The grand SEZ dream on deathbed

December 29, 2011
5 mins read

Calculations seem to have gone offtrack along the way; the initiators blame policy confusion and lack of comprehension in coordination.

The Special Economic Zone (SEZ) policy was launched with considerable hype in India in 2006, when the economy was booming and investors around the world were looking at the country as a credible investment destination. It was launched with the promise of lucrative tax incentives, to substantially boost export.

However, five years later, with the change in the global economic scenario, coupled with unstable policy, the SEZ story is dying a slow death.

In the past couple of years, a wide gap has emerged in the number of new proposals getting approvals and that of SEZs becoming operational. Today, the ministry that conceived the idea and implemented the scheme is busy shifting gear backwards and, instead, promoting the concept of national investment and manufacturing zones (NIMZs) under the recently introduced National Manufacturing Policy. According to experts, NIMZs are just another re-branding attempt in the backdrop of SEZ activities increasingly becoming tepid, though SEZs are meant exclusively for exports and NIMZs are aimed to boost domestic manufacturing.(Click here for table & graph)

“We are seeing a slowdown in getting clients for our SEZs,” said Arun Nanda, chairman, Mahindra Lifespace Developers. “The government should realize that SEZs have become an issue of credibility. Companies were attracted to the scheme due to tax incentives. The government cannot go back on its promise. Rolling back the policy would become a huge issue. While the concept of NIMZs is laudable, unless there is a concerted effort between the central and state government to make it a success, the scheme would remain on paper.”

Mahindra World City SEZs in Chennai and Jaipur are regarded as success stories that boast of a clientele of BMW, CapGemini, Infosys Technologies, Renault-Nissan, TVS Group and Wipro, among others.

The SEZ Act was enacted in June 2005 and made operational from February 2006. The scheme made phenomenal progress in terms of exports, employment and investment, based on the government’s promise to investors of long-term continuity. It was launched primarily because all other efforts made by successive governments had failed. The idea was first mooted in 2000-2001 under the then commerce and industry minister, Murasoli Maran.

“In some sectors, we did achieve considerable success against China, like the Nokia SEZ and others,” said former commerce secretary G K Pillai, who was instrumental in implementing the policy in 2006. “The government has to make the policy stable to bring in foreign and other investors. Investors today look at cash flows. If we do not offer them a stable policy, they would rather go to other countries. Amidst widespread public misconception about the policy, we forgot the various unintended benefits these SEZs brought. There is bound to be some problem while doing big things, but the government has to stick to the rules. Somewhere over the years, the commerce ministry abdicated responsibility.”

Pillai also highlighted the aspect of job creation in SEZs. Jobs created within SEZs as on September are given as 7,32,839. “If a tax concession creates millions of jobs, then why not?” asked Pillai, arguing that the revenue forgone due to the concession would come back to the state coffers when a person working in the SEZ pays taxes.

The ministry of commerce and industry recently floated a discussion paper to ascertain ‘shortcomings in the conception and implementation of the SEZ policy framework’. While 583 SEZs had been formally approved as on October 31, only 381 have been notified, of which 143 are exporting. Ministry data admits to a skewed export pattern, inadequate progress of manufacturing activity, uneven sectoral dispersion, limited number of operational SEZs and the fact that the hinterland has been untouched.

India was the first country in Asia to set up an Export Processing Zone (EPZ), in 1965 at Kandla in Gujarat’s Kutch district, called the Kandla Free Trade Zone. After this, six more EPZs were set up, at Santa Cruz (Mumbai), Falta (West Bengal), Chennai (Tamil Nadu), Noida (Uttar Pradesh), Cochin (Kerala) and Visakhapatnam (Andhra Pradesh).

“Frankly, the government did not have the resources then to create infrastructure that would propel exports,” says N L Lakhanpal, former director general of foreign trade (1997-2002) under Maran. “Schemes like Export-Oriented Units (EOUs) and Software Technology Parks of India (STPI) failed to live up to their objectives of creating world-class infrastructure and, moreover, these were under heavy regulations. So, we wanted to create earmarked zones, where all regulations would be suspended and, to attract developers, we had to incentivise by offering income tax relief. The NIMZs would meet the same fate as the SEZs.”

Pillai agrees the NIMZs would be a non-starter, since each requires a minimum of 5,000 hectares, which is going to pose a challenge in a world where land acquisition has become a huge problem.

The size of incentive package stipulated under the SEZ Act and Rules were reduced by the government with the withdrawal of exemption from Minimum Alternate Tax (MAT), levy of Dividend Distribution Tax (DDT) on SEZ Developers and grandfathering of the benefits to SEZ Developers (notified on or before March 31, 2012) and SEZ units (commencing on or before March 31, 2014). These withdrawals have all been challenged in court, so investors are unsure what to expect.

“We had the potential to compete with China but we did not achieve the objectives,” says Ravindra Sannareddy, managing director, SriCity SEZ, southern India’s largest private sector one. “Investors are still interested in the SEZ story of India but they are not very comfortable. They are confused, they don’t know how to read the policy. Moreover, the 2008 meltdown also dampened the SEZ story.”

Dipak Chatterjee, former commerce secretary, who oversaw preparation of the draft SEZ Act during his 2002-04 tenure, believes the SEZ concept got clobbered due to clearances given to a large number of projects and not to a selected few. “Unfortunately from the very beginning, the revenue department was determined to make it difficult on the ground of revenue lost. It was very difficult to convince them that duties and taxes are never exported, so instead of a regime of duty refunds post export, it is much simpler to have tax and duty-free export. The idea was to start with a handful of SEZs and if these proved a success, to replicate on a large scale. However, this was not done,” he said.

Recently, the Board of Approval of the ministry of commerce and industry, under commerce secretary Rahul Khullar, provided much-needed relief to cash-starved developers by allowing them to dilute their stake partly or fully to other promoters, including foreign companies, since more and more were finding it difficult to carry on with their SEZ projects.

According to CUTS Inter-national, an advocacy group, a National Coordination Comm-ittee on SEZs should be formed under the Prime Minister’s Office, with direct involvement of all states.

SEZ units are given 100 per cent tax exemption for the first five years, 50 per cent for the next five years and 50 per cent of the ploughed-back export profit for the next five years under section 10 AA of the Income Tax Act. Under section 115JB of the IT Act they are also exempted from Minimum Alternate Tax (though, as mentioned, this is under litigation). Besides these, the units are also exempted from central sales tax, service tax, state taxes and levies.

The draft Direct Taxes Code bill has suggested continuation of the 15-year tax holiday for units operational by March 31, 2014. In other words, the units have to start exporting before this date to avail of the I-T concessions available for SEZ units, even if they have got all the necessary approvals.


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