Will the sun set upon special economic zones in India?

Special Economic Zones (SEZs) are specifically delineated duty-free enclaves deemed to be foreign territory for the purposes of trade operations, duties and tariffs.  SEZs were initiated by the Indian government in April 2000 and have brought a boom in the Indian economy as they fetch foreign currency for Indian pockets, thereby promoting trade between nations. India has 232 SEZs, of which 25 are multi-product ones and the rest sector-specific ones, with 5,109 approved units, as of 31 March 2019. Exports from SEZs rose 21% to INR 7000 bn in FY18-19.

However, a major incentive offered to units in SEZs is set to disappear as per the sunset clause, which would apply from April 2020. This incentive offered 100% income tax exemption on export income for SEZ units under Section 10AA of the Income Tax Act for the first five years, 50% for the next five years thereafter and 50% of the ploughed back export profit for the next five years.

Hence, the following questions arise:

1. Would SEZs still be a feasible option for developers and occupiers to set up new units?
2. Why is there new supply planned for SEZs in India?

The form of governance present in these zones has enabled investments in a big way. The incentives and facilities offered to units in SEZs to attract investments include:

• Lower infrastructure cost which translates to low cost of land to the benefit of developers
• Exemption from goods and services tax on input services
• Duty-free import/domestic procurement of goods for development, operation and maintenance of SEZ units
• Exemption from customs/excise duties for development of SEZs for authorised operations approved by the Board of Approval
• Exemption from payment , duties and other levies like R&D (for occupiers)
• Exemption from stamp duty and registration fee (for developers)
• Procedural simplifications – single-window clearance for Central and State level approvals
• Free external commercial borrowings up to USD 750 million (for occupiers)

With developers partially passing the benefits to occupiers in the form of lower rents as compared to IT parks, industrial and commercial developments, along with the benefits, incentives and facilities offered to occupiers in SEZs, we believe that the demand for SEZs will remain high and will create a win-win prospect for both developers and occupiers.

Despite the above benefits, a few challenges have been raised in implementing the SEZ policy:

1. Large areas of cultivated land are being acquired with inadequate compensation to farmers and other displaced industries.
2. Substantial loss of revenue for the government, as manufacturing and service industries move to these tax-free havens.

The first challenge is being dealt with positively by state governments in India. A large proportion of the land to be allotted to approved SEZs will come from land parcels already acquired by respective state industrial development corporations. Other state governments will follow the Maharashtra example of stating unambiguously that arable and fertile land will not be acquired and whatever land that is acquired, will be at market rate. West Bengal, for instance, compensates farmers to the tune of 152% of the existing market price of the land. There is also a guarantee of a job for at least one member of the family whose land has been acquired in the SEZ production units.

The second challenge has also been taken care of by the Central Government by removing the tax holidays for SEZ units. Until recently, the government of India has reduced the corporate tax rate to 22% from 30% for existing firms and an even lower rate of 15% for new manufacturing companies. By doing so, the government has not only checked its loss of revenue but also partially nullified the adverse effects of the sunset clause on SEZ units.

We believe there is a strong case for SEZs to continue to shine in India even if the sunset clause is applied and benefits thereby cease to exist.

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