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DOING BUSINESS IN INDIA – BENEFITS UNDER SEZ

DOING BUSINESS IN INDIA – BENEFITS UNDER SEZ

Dinesh Kumar Agrawal

Grad. ICWA, FCA, Ex-IRS

India is one of the first in Asia to recognize the effectiveness of the Export Processing Zone (“EPZ”) model in promoting exports, with Asia’s first EPZ set up in Kandla in 1965. Now, the Government has framed Special Economic Zone (“SEZ”) Policy and enacted the Special Economic Zone Act, 2005 (“SEZ Act”) to remove shortcomings of EPZ, create world-class infrastructure and provide a stable fiscal regime to attract larger foreign investments in India. The SEZ Act and SEZ Rules framed thereunder have come into effect on 10th February, 2006. The preset laws has simplified setting/operational/exit procedures and provided a single window clearance on matters relating to central as well as state governments. These SEZs have a definite notified area which is surrounded by a boundary wall and thus separated from the domestic area (“DTA”). SEZ is considered as deemed foreign territory for taxation purpose. Every SEZ is divided into a processing area where alone the SEZ units would come up and the non-processing area where the supporting infrastructure is to be created.

The SEZ Policy envisages establishment of sector specific SEZs for manufacture of Textiles & Apparels, Leather Footwear, Automobile components, Engineering etc., multi product SEZs, service SEZs like information technology and information technology enabled services (“IT/ITES”) and trading and warehousing SEZs. Units can be set up in notified SEZs for manufacture of goods or for providing services or for warehousing and trading. A large number of incentives and facilities have been offered to the units in SEZs for attracting investments into the SEZs. A well informed entrepreneur can appreciate incentives offered to the SEZ units. This article is an attempt to give an overview of the existing local taxes and levies, which a DTA unit suffers on goods and services in manufacturing of goods or providing services or on sale of goods in India. Levies and taxes add to the cost of goods and services, hence becomes relevant for cost analysis as well as evaluating benefits of setting up a unit in SEZ vis-à-vis DTA unit.

In India, various taxes and duties are imposed under the Central statutes by the Central Government of India and State statutes by the State Governments and local authorities. Various taxes can be grouped under indirect tax and direct tax. Indirect tax is a tax collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the customer). On the other hand, direct tax is collected directly by government from the persons (legal or natural) on which it is imposed.

Indirect Tax

      Customs Duty

India is a founding member of the World Customs Organisation (“WCO”) and the World Trade Organisation (“WTO”). India follows 8 digit classifications of goods under the Harmonised Commodity Description and Coding System (“HSN”). India is also a signatory of Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994 (“Customs Valuation Agreement”), thus classification and valuation system of imported goods are easy to understand for a foreigner. Under the Customs Act, 1962, customs duties are payable on import of goods in to India or export of goods outside India. The duty rates and duty exemptions are specified in the Customs Tariff Act, 1988.  Customs duties are levied on the transaction value of imported goods. In case of import of goods from related parties, the value for the purposes of computation of customs duty is calculated on arms length basis.  Customs duty consists of Basic Customs Duty (“BCD”), Additional Duty of Customs equal to central excise duty levied on similar goods manufactured in India (also called as countervailing duty) (“CVD”) and Special Additional Duty (“SAD”). In addition to above, Education Cess is also levied by the Indian Government as part of customs duty. At present, most of the industrial goods attract BCD @ 7.5% ad valorem and CVD @ 8% ad valorem. Total customs duty is computed as set out below:

A    Assessed value of imported goods   Taxable value   Tax Rate

B     BCD                                                                                     7.50%

C     CVD                                                                A+B                 8%

D     Education Cess on CVD                                C                   3%

E     Education Cess on customs duty           B+C+D               3%

F     SAD                                                         A+B+C+D+E           4%

G    Total import duty                                                        B+C+D+E+F

In some cases, industry specific cess is also collected as part of CVD. Indian Government is empowered to exempt, partially or fully, a class of goods or importers from the levy of customs duty. There are several product specific or thematic exemption notifications which partially or fully exempt certain goods. Therefore, the duty rates set out above are indicative. The applicable rate of customs duty may vary (which may be higher or lower) depending on type of goods under import and ‘end use’.

Goods imported by a unit in SEZ for development, authorised operation and maintenance of the SEZ units is exempt from customs duty whereas a DTA unit is liable to appropriate customs duty thereon.

      Central Excise Duty

The Central Government levies excise duty on manufacture of goods in India under the Central Excise Act, 1944. The duty rates are specified in the Central Excise Tariff Act, 1985. Excise Tariff follows 8 digit classifications of goods and aligned with HSN. Excise duty is levied on the transaction value of manufactured goods at the point of sale. At present median rate of excise duty is 8%. In addition to above, Education Cess is also levied by the Indian Government.

In some cases, industry specific cess is also collected as part of excise duty. Indian Government is empowered to exempt, partially or fully, a class of goods or importers from the levy of excise duty. There are several product specific or thematic exemption notifications which partially or fully exempt certain goods. The applicable rate of excise duty may vary (which may be higher or lower) depending on type of goods manufactured and ‘end use’.

A unit in SEZ is not liable to pay Excise Duty on manufacture of goods. Further, SEZ unit may also procure indigenous goods for development, authorised operation and maintenance of the SEZ units from the DTA market without suffering Excise Duty as supply to SEZ unit is considered as equivalent to export (deemed export).

      Service Tax

The Central Government levies service tax on certain specified services under the Finance Act, 1994 as amended from time to time. Presently 114 services attract service tax which inter alia includes consulting engineers’ services, scientific and technical consultancy services, design services, intellectual property services, and information technology (IT) software services. Ordinarily, the provider of specified services is liable to pay Service Tax. However, in case of taxable services received from outside India, the recipient of services is liable to pay service tax thereon.  In some other specified cases also, the service tax is collected from the recipient of service under the reverse charge system. At present, service tax rate is 10.30% inclusive of Education Cess @ 3%.

Taxable services imported and/or procured within India by a unit in SEZ for authorised operation is exempt from service tax. In the case of certain services procured from local service providers and entirely used within SEZ are exempt from service tax whereas in the case of other services, exemption is provided by way of refund.

      R&D Cess

Import of technical or special knowledge or special services required by an industrial concerns under any foreign collaboration including designs, drawings, publications and technical personnel attracts R&D Cess @ 5% under the Research And Development Cess Act, 1986  (“R&D Cess Act”).

A unit in SEZ is not liable to pay R&D Cess on import of technology.

      Value Added Tax

India is divided into 29 states which also have power to levy certain taxes including taxes on sale of goods. State Governments levy VAT on the sale of goods within the state. CST is levied in case of inter-state sale of goods under the Central Sales Tax Act, 1956.  Most of the specified industrial products are subject to VAT @ 4% whereas other goods ordinarily attract VAT @ 12.5% on the transaction value. At present the CST rate is 2% when the goods are sold inter state by one registered business entity to another registered business entity subject to fulfillment of certain procedural requirements. 

VAT/CST is not levied on sale of goods in the course of import or export out of the territory of India. Purchase of goods in the local market for fulfillment of export order is considered as ‘last sale’ or ‘penultimate sale. Such, ‘last sale’ immediately preceding the export is also exempt from VAT/CST subject to fulfillment of specified conditions.

Purchase of goods by a unit in SEZ to carry on the authorised operations is exempt from CST.

Most of the State Governments have exempted sale and purchase of goods within SEZ from levy of VAT. Some State Governments have also exempted sale of goods to SEZ units for authorised operations from levy of VAT.

      Local levies

Local bodies like municipal corporations, municipalities levy octroi on entry of goods in the local area administered by such local bodies. Most of the states in India has abolished octroi levy. However, many of the Municipal Corporation in the state of Maharashtra like Mumbai, Thane, Pune etc. still levies octroi. These levies add to the procurement cost of goods and services.

At present, there is no exemption from levy of octroi for the SEZ units. If the SEZ units are located inside the area administered by local bodies levying octroi, the SEZ units has to suffer the same.

      Tax Set-off and credit mechanism

A discussion on indirect tax can not be complete without discussion about credit of input tax and set-off mechanism which removes cascading effect of duty/tax and ‘zero rating’ of export of goods and services. Levies eligible for credit and set-off are not considered as cost of the inventories.

The CENVAT Credit Rules, 2004 (“CCR”) prescribe the entitlement and utilisation of tax credit of the CVD, SAD and excise duties paid on inputs and capital goods and Service Tax paid on input services used in manufacture of excisable goods or provision of taxable services. The credit of such duties/taxes is permissible only if the said input goods or input services have been used in the manufacture of excisable goods or for provision of taxable services. In the case of imported inputs such as raw material, duties & cess paid under C, D and F (in the table set out above) are eligible for cenvat credit. Such cenvat credit can be used in payment of excise duty on manufactured goods or service tax on taxable output services.

SEZ units engaged in manufacturing of gods are not eligible to avail credit of levies under the CCR as SEZ units are not required to pay excise duty. Delivery of goods by the SEZ unit to DTA area attracts duty equivalent to customs duty leviable on import of such goods. It appears that Service SEZ units will be eligible to avail credit of inputs/input services used in provision of taxable services in DTA as the SEZ units will be liable to pay Service Tax on service provided in DTA.

VAT paid on input materials is allowed as input tax credit and can be adjusted against output tax payable on sale of goods. In the case of inter-state sales, certain States retain a part of credit availed on input, generally in the range of 2 to 4%. The balance credit is allowed to be availed as input tax credit. 

SEZ units are permitted to avail credit of VAT which can be subsequently setoff against output tax.

      Duty drawback, rebate and refund

Primary purpose of the SEZ Policy is promotion of exports of goods and services so that additional economic activity can be generated in India which in turn will create employment opportunities to the Indians. Every nation strives to promote exports and it is cardinal principle of export that nations export goods and services not taxes. Therefore, most of the countries eliminates incidence of tax suffered on export goods and services by giving various incentives. Hereunder, basic discussions on some of the available incentives on exports have been which may properly evaluate SEZ benefits vis-à-vis DTA units.

An exporter can seek duty drawback of customs duty and excise duty paid on inputs used in the goods exported out of the territory of India. The Central Government has prescribed duty draw back rates in the case of most of the goods exported out of the territory of India. These rates are based on periodical review of input tax incidence suffered on raw materials by the relevant industry. An exporter can lodge duty drawback claim at such all industry rate prescribed by the Central Government under the drawback schedule. In case of a product where all industry rate is not prescribed, or when an exporter is of the view that all industry rate is insufficient compared to the actual incidence of such input tax, the exporter has option to apply for special ‘brand rate’ for duty drawback which will be determined by the authorities on a case by case basis having regard to factual aspects and actual incidence of duty.

A manufacturer can also export goods without payment of excise duty by following a prescribed statutory procedure and maintaining certain documentation. The manufacturer is required to furnish a bond/undertaking to export the goods and submit proof of export. If the exporter fail to export such goods, he will be liable to pay excise duty thereon. In such cases, the input tax credit of duty on goods used in export production is permitted to be used against excise duty payable on other domestic clearances of goods. Alternatively, the manufacturer may pay the applicable excise duty on goods by utilising credit of duty on inputs and seek a refund of such excise duty on export as per the prescribed procedure. Such refund of excise duty is known as rebate. Such rebate is granted on submission of proof of export.

A service provider is also eligible to avail credit of tax on inputs and input services used in provision of output services. The output services can be exported without payment of service tax. In such circumstances, CCR permits refund of accumulated input tax credit.

Apart from aforesaid “zero rating” of export, the Government has also given some other incentives to DTA units which are engaged in export of goods and services. These incentives include duty free import of goods against Advance Authorisation Scheme (“DEEC”), import of capital goods for manufacture of export goods and services (“EPCG”), refund of customs duty incidence on export goods (“DEPB”) and (“DFIA”).

A SEZ unit will not be eligible for aforesaid benefits on export of goods and services.

Direct Tax

Entrepreneurs are eligible for 100% Income Tax exemption on export income for SEZ units under Section 10AA of the Income Tax Act for first 5 years, 50% for next 5 years thereafter and 50% of the ploughed back export profit for next 5 years. Income Tax benefit for the unit will be computed as follows:

“Profits of the business of the undertaking X Export turnover of the undertaking)/Total turnover of the business of the undertaking*”

Entrepreneurs are eligible for exemption from minimum alternate tax under section 115JB of the Income Tax Act.

Stamp Duty

Sale and purchase of immovable property including land and building is subject to levy of stamp duty.

The Government has exempted SEZ developers and SEZ units from levy of stamp duty.

Repatriation of FOREX

The freely convertible foreign exchange (“FOREX”) receivable against the export of goods or services from India is required to be repatriated to India within a period of 12 month under the present exchange control regulations in India. In exceptional circumstances, on case to case basis, Reserve Bank of India is empowered to extend the time limit.

In the case of units set up in SEZ, this period of 12 months is relaxed for repatriation of export proceeds.

External commercial borrowing

SEZ units are permitted for external commercial borrowing upto US $ 500 million in a year without any maturity restriction through recognized banking channels.

Incentives, exemptions and benefits granted to the SEZ units and developers have led to massive investment in SEZs amounting to Rs 1000 billion. However, the Government has to ensure that such incentives, exemptions and benefits are not misused and should result in increase of export of goods and services. SEZ units have certain obligations, which includes FOREX earning as explained below:  

Net Foreign Exchange Earning

The SEZ Policy has granted many incentives, exemptions and benefits to the SEZ units for the promotion of export of goods and services from India. Therefore, the SEZ units are required to meet net foreign exchange earning (“NFEE”) criteria in the block of 5 years, i.e. that the unit in the SEZ would be required to have greater income from exports of goods and services than the expenditure incurred in foreign exchange by it in importing the goods or services.

The SEZ units are required to execute a “Bond-Cum-Legal Undertaking”, inter alia, with regard to achievement of positive NFFE. The performance of the SEZ units will be continuously monitored by the authorities. If a unit in SEZ continues to be NFEE negative by the end of 3rd year, a show cause notice will be issued by the competent authorities and if the negative performance continues till the 5th year, the competent authorities will initiate penal action. If a SEZ unit is unable to meet the NFEE criteria, such SEZ unit will be liable for payment of penalty as may be imposed by the adjudicating authority in accordance with the provisions of the Foreign Trade (Development and Regulation) Act, 1992.

Export Performance of SEZ

In recent past, exports from SEZ units have seen significant growth as given below:

Year                        Value in Million Rupees      Yearly Growth Rate

2004-2005                        18,314                            32%

2005-2006                        22,840                            25%

2006-2007                        34,615                            52%

2007-2008                        66,638                            92%

The overwhelming response to the SEZ scheme is evident from the flow of investment and creation of additional employment in the country. The SEZ scheme has generated tremendous response amongst the investors, both in India and abroad. A large number of multi-national companies have set up SEZ/SEZ units in India which includes Nokia, Flextronics (Tamil Nadu), Adidas (Andhra Pradesh).

The SEZ Policy provides an excellent opportunity for the entrepreneurs and enterprises to expand business activity in India without hassles. Prosperity to entrepreneurs and enterprises also bring prosperity to the nation.

 

About the Author

The author is a member of the Institute of Chartered Accountants of India and also a member of Institute of Cost & Works Accountants of India. He has gained vast experience in the Customs, Central Excise and Service Tax while working in the Indian Customs and central Excise Department under the Ministry of Finance, Government of India. For more information, please visit http://dineshagrawal.info

Jerry Brown speaks with Eric Schmidt

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