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Special Economic Zones Act, 2005 & Special Economic Zones Rules, 2006

The Government of India had announced a SEZ scheme in April, 2000 with a view to provide an internationally competitive environment for exports. The objectives of SEZs include making available goods and services free of taxes and duties supported by integrated infrastructure for export production, expeditious and single window approval mechanism and a package of incentives to attract foreign and domestic investments for promoting export-led growth.

In order to give a long term and stable policy framework with minimum regulatory regime and to provide expeditious and single window clearance mechanism, the Special Economic Zones Act, 2005 has been brought into effect along with the Special Economic Zones Rules, 2006 from 10 February 2006.

The Act and the Rules together aim to provide a single self contained legislation governing the operations of SEZs and replaces the hitherto applicable legislations and rules governing the operations of SEZ in India.

Under the Act, SEZ could be set up either jointly or severally by the Central Government, State Government, or any person (including a private or public limited company, partnership or proprietorship):

• for manufacture of goods; or
• for rendering services; or
• for both manufacturing of goods and for rendering services; or
• as a Free Trade and Warehousing Zone.

The Act provides for certain fiscal incentives to developers of SEZ and units established in SEZs. Key fiscal incentives have been outlined below:
Fiscal incentives for developers/ SEZ units - Indirect Tax incentives
Developer and the SEZ unit shall be entitled to the following exemptions, drawbacks and concessions:

• exemption from customs duty on goods imported into the SEZ by the Developer or SEZ Unit to carry on the authorised operations;
• exemption from customs duty on goods exported from the SEZ by the Developer or SEZ Unit to any place outside India;
• exemption from excise duty on goods brought from Domestic Tariff Area ("DTA") to the SEZ by the Developer or SEZ unit to carry on the authorized operations;
• drawback or such other benefits (as may be admissible from time to time) on goods brought from the DTA into a SEZ by the Developer or Unit to carry on the authorized operations;
• exemption from service tax on taxable services provided to a Developer or Unit to carry on the authorized operations in a SEZ. However, please note that there is no specific service tax exemption on services provided by a Developer of an SEZ or a SEZ Unit. Exemption, if any, would be as per the service tax legislation;
• exemption from the securities transaction tax in case the taxable securities transactions are entered into by a non-resident through the International Financial Services Centre ("IFSC");
• exemption from levy of Central Sales Tax on the sale or purchase of goods by the Developer or SEZ unit if such goods are meant to carry on the authorized operations;
• Local sales tax/ VAT exemption or concession on supply of goods to an SEZ Developer or Unit or sale of goods by an SEZ Developer or Unit is subject to the respective sales tax/ VAT legislation of the state in which the SEZ is set up.

The Central government has prescribed the manner, terms and conditions subject to which above exemptions/ concessions would be available.

Removal of goods into DTA is subject to prescribed conditions and on payment of applicable customs duties as levied on importation of such goods into India.

Fiscal incentives - Income Tax incentives for SEZ units

1. Tax Holiday for SEZ units engaged in manufacture or providing services A new section 10AA has been inserted in the IT Act by SEZ Act, 2005 which provides that the units in SEZ which start manufacturing or producing articles/ things or which start providing services on or after April 1, 2005 will be eligible for a deduction of 100 percent of export profits for the first five years from the year in which such manufacture/ provision of services commences and 50 percent of the export profits for the next five years. Further, for the next five years a deduction shall be allowed of upto 50 percent of the profit as is debited to the profit and loss account and credited to the Special Economic Zone Reinvestment Reserve Account (subject to conditions).
2. Tax Holiday for Offshore Banking units in SEZ
   A deduction in respect of certain incomes would be allowed under the new section 80LA, to scheduled banks or foreign banks having an Offshore Banking unit in SEZ or to a unit of IFSC. The deduction shall be for 100 percent of income for five consecutive years beginning from the year in which permission/ registration has been obtained under the Banking Regulation Act or the SEBI Act or any other relevant law and 50 percent of income for next five years.
3. Interest received by non-residents and not ordinary residents on deposits made with an Offshore Banking Unit on or after April 1, 2005 shall be exempt from tax.
4. Exemption from Minimum Alternate Tax ("MAT")
   Income arising or accruing on or after April 1, 2005 from any business carried on, or services rendered by SEZ unit would be exempt from MAT under section 115JB.
5. Exemption from Capital Gains
   Capital gains arising on transfer of assets (machinery, plant, building, land or any rights in buildings or land) on shifting of the industrial undertaking from an urban area to any SEZ would be exempt from capital gains tax.

The exemption would be allowable if within one year before or three years after such transfer:

• machinery or plant is purchased for the purposes of business of industrial undertaking in SEZ by the assessee;
• assessee has acquired land or building or has constructed building for the purposes of business in SEZ;
• the original assets are shifted and establishment of the industrial undertaking is transferred to SEZ; and
• other specified expenses are incurred.

The amount of exemption for capital gains would be restricted to the costs and expenses incurred in relation to all or any of the purposes mentioned above.

Fiscal incentives - Income Tax incentives for SEZ developers

1. Tax holiday for SEZ developers
   A new section 80-IAB has been introduced in the IT Act vide SEZ Act, 2005 whereby a deduction of 100 percent of profits derived from the business of developing SEZ (notified on or after April 1, 2005) would be available to developer of SEZ for any 10 consecutive years out of 15 years beginning from the year in which SEZ has been notified.
2. Exemption under section 10(23G) that was available to infrastructure capital fund or a cooperative bank on interest and long term capital gains investment had been extended to investment made by SEZ developers qualifying for tax holiday under section 80-IAB of the IT Act. However, this exemption has been withdrawn with effect from assessment year 2007-08.
3. Exemption from Dividend Distribution Tax ("DDT")
   No DDT would be payable by a developer of SEZ on dividend declared, distributed or paid on or after April 1, 2005 out of current income.
4. Exemption from MAT
   Any income earned on or after April 1, 2005 by a SEZ developer would be exempt from MAT under section 115JB of the Act.
   Sale from Domestic Tariff Area (DTA) to SEZ

Regarding implementation of the Special Economic Zone Act, 2005 and the Special Economic Zone Rules, 2006, a Circular No 29/2006-Cus, dated December 27,2006, has been issued which clarifies that the procedure for procurement of goods from Domestic Tariff Area to a SEZ Developer or a unit would be governed by the provisions of Rule 30 of the SEZ Rules, 2006.

Updated on: 31 Jan, 2007