxed at an effective rate ranging from 26% to 34.94%. Thus effectively, the tax rate applicable will range from 13% to 17.4%

It can be observed that the incremental tax rate applicable to a company claiming tax holiday vis-à-vis a company not claiming tax holiday ranges from approximately 25.17% in years 1-5 to 7% in years 6-15. The cash tax outflow of a company not claiming tax holiday increases by 7.7% (difference between 7.47% and 25.17%) in years 1 to 15.

Conclusion

In view of the above, an extension of the sunset clause would throw a lifeline to the SEZs and make them more appealing to investors. Investors joined the SEZ scheme keeping in mind the incentives available, including income-tax exemption. Withdrawing such a major incentive could hamper the investments made in SEZs.

Apart from extending the sunset clause, the government could also consider doing away with MAT and reducing the tax rates for new SEZ units to 15 percent on par with the tax rate applicable to new manufacturing companies.

Extension of the tax holiday along with other measures to revive the SEZs in India, could boost domestic and foreign investment, strengthen employment generation and consumption, which in turn would help turnaround the Indian economy. SEZs could contribute in achieving the government's goal of becoming a US$ 5 trillion economy before 2025.

SEZs certainly deserve some more time. All eyes are now on the upcoming Budget!

Information for the editor for reference purposes only


Rajesh Gandhi is a partner, Utkarsh Trivedi is a director and Vinita Abhyankar is a manager with Deloitte Haskins and Sells LLP

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 1.  Data as on 14 November 2019 as per the SEZ factsheet available on www.sezindia.nic.in.

 2.  Dta as on 14 November 2019 as per the SEZ factsheet available on www.sezindia.nic.in.

 3.  Tax rate applicable to domestic companies with turnover up to INR 4000 million in FY 2017-18