The Hindu Business Line : On how ambiguity robs the SEZ-sop of its sizzle

If the SEZ tax benefit is to be fully realised, the Government ought to formally amend the formula, or adopt a pragmatic approach at the time of assessment and grant the full deduction, based on a beneficial interpretation of the law.

Mr Bharat Varadachari, Tax Partner, Ernst & Young.

Our tax law generously speaks of a 100 per cent tax holiday, but it may turn out to be a mere theoretical benefit, fears Mr Bharat Varadachari, Tax Partner, Ernst & Young. "The issue is with the formula for computing income-tax deduction with respect to the profits of an SEZ (Special Economic Zone) unit under Section 10AA of the Income-Tax (I-T) Act, 1961," he explains, in the course of a recent e-mail interaction with Business Line. "Based on the plain text of the formula, it appears that companies that have established SEZ units in the same legal entity that houses other businesses/units may not be able to fully realise the income-tax deduction," Mr Varadachari elaborates. "If this were the result, it means that one of the stated fundamental objectives of the SEZ policy framework, which seeks to grant tax-free status to exporters, would stand violated."

Excerpts from the interview:

Has the tax sop attracted interest?

Widespread interest, and understandably so. With the 10-year tax holiday under the STP (software technology park) and EOU (export-oriented unit) schemes set to lapse in March 2009, the 15-year tax holiday for SEZ units (sans a sunset clause) has been popular.

Several corporates with existing businesses have initiated steps to establish, or have already established, SEZ units to house incremental or greenfield operations.

Why is the formula a problem?

In a nutshell, the deduction from the SEZ unit's profits is required to be computed as a proportion of the export turnover of the SEZ unit, to the total turnover of the business carried on by the taxpayer.

Question that arises is how does one interpret the term `total turnover of the business' in the absence of clarity.

Are different interpretations possible?

Yes. For instance, should the phrase mean turnover from all business activities carried on by the taxpayer (both inside and outside the SEZ unit)? Should it mean total turnover of all units engaged in the same business segment as the SEZ unit? Or should it be restricted to the total turnover of the business carried on by the SEZ unit only?

Can you explain with an example?

Let us assume three situations where the taxpayer is otherwise eligible for a 100 per cent tax holiday (first five years) for its SEZ unit(s):

i) The taxpayer operates one SEZ unit and two DTA (domestic tariff area) units. ii) The taxpayer operates one SEZ unit and two STPs/EOUs. iii) The taxpayer operates three SEZ units. Let us assume that the turnover of each unit of the taxpayer (whether SEZ or otherwise) is Rs 100. In all the three scenarios (including where the taxpayer has no DTA presence at all), based on the vague manner in which the formula is currently prescribed, it is possible that only a third (Rs 100/Rs 300) of a particular SEZ unit's profit may be treated as a deductible benefit.

Not acceptable?

Not at all. The result appears illogical. If the deduction is with respect to a specific SEZ unit, then the formula should also operate such that the deduction is available in the proportion of the export turnover of the SEZ unit to the total turnover of the SEZ unit, without considering the turnover of other businesses/units of the taxpayer in the denominator. Any other interpretation of this formula would render the 100 per cent tax holiday, a mere theoretical benefit.

Is there a way out?

Given the potentially absurd result that the formula may throw up, one would have expected the lawmakers to amend the provision and remedy the ambiguous wording/ drafting error.

A similar computational issue in the case of eligible exporting units was addressed by way of an amendment to Section 10A and, accordingly, such an amendment should have also been carried through in Section 10AA. The amendment was, in fact, expected in Budget 2007, but was conspicuous by its absence.

How are businesses coping with the ambiguity?

Interestingly, the drafting error has caused several companies to contemplate establishment of a distinct new legal entity to house each SEZ unit.

This way, assuming that the total turnover of the taxpayer entity will be equal to the export turnover from one SEZ unit, the numerator in the formula will equal the denominator and 100 per cent of the SEZ unit's profits would be available as a deduction.

Any flip side?

Setting up multiple legal entities to house each SEZ unit is otherwise inefficient, as it only multiplies tax and regulatory compliances apart from complicating the overall group operating structure.

Your suggestions, going forward. If the SEZ tax benefit is to be fully realised, the Government ought to formally amend the formula, or adopt a pragmatic approach at the time of assessment and grant the full deduction, based on a beneficial interpretation of the law.

Between the two options, clearly, the former would be a more effective remedy, as availability of full benefits would be more predictable and certain to the taxpayer.

D. MURALI

http://Detaxification.blogspot.com

More Stories on : Taxation | Interview | Infrastructure

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page