By Sachin Menon, Partner, National Head – Indirect Tax, KPMG in India
Special Economic Zone (SEZ) is a specifically demarcated geographic area in a country that is subject to different economic regulations. These zones offer incentives to resident businesses, such as competitive infrastructure, duty free procurements, tax incentives, and other measures designed to make it easier to conduct business than other regions within the same country.
Conception of SEZ scheme in India
The SEZ scheme was started in India on 1 April 2000. Its prime objective was to enhance foreign investment and provide an internationally competitive and hassle-free environment for exports. At that point in time, the Indian government established several Export Processing Zones (EPZs) in India to promote exports. However, infrastructural and administrative challenges limited the success of EPZs in India.
With the introduction of The Special Economic Zone Act, 2005, several existing EPZs were converted to SEZs, with notable zones in Noida, Falta, Visakhapatnam, Chennai, Cochin, Santacruz, Indore, Kandla and Surat.
SEZ and trending statistics
According to the Ministry of Commerce and Industry1 , SEZ exports increased by 3,300 per cent between 2005-06 and 2020-21, from INR228.40 billion in 2005-06 to INR7595.24 billion in 2020-21. Further, investment in SEZs increased by 15,300 per cent between 2005-06 and 2020-21, from INR40.355 billion in 2005-06 to INR6174.99 billion by 2020-21. Despite these statistics, it is arguable that the SEZ scheme in India did not enjoy the same success as those in China even though the benefits of India’s SEZ policy have been multifold.
The SEZ scheme was introduced with the intention of boosting foreign direct investment in export-oriented manufacturing. However, the sector which actually gained the momentum in recent few years is IT/ITEs sector. Basis the sector-wise distribution of approved SEZs (as on 29.02.2020) 2, the highest number of operational SEZs (145 out of a total of 240 operational SEZs) relates to IT, ITes electronic hardware, semiconductor and telecom equipment sectors, comprising ~60.42 per cent of SEZs in India. Thus, the initial focus to boost the manufacturing sector did not materialise, and a rather unprecedented jump was seen in service exports, IT software, electronic items, assembled parts such as printed circuit boards (PCBs), etc. Therefore, it is safe to say that even though other sectors did not gain the required momentum from the SEZ scheme, nonetheless, it proved to be boon for the IT/ITes industry.
The global competitive advantage that Indian SEZs initially had, slowed down in pace in the last few years. This was a consequence of several ASEAN countries changing their regulatory and economic policies with an aim to attract foreign investment by providing more lucrative incentives and operational flexibility to international players. As a result of this paradigm shift, several business units migrated to other ASEAN nations that provided better fiscal benefits and trade environment.
This loss of business has resulted in relatively reduced forex earnings attributable to the SEZ sector. The same is also evidenced by decline in the value of exports3 , from INR 7,96,669 crores in FY 2019-20 to INR 6,10,301 crore in FY 2021-22.
It is also pertinent to highlight that a total of 336 SEZ units exited during the last three years.4 The reasons for winding down operations include variations in international market conditions specified above, slowdown of orders, merger of units, etc.
With the surrender of SEZ licenses in the recent past showing a declining trend, it is the need of the hour for the government to revamp the SEZ system so that it gets appropriate attention by business houses.
In order to examine the ramifications of the existing SEZ policy and to bring in global best practices to maximize capacity utilization and potential output of SEZs, the Ministry of Commerce and Industry constituted the Baba Kalyani Committee (BKC). The BKC had submitted its recommendations in November 2018, some of which are: 5
- Formulation of separate rules and procedures for manufacturing and services SEZs
- Procedural relaxations for developers and tenants to improve operational and exit issues
- Extension of sunset clause and retaining tax or duty benefits
- Broad-banding definition of services/allowing multiple services to come together
- Additional enablers and procedural relaxations
- Unified regulator for Indian Financial System Code (IFSC)
- Utilising multi services SEZ IFSC for all inbound and out bound investment of the country
- Incentives for availing services from IFSC SEZ by domestic institutions
- Extension of benefit under services export incentives scheme
- Specified domestic supplies supporting ‘Make in India’ to be considered in Net Foreign Exchange (NFE) computation
As a case study, a good example would be the strategic investment policies and approach of China. Even though China has five SEZs, each of these are the size of a mega city and strategically located close to ports and trade-friendly locations such as Hong Kong Special Administrative Region (SAR), China, Macau (SAR), China and Taiwan. There is also no minimum area requirement to set up an SEZ in China. Moreover, China does not offer tax incentives across the board to all companies; their incentives differ from zone to zone and are based on the number of years of operation, use of advanced technologies, extent of exports and the type of activities indulged in. 6 For example, companies involved in building infrastructure get special tax benefits.
One of the crucial steps in making the SEZ scheme attractive to investors is to enhance the ease of doing business. It is time that we move to a record based/trust-based system to conduct business in SEZ, with stringent penal provision against misuse and violations, holding the promoters accountable. The freedom as to how to run the business including issues like work from home should be left to the businesses. The process of entry and exit could be reasonably fast and simple. It is also worth considering whether the SEZ can be provided with infrastructure status to improve their access to easy finance and enable long-term borrowings. The SEZ policy should be revamped completely to provide much needed fillip to the manufacturing sector. Then only India can fully exploit the benefits of expanding supply chain strategies that are being adopted by developed nations, backed by the PLI schemes announced by the government to boost R&D, domestic manufacturing and exports from India.