Business

SEZs: Many unanswered questions

The attractiveness of the zones lies in their promised access to much better infrastructure

SPECIAL ECONOMIC Zones (SEZs), which are modified versions of the earlier export processing zones, have been in the news recently. The policy to set up SEZs was first introduced in April 2000.The Act was passed in 2005. In February this year, the Government notified the rules.

The existing eight export processing zones have been converted into SEZs. More than 100 SEZ proposals have reportedly been cleared already and many more applicants are waiting in the wings. However, despite the early enthusiasm, it would be naïve to conclude that the SEZ idea is inherently sound and one whose time has come.

SEZs are specially demarcated areas that allow units locating there to function under a set of tax and other rules very different from those in the rest of the country. The idea is to facilitate exports through special tax treatment to the units and entrepreneurs operating there. The substantial concessions they will enjoy both in income tax and indirect taxes are meant to make exports from these zones competitive.

These are also intended to be sops for foreign direct investors to set up shop in India. The rules have been so framed that practically any type of entrepreneur — foreign, domestic, government, whether Central or State — can start a unit. Units located in these zones will not be subjected to any pre-determined value addition or minimum export performance. They can sell their products in the domestic tariff area on payment of the relevant duties.

Specifically, units coming up in SEZs are exempt from any kind of duty, whether customs or excise, while importing or procuring locally, capital goods, intermediates or raw materials for their projects on hand. No special approval is necessary. Such units will have to utilise the goods imported (or bought indigenously) free of duty, over a five year period.

There are generous concessions in the area of direct taxes as well. SEZ units will enjoy 100 per cent tax exemption for the first five years, 50 per cent for the next two and 50 per cent of the ploughed back profits for the next five years. Losses can be carried forward.

Sops for developers too

SEZ developers (promoters) too get income tax concessions for ten years within a block of 15 years. They are allowed to import or procure locally, goods for the development, operation and maintenance of SEZs. They can also allot fully developed plots to SEZs on commercial terms. They can provide all types of support services — utilities, housing, restaurants, and security on commercial terms. They also enjoy exemption from the service tax.

Other than the favoured tax treatment, the attractiveness of the SEZs lies in their having access to much better infrastructure and the provision of a single window clearance for all types of government clearances. Naturally, promoters of SEZs or those setting up units there are enthusiastic even at this early stage. The official expectation is that Indian manufacturing and exports will get a major boost. It is hoped that substantial investments will flow into these complexes and a number of new jobs created.

However, both the concept and execution of the SEZ has been faulted. Surprisingly, at the policy level the controversy so far has been on issues such as the minimum size. In China where the concept has been successful, the average size is very large. Small sized SEZs cannot deliver in terms of scale and will be difficult to monitor in a scenario where distortions in fiscal policy are to be expected.

There are other weighty objections. SEZs will distort resources allocation in the country and will be another outstanding example of the counterproductive character of micro-economic management. Special tariff zones that are being created go against the well-recognised canons of public finance that advocate uniformity.

Diversions likely

In the Indian context, it is far more likely that instead of new investments flowing into the SEZs, existing ones will get diverted. A more recent government clarification says that existing units will not be allowed to shift to a SEZ only to get concessions.

In that sense, the SEZs will be no more than tax shelters and will become a major, albeit legal, avenue for tax avoidance.

The provision to let a unit move from one SEZ to another (and still get all the tax advantages) is a loophole that is bound to be exploited to perpetuate tax avoidance beyond the period of 15 years now permitted under the SEZ rules.

Again, even if SEZs deliver on their promises, they will merely touch the fringes of the major problems confronting Indian manufacturers and exporters. Poor infrastructure and multiplicity of regulations have been hampering these. The question then arises as to whether the selectivity that is inherent in the SEZ policy will slow down action on the tougher tasks of improving infrastructure for the whole country.

Regional disparities

There is a strong possibility that SEZs will be more popular in States where there is already a strong tradition of manufacturing and exports. The trend is already seen in the initial approvals. Regional disparities will be further aggravated.

Finally, there is a big question mark over the appropriateness of the several tax and other SEZ incentives under the WTO regime.

It is feared that the tax incentives will be contested on the ground that it is not compatible with the multilateral trading rules to which India is a signatory. Going further, the Indian exporter may even lose the advantage if the importing country slaps a countervailing duty.

C. R. L. NARASIMHAN

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