To SEZ or not to SEZ

The emergence of SEZs in a conservative society like India is aimed at changing the Indian outdated thinking and environment. India converted eight of its existing export processing zones into SEZs six years ago. An analysis of the zones' contribution to industrialisation efforts in India reveals that EPZs have had a catalytic effect in promoting new production sectors, exporting new products and in building up the country's image in certain products in international markets.

The SEZ Act 2005 offers a highly attractive fiscal incentive package, which ensures:
# Duty-free import/domestic procurement of goods for development, operation, and maintenance of SEZs and SEZ units.
# Extension of income tax benefits to SEZ developers for a block of 10 years in 15 years, as per the choice of the developers.
# 100% income tax exemption for SEZ units for the first 5 years, 50% for 2 years thereafter, and 50% of the ploughed back export profit for the next 3 years.
# 100% income tax exemption for 3 consecutive years and 50% for the next 2 years to off-shore banking units set up in Special Economic Zones.
# External commercial borrowing by SEZ units without any maturity restrictions through recognized banking channels.
# Treating supplies from the Domestic Tariff Area (DTA) to SEZ at par with physical exports.
# Exemption from Central Sales Tax on sales made from the DTA to SEZs.
# Exemption from Service Tax for SEZ units and developers.
# Exemption from State taxes and levies, as notified by various State Governments.

Moreover, provisions have also been made for (i) establishing free trade and warehousing zones for creating trade-related infrastructure, thereby facilitating import and export of goods; (ii) setting up of offshore banking units and units in an international financial service centre in SEZs; (iii) public private participation in the infrastructure development; and (iv) setting up of SEZ authority in each central Government SEZ for developing new infrastructure and also for strengthening the existing one.

In addition, there are certain requirements of the SEZs under the said scheme:
# These units have to achieve positive Net Foreign Exchange earning i.e. NFE;
# They also have to provide periodic reports to the Development Commissioner and Zone Customs;
# These units are also supposed to execute a bond with the Zone Customs for their operation in the SEZ.
# Moreover, any company set up with FDI for undertaking Indian operations, has to be incorporated under the Indian Companies Act with the Registrar of Companies.

But even today some still argue that agriculture must be the priority, while others contend that industry should take precedence. There is no use in debating, as this approach will get India nowhere. Be it increasing urbanization or SEZs, we must accept the fact that change has arrived on India's doorstep and agriculture will have to adapt to these modifications. What India needs is to welcome these transformations, and manage them successfully.

However, there still are many critics of this scheme who point at the following issues:
(i) real estate exploitation; (ii) the loss of land to agriculture and inadequacy of compensation and other deprivation suffered by farmers and rural workers; (iii) the impact of tax exemptions and other fiscal incentives, on the central state and state revenue; (iv) the impact on the regional balance in developments and (v) administrative weaknesses.

Exploitation of the Real Estate

Why is there such an interest among private developers, especially property developers, to rush into the area of SEZ development? Section 5(2) of the SEZ Act, addresses the issue of land acquisition. It provides for non-industrial use of 75% of the land in the possession of an SEZ developer. This is justified by the argument that social infrastructure, which would constitute things like housing facilities and entertainment, is extremely critical. This means that many real estate companies who have no track record in manufacturing or exports have become SEZ promoters.

The developers are aided by duty exemptions on their inputs and other fiscal exemptions plus cheap acquisition of land from farmers. They are therefore bound to make a huge profit through real estate. The development of housing and other social infrastructure requirements in the non-processing parts are being given the same fiscal incentives as the business units in the processing area, allowing prosperity in real estate development.

…the whole scheme is one that paves the way for private capital to make huge profits at the expense of the small property owner and the state with limited benefits in the form of foreign exchange revenues.

Solution
It has been suggested that the Government should evolve a new Township Development Policy with suitable rules and incentives (fiscal and non - fiscal). The incentives should be stronger at the proposed township that is farthest from the Metros and big cities, therefore providing less urban areas with the opportunity of prosperity.

SEZs should be primarily devoted to exporting. If any social infrastructure has to be built, it should be only for the provision of housing for workers and other stakeholders (healthcare, education etc). If any further infrastructure has to be built in the surrounding areas, it should be treated as a township whereby the government develops a separate and more suitable policy.

Loss of Land to Agriculture and Inadequacy of Compensation

The biggest bone of contention in the SEZ skeleton is the building of SEZ units on prime agricultural land and the displacement and inadequate compensation provided to farmers, and other deprivation suffered by them and other rural workers. For acquisition of land from farmers, two methods are followed. The first is of compulsory acquisition , whereby the so called 'fair' market price is determined by taking an average of recorded sales and adding 30% solatium to it. The other way is to let the SEZ developers' purchase the land directly from the farmers. In either method, the farmer stands at a disadvantage. In the compulsory acquisition mode, he is at a serious disadvantage because the recorded sales rarely disclose the real opportunity price.

In the other mode also the farmer is a weaker bargaining party and the SEZ developer is immensely more powerful, given his financial prowess and the easy availability of real estate intermediaries. . Critics argue that the process of acquiring land, laid out by the Land Acquisition Act 1894, is illogical. Once notification is issued, public objections are invited, and after they are heard the Government decides on the compensation package. The question that arises is this; how can people accept or reject land acquisition until they know what deal they are going to get?

When agricultural land gets transformed into industrial or urban land, it secures a huge value addition, and this is something that needs to be taken into consideration. As an example, one can look to Mumbai, where land acquisition law states (STATUTE) that the price of the land should not only be judged by the current market rate, but also of the value of the land after development takes place.

Solution
Adequate safeguards need to be provided in the SEZ policy to ensure that irrigated and agriculturally fertile land is not swallowed up by the SEZs. The SEZ proposals should be supported by certification of the agricultural quality of land by the local revenue authority and the format of assessment for building on prime agricultural land should be made clear. The CPI (M) also wants a new Act to replace the existing Land acquisition Act of 1894. The Government has said that the Land Acquisition Act will have to be reviewed in light of the SEZ rules, 2006 and the SEZ Act, 2005. Sonia Gandhi also expressed opposition. She said, Prime agricultural land should not normally be diverted to non-agricultural uses and called for satisfactory compensation to be paid when land was taken over
State governments must prescribe minimum prices for land in various areas, which will be valid both for registration of sales deeds as well as payment of compensation. The prices should be high enough to reflect the opportunity prices of land. In addition to suitable financial compensation, the displaced farm labour and rural workers should be given preference in employment either by the SEZ developer or in the business units in the SEZ. Every SEZ developer should be required to set up a training institution where appropriate training is provided for these workers who have been displaced from their traditional employment. The government has drafted a National Policy on Relief and Rehabilitation stating that all projects leading to 'involuntary displacement' can be challenged in court, if violated.

The policy, which also underlines that farmers be adequately compensated for their land and rehabilitated fairly, comes in the face of mounting pressure from farmers and political parties who believe that the development of business interests, took precedent over the interests of India's farmers.

The new policy introduces several firsts. Amongst the exhaustive list includes:
# Introducing the concept of Social Impact Assessment (SIA) along with the current norm of Environmental Impact Assessment. The SIA would also involve public hearings on displacement related issues such as loss of livelihood; compensation; and effects on family
# For agricultural workers, at least one person in the family shall be given employment or a one time rehab grant. If it is a corporate project, a fifth of the compensation will be in the form of the company's shares
# State governments will appoint an officer to be in charge of control formulation, execution and monitoring of the rehab plan, alongside a National Rehabilitation Commission and high level national monitoring committee who will monitor progress of implementation of scheme
# If a land development project, a site or apartment within the development project will be given to a member of the affected family.
# Those whose entire land has been acquired may be allotted the same cultivable land to the extent of actual land loss subject to one hectare of irrigated land and two hectares of unirrigated land.

Raghuvansh Prasad Singh, Minister for Rural Developments has said, This kind of policy will have no meaning unless it is enforceable in a court of law, and its effective implementation has yet to be seen. Further, the issue of land acquisition arises with the concern that SEZs will be built on prime agricultural land with serious implications for food security. The state governments believe that mainly waste and barren land and, if necessary, single crop agricultural land alone, shall be acquired for SEZs. If double crop land should be acquired, then the minimum area requirements should not exceed 10%. While this may be good in theory, in practice many Indian states do not have sufficient free land. In India, wastelands constitute 17.6% of total cultivable land, and in high population-density states like West Bengal, this figure is less than 1%. The Government has separate policies for industry, SEZs, labour and land acquisition, but no policy for agriculture, on which more than 50 per cent of the population depends.

The impact of tax exemptions and other fiscal incentives revenue

Tax concessions and other privileges extended to SEZ projects are steadily leading to an unequal trade-industry regime, which is bound to be hazardous to the country's economic health in the medium and long term. "We also oppose tax holidays for SEZs and demand that labour laws be made applicable there," said CPI (M) politburo member Sitarm Yechury. [The CPI (M)'s opposition is particularly hollow given its crucial support in passing the SEZ legislation in May 2005].
The Ministry of Finance has estimated the loss of revenue of Rs. 97,000 crores until 2010 of which about Rs. 50,000 crores will be due to loss of direct taxes and the rest as loss of customs and excise duties and other central taxes. To the extent that tax concessions to units in SEZs erode the legally defined tax base, the revenue loss is permanent, he said. The International Monetary Fund, Finance Ministry and the Reserve Bank of India have also criticised the policy in recent times. All have pointed to hundreds of proposed or approved SEZs that are far too small to improve India's performance in the long term. These SEZs have proved to be little more than tax loopholes for real estate speculators and developers. The IMF research director Raghuram Rajan described India's SEZ policy as a tax give-away that was likely to shift Indian production to SEZs rather than create new economic activity. He said the zones would be viable only if they focused on providing superior infrastructure, business-friendly regulations and exemptions from labour laws rather than offering often misdirected subsidies, guarantees, and tax sops that a stretched budget can ill-afford.

Tax exemptions were incorporated in the Income Tax Act 1961 through sections 80I and 80J and were consequently replaced by section 80IA, 80IB AND 80IC which allow for tax exemptions for new industries in the SEZs. The operation of these provisions gave rise to endless problems and litigation. They caused problems in administration and gave rise to inefficiencies in the economy by creating distortions. The SEZ Act 2005, consolidates, and extends the benefit meant primarily for promoting exports and new technology and have been extended from time to time under the umbrella of free trade areas (FTAs), and EPZs.
Since the development of SEZs is an activity that the private sector can both initiate and participate in, the incentives have been extended to apply to the development of the SEZs aswell as the establishing units. Section 10A and 10B of the Income Tax Act are to be phased out in 2010. However, the SEZ Act, 2005 seems to have given a fresh lease of live for tax incentives. This means that the incentives in income tax along with the exemption from customs and excise will be available for SEZ units even after sections 10A and 10B cease to apply.

The continuation of tax incentives for exports under the SEZ act has been questioned for the following reasons:
# These incentives are not all compatible with India's WTO obligations.
# There is no evidence to substantiate that tax benefits to SEZs have served to foster their growth in recent years or played any significant role in promoting exports. Special dispensation for exports was not considered necessary when India's economy was heavily controlled and protected, the tax system was not export friendly and Indian industry was not globally competitive.

Solution
One of the most emphatic panels has been the Kelkar Task Force on Direct Taxes, appointed in 2002. They have also strongly recommended ending the exemption raj. They task force recommended the elimination of concessional terms for SEZs, since they are deemed to benefit from superior infrastructure. Further, since other exporters cannot avail these concessional terms in their sales, such provisions discriminate against exports from the rest of the economy, (an issue which we will revert to later in the article). There is no good evidence to support the case for tax incentives for SEZ units apart from remission of customs and domestic trade tariffs, which should apply to all exports irrespective of whether they are located in an SEZ or outside.

India believes that by providing breaks in the tax it will encourage investment. The breaks need to be designed carefully in order to ensure their efficacy and minimize costs. It is argued that these tax breaks do not adequately benefit society. Further, the tax subsidies being offered by the government may well be challenged in the World Trade Organization, and could attract trade retaliatory measures from importing countries.

The Impact on the Regional Balance in Development

The issue of the impact on the regional balance in development has briefly been touched upon already in this article. It is contended that the SEZ policy has induced further imbalances in the regional distribution of industrial activity. The number of SEZ proposals and the number of those approved vary greatly across states. The numbers are far greater in the states that are already industrially more advanced and the discrimination so created with regards to the businesses and the entities located outside the SEZ will be unjust and will be difficult to sustain even in a court of law. New manufacturing units tend to be located in the SEZs, because of the tax benefits and the better infrastructure that they allegedly provide, and the areas outside SEZ, will get to host fewer units. The fear is that even the existing units outside SEZs may consider relocating into SEZs, provided that the costs of relocation are not out-weighed by the benefits available in the SEZs. On the one hand, checks are being provided against such relocations. On the other hand, some tax incentives are being provided for relocation, such as exemption of capital gain tax on the disposal of industrial assets outside the SEZs, when such disposal is a precursor to relocation into an SEZ.

Solution
Measures must be taken to help the industrially backward states to generate and implement SEZ projects. The state governments, while recommending SEZ proposals and the Board of Approvals while approving them should ensure that the SEZs are located not in the vicinity of larger urban areas and thereby further expanding their sprawl.

The SEZs should be close to the smaller towns which have the potential for expansion and trained manpower which can be gradually expanded by educational and training effort. [This proposal will be contended by SEZ units and developers who believe that it is essential to develop their units nearer to larger urban areas, due to the superior transport facilities available to them].

All the SEZs so far created are in the urban town areas, which already otherwise are well developed. At many places over development of these areas has created an urban chaos so creating SEZs here makes in no sense of the logic that SEZs are meant for sustainable development of the economy. SEZs in these areas would create further urban chaos.

The SEZ model has come under heavy criticism, even in China, as it creates enormous economic disparities, rather than broad based development and this evaluation is apt for the problems that India may face in the future.

Administrative Weaknesses

The last issue that must be addressed is the administrative weakness of the SEZ laws and proposals. The Development Commissioner and the Approval Committee have been given authority under numerous SEZ laws with the objectives of minimizing the hassles of the SEZ developers as well as potential investors. However, ownership of the entire SEZ land vests in the developer and if a land dispute arises between the state and developer, then the latter will have more prowess to reign supreme. There should be an independent regulatory authority to deal with issues related to SEZs.

Communist Party India member Sitarm Yechury argues that the SEZs are being used as real estate developments for those acquiring land at very inexpensive prices. In many cases, the SEZs are little more than real estate ventures rather than production zones. The rules require only that 35% of a SEZ be devoted to productive activity. A developer can use the rest of the land to build apartments, hotels and commercial offices. States have urged the Central Government to come up with a clear-cut policy to prevent "improper usage of land" by the developer.

Tax concessions and other privileges extended to SEZ projects are steadily leading to an unequal trade-industry regime, which is bound to be hazardous to the country's economic health in the medium and long term. Despite the Government's determination to proceed, the flaws and criticisms of the SEZs are a significant blow to the investors and developers. A recent Financial Times article described the situation. While manufacturers are attracted to India's low-cost environment and burgeoning domestic market, they are worried about moving their goods—be it cars, mobile phones or textiles—through the country's poor network of roads, overburdened airports and clogged ports. Power cuts can force business to a grinding halt.

As it stands, tax concessions and other privileges extended to SEZ projects are steadily leading to an unequal trade-industry regime, which is bound to be hazardous to the country's economic health in the medium and long term.

Solution
The policy relating to the SEZs is contained in the Foreign Trade Policy, incentives and other facilities offered to the SEZ developer and units are implemented through various notifications and circulars issued by the concerned Ministries/Departments. The present system, it is argued, does not inspire enough confidence for investors to commit substantial funds for development of infrastructure. To provide a long-term and stable policy framework, a Central Act for SEZs is necessary to be compatible with international practice. The introduction and passage of the Bill should provide the confidence and stability to domestic and foreign investors and signal the Government's commitment to the SEZ policy framework.

Conclusion
It was believed that the Bill of 2005 would have provided a stable framework for SEZs to create employment opportunities, and initiate deals on both the foreign and domestic front, however, a lot more still needs to be done. Business leaders are also pushing for more pro-corporate labour laws, regulations, land zoning and taxation across the country, not just in the SEZs. An analysis of the zones' contribution to industrialisation efforts in India reveals that EPZs have had a catalytic effect in promoting new production sectors, exporting new products and in building up the country's image in certain products in international markets. However, there is no assurance that SEZs will follow the same way. The constant backlash that the scheme faces ensures that road to SEZs will be a rocky one.

The author can be reached at: priyanka.pali@legalserviceindia.com / Print This Article

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