Tax exemptions: Extend sunset date for SEZs to drive 'Make in India' initiative

The Finance Minister in his Budget speech in February 2015 had mentioned that the basic rate of corporate tax in India at 30 per cent is high and thus makes our domestic industry uncompetitive. As such, he proposed to reduce the corporate tax rate over the next four years to 25 per cent, coupled with a removal of various kinds of tax exemptions and incentives for tax payers.

The Central Board of Direct Taxes (CBDT) has since issued a draft proposal on 20 November 2015 seeking public comments. The draft provides for restricting certain tax incentives (e.g. benefits for Special Economic Zone (SEZ) units u/s 10AA, specified developers u/s 80-IA/IB etc, specified businesses under 35AD, etc.) without an end date, to 31 March 2017, and terminating the weighted deductions after 31 March 2017.

As of July 2015, there are 416 formally approved SEZs under various sectors. The units in these SEZs have a 100 per cent tax holiday (normal tax rates being 34.61 per cent) for an initial five-year period, followed by a 50 per cent tax holiday in the next five years and subject to certain conditions, a 50 per cent tax holiday for another five years for its export profits.

However, they are also liable to pay Minimum Alternate Tax (MAT) of 21.34 per cent. The MAT paid in a year is creditable over the next 10 years. Going forward, in case the current draft were to be implemented, then these units will have to start paying normal taxes and the available MAT credit can be utilised. Thus, over a short term, these units would be benefited as they would enjoy a reduced liability due to decreasing tax rates and also utilise MAT already paid. The draft provides a window of only another year for companies who intend to commence operating from these SEZ units and are willing to enjoy this 15 year tax break.

The draft does not affect the existing SEZ units (Sec 10AA) / SEZ developers (Sec 80-IAB)/ any enterprise carrying on business of development, operation and maintenance of infrastructure facility (Sec 80-IA), which are entitled to a tax holiday. Once the 31 March 2017 window is over any new unit or developer that would want to set up in an SEZ or undertake development, operation and maintenance of infrastructure facility, will continue to enjoy the indirect tax benefits but, would become a normal tax paying unit unlike other domestic tariff area units. Thus, new investments in SEZ units may majorly be impacted due to the withdrawal of direct tax benefits.

Similarly, research and development ('R&D') and innovation are vital to the manufacturing sector for its growth. Currently, a weighted deduction of 200 per cent can be claimed as a deduction, on the total spend, including specified capex, primarily by manufacturing companies. The CBDT proposal intends to restrict the deduction to only 100 per cent.

The world is looking forward to investing in India and many companies have been evaluating India as a manufacturing hub. India, being a fast developing economy with a varied, versatile and abundant workforce, has the potential to attract huge investments.

The government's recent 'Make in India' initiative focuses on promoting manufacturing of products in India. As can be seen from the emergence of the SEZs, the annual exports from these operational tax incentive units have increased 20-fold over the past 10 years! Considering this, the government should relook at extending the sunset date for at least another few years, by which the intended lower tax rates would be in force. This incentive would further promote the 'Make in India' initiative and attract not only foreign investment but also start-ups and help augment the 'Start-up India' initiative.

Also, the government could mull a 'Research in India' initiative and continue the weighted deduction in India's own interest to bolster innovation, intellectual property and industrial growth.

Once a uniform tax regime is in place, investments would flow into various parts of the country and would also help in decongesting the urban agglomerations. Any decision from the government has to therefore, keep in mind the larger economic objectives of growth and prosperity of the country. All eyes now on the forthcoming Budget!

The author is Partner, Tax & regulatory, PwC India (with inputs from Nachiket Barve)