Special Economic Zones were set up in 2005 in order to provide impetuous for rapid growth and promotion of exports. The inspiration for the concept came from China which had successfully implemented the same for well over 25 years and more. There were several key elements in the policy formulation with regard to SEZ.
No income tax was to be levied for the first five years of the setting up of the unit in SEZ and concessional taxation was provided for the next 10 years. The hope was that these SEZs will increase employment opportunities and drive exports. Land was to be acquired by the Government and given to units cheaply. Approvals for setting up the units were to be cleared in no time.
The concept received overwhelming welcome from entrepreneurs and captains of industry. About one third of India's exports came from SEZs. Till October 2011, the Government had approved 583 SEZs all over India. About 143 became operational. In the past two years, problem arose in the implementation of the policy. The policy is being handled by the Ministry of Commerce and also the Ministry of Finance. This itself leads to a tussle in laying down a long term plan. Many things happened which dealt a serious blow to the very idea of an SEZ itself.
Problem of Land
There was a rush to the set up SEZs in 2008. The incentives offered were attractive. Companies queued up to grab land at cheap cost. Suddenly there was popular eruption in Nandigram and Singur.
Purchase of land at cheap prices by the Government for making it available to industry ostensibly for public purpose came to be exposed as lending a hand to powerful industrial lobbies to acquire land at throwaway prices resulting in the impoverishment of the peasant land lords. The Government had to step back. It told industrialists that they should negotiate the land owners and acquire land at market prices. Recession cropped up and there was a cash crunch. Developers in SEZs fell into a debt trap.
The Direct Tax Code brought about radical changes in incentive deductions. It recommended shifting from profit-linked incentives to a system where deductions will be allowed on investments. The original draft of the Code was silent on the question of extending tax holiday benefits to SEZ units.
However, the Bill as introduced in Parliament has provided deductions under Section 10AA of the Income Tax Act, 1961 to such of those units that begin to manufacture or provide any services on or before March 31, 2014. These units will be entitled to claim profit-linked tax holiday benefits.
Unexpired tax holiday benefits for developers will be grandfathered. After April 1, 2014, there will be only investment-linked tax incentives.
Since the SEZ units have a long gestation period, the change of policy proved a disincentive. The DTC also sought to impose book profits tax on the unit in the SEZ at the rate of 20 per cent. The shift from a zero per cent tax regime to a 20 per cent regime came as a shock.
Once the DTC is enacted, as the Commerce Secretary, Rahul Khullar explained, SEZs won't be an attractive option. It was the IT companies that took maximum advantage of the concept of SEZ. They have low investments but generate high profit margins. Budget 2011 saw the Finance Minister levying 18.5 per cent of MAT on SEZs and also a 15 per cent tax on dividends declared.
He pointed out that revenue foregone because of the concession to the SEZ stood at Rs 8, 614 crore and wanted equal sharing of corporate tax liability.
Defenders of the SEZ scheme argued that the so called revenue foregone is notional and does not take into account the huge employment opportunities created by the SEZs. It promoted consumption and Government received duties on products purchased and consumed by the people. According to the Department of Commerce, for every job created in an SEZ, two jobs are created for activities outsourced and this estimate indicates that SEZs have created 2.1 million jobs.
The Department of Commerce is bringing out a discussion paper laying down the blue print to reform SEZ policies.
It suggests sharing of profits between the developers and the land owners. It also suggests shrinkage of the area under the SEZs and reducing the minimum land requirement for multi product SEZs. It is a matter for serious concern that out of 583 approvals for SEZs, only 143 became operational. There has been no investment in SEZs in almost the whole of 2011.
Too many policy shifts and failure to grapple with periodic problems will deal a death blow to the SEZs.
The concept is a brand new idea in India's economic policy and should not be allowed to whither away because of lukewarm attitude of the Ministry of Finance.