Industry expects the Centre to extend the sunset clause beyond 2020 in the upcoming Budget
The year 2005 could easily be termed a pivotal one in so far as India’s export policies are concerned. This was the year when the country introduced a Special Economic Zone (SEZ) Act, which would set the road map for converting India into a global manufacturing and exports hub. Tax deductions offered under Section 10AA of the Income Tax Act proved a major driver, as both developers and operators came forward to make the most of the business opportunity.
A look at the past 14 years does present an encouraging picture. Since the enactment of the SEZ Act, over 20 lakh jobs have been created, with an incremental growth of 25.19% year-on year. Today, India has a total 231 operational SEZs (from them 136 are information technology SEZs). Official data shows that investment in SEZs stood at over Rs 5 lakh crore at the end of March 2019, and exports at over Rs 7 lakh crore.
Policy changes that came along the way, however, somehow hindered the growth these duty-free enclaves were supposed to register. The government in 2011 decided to levy minimum alternate tax (MAT) and dividend distribution tax (DDT) on special economic zones, a move often seen as against the very concept of such zones.
Subsequently, SEZs’ share of India’s total exports in value terms, after growing progressively until 2013 (when it peaked at 29.1%), stagnated at approximately the same level. The share of SEZs’ in total exports in 2018-19 was around 30%. Despite their share remaining more or less unchanged, SEZs’ growth on a year-on-year basis has remained sluggish.
Examining the sunset clause
So far, business units in SEZ get full income-tax deduction on profits and gains for the first five years. For the next five, only 50% income is taxed, and in the last five only 50% of the profits credited to the SEZ Re-Investment Reserve Account are taxed. Come March 31, and the sunset clause, which was announced in Budget 2016, will come into force, putting an end to several tax sops enjoyed by SEZs, unless, of course, the government decides to offer an extension.
We, however, have reasons to believe SEZs might continue to enjoy their current position — the government is learnt to be considering extending the clause and sector stakeholders are expecting an announcement on this front in the upcoming Budget on February 1. This is also one of the key demands IT industry body NASSCOM made from the finance minister in its Budget wish-list. NASSCOM is also of the view that the sunset clause should be extend for at least another 5 years so that SEZs continue to attract investment and contribute to exports and employment generation. Meeting that demand is important in view of the current business environment, factoring in that a significant number of SEZ premises still have potential for growth.
Amid decelerating economic growth, which hit 4.5% in the July-September quarter of this financial year, the government has lately launched several measures, including a reduction in corporate tax as part of its mega-stimulus package, with the prime aim to boost investment climate. Extending the time limit under the sunset clause becomes important not only to keep the growth momentum going for SEZs but also to make the government’s Make in India initiative a success. On the other hand, extending the clause will further boost the IT/ITeS sector, which has already been the biggest beneficiary of the policy, and help the manufacturing sector emerge out of the ongoing slowdown.
The measures suggested by the Baba Kalyani panel in 2018, if implemented, could also help bring some positive changes to the SEZ sector. These include delinking SEZs from exports, foreign currency payments, converting them into employment and economic enclaves and allowing supplies to domestic market in rupees for service SEZs. The fact that India will need to tweak its SEZ policy from export-oriented incentives towards an investment-driven incentive mechanism under a recent ruling by the World Trade Organization gives us more reasons to believe that the sunset clause might be extended.
What if the government goes the other way?
Policy flip-flops notwithstanding, IT SEZs in India’s seven mega cities have consistently held a sizeable share of the country’s office stock, retaining a long-term average share of 25% since 2014. Our research also indicates that most of the occupiers are considering SEZs as a viable option for expansion, relocation or consolidation, in both short- and long-term space strategies. If the government were not to intervene and extend the tax benefits currently offered to SEZs, new units being set up by occupiers starting operations from 1 April 2020 will not be eligible for direct tax benefits. However, the sunset clause will not impact their indirect taxes benefits, including goods and services tax (GST) exemptions and incentives on eligible services if they are operational.