Tuesday, May 09, 2006

>Sez the Mezz

  1. At last count, 110 new special economic zones (SEZs) had received their approvals.
  2. If the finance ministry has its way, several of those could well find their approvals yanked off even before they can get started.
  3. Even as promoters of the approved SEZs are rushing to set up their projects, the new SEZ Act, which came into force on 10 February this year, is being questioned by the finance ministry.
  4. A note has been sent to the group of ministers (GoM) and to the Prime Minister’s Office (PMO) with the objections of the ministry on record, seeking many changes and modifications to the Act. The changes proposed, if approved, could end up disqualifying over half the SEZs that have already got their approvals from the commerce ministry.
  5. The finance ministry, led by the revenue department, contends that the SEZ policy has far too many loopholes that can be abused by unscrupulous businessmen.
  6. A senior official of the finance ministry points out that, under the current policy, SEZs can come up in any location, with any amount of acreage, activity and capacity. “At this rate, the entire country will slowly become one big SEZ!” he says.
  7. Also, he points out that if everyone relocates in an SEZ (because it is so easy to set up) and avails all the tax breaks, there will be hardly any companies left to actually pay taxes. The finance ministry also smells a rat in the way the SEZ approvals are being handed out and provides data to support its claim.

Detailed description underneath

The main problem is that there is fairly wide latitude given in the new policy in terms of the size of land that is required to set up an SEZ. The Act states that multi-product SEZs must have an area of 1,000 hectares or more but services sector SEZs can have an area of 100 hectares. Then, to support sectors where India has a competitive advantage, such as gems and jewellery, IT, biotechnology, sector-specific SEZs sectors can be set up with an area of just 10 hectares.

“To add to the confusion, the area requirement for multi-product SEZs for certain states like the North-east, Himachal Pradesh, Goa, Jammu & Kashmir, has been relaxed to 200 hectares and for sector-specific SEZs to 50 hectares,” says an official. “We are of the view that a minimum size of 100 hectares should be mandatory for sector-specific SEZs. Here, they are permitting sector-specific SEZs of all kinds of sizes — even three hectares as laid out by Haryana and six by Delhi and Andhra Pradesh governments. At this rate, my backyard could be an SEZ,” says one revenue department official.

As the finance ministry note on the issue points out: “In China, the size of SEZs is between 75-250 sq. km. In the Philippines, there are SEZs of 16,200 to 28,000 hectares.” An SEZ of this size allows a promoter to build and provide world class infrastructure and global scale facilities. “What world-class facility can you provide in a 100 acre piece of land,” argues an official. The finance ministry says that the current lot of applicants who are applying to set up small SEZs are interested in nothing more than grabbing land cheaply and getting a lot of tax breaks that have been promised by the current Act. One finance ministry official holds that many of the promoters of the smaller SEZs are just real-estate builders who are only in the game to take advantage of the tax breaks on offer.

Apart from the issue of land size, the other clause that has earned the ire of the finance ministry is the one that will allow existing domestic tariff area (DTA) units to relocate to the SEZ with old plant and machinery. “As we understood it, the idea was to attract new investment into the SEZs. If you allow old units to relocate, what new investment will be created? Also, all the existing DTA units that are paying taxes will stop paying. This will amount to substantial revenue loss. In a sense, this is the old Section 80 HHC (this section of the Income Tax Act allowed for total tax exemption for export profits) coming back,” points out another source. They argue that if these units relocate, there will be massive displacement of labour and many will lose their jobs as they may be unable to relocate. The commerce ministry has a ready answer to this accusation of labour being displaced. It holds that if old units producing similar products are not permitted to move out of DTA into the SEZ, the unit will not be able to compete with a unit producing similar products in the SEZ. This may cause units to shut down and add to the problem of displacement of labour.

Meanwhile, the revenue department also has objections with the scope of activities that are being permitted to set up SEZs. “The rules have expanded the concept of manufacturing to include trading, warehousing and other related activities. Services, too, have been included. Who will pay tax if SEZs are set up covering virtually every sector of the economy?” asks a senior revenue department official.

Then, the revenue department points out, the new SEZ policy allows supplies made by units in the SEZ to DTA units to be counted towards their total export obligation if the buyer pays for it in foreign exchange. So, in addition to availing all the tax breaks that come with locating in an SEZ, the unit is not expected to work too hard trying to earn a certain amount of foreign exchange. However, the Act says, the SEZs must be forex positive within five years of being set up. Unlike in countries like China and many others, where units in the SEZ were expected to have a certain FDI component, it is not necessary condition in the Indian SEZ Act. “I call it a total giveaway. It has all the makings of an SEZ scam,” says a revenue department source.

The finance ministry holds that it has no objection to the setting up of SEZs in general. It says that it also recognises that tax breaks are a part and parcel of any attempt to develop such zones. The question is whether the current SEZ Act is the way to go about it. The ministry is keen to see at least two of its main points of contention modified: the size of proposed SEZs and allowing old, existing units to relocate to SEZs. But if this does happen, several SEZ promoters could find that they have been building castles in the air.

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