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From DESH To The SEZ Amendment Bill (2024): Another Attempt At Revamping SEZ’s? – IMPRI Impact And Policy Research Institute

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From DESH to the SEZ Amendment Bill (2024): Another Attempt at Revamping SEZ’s?

Policy Update
Armaan Rawat

Introduction 

The proposed SEZ (Special Economic Zone) Amendment Bill (2024) marks yet another attempt by the Indian government to reform and improve the functioning of SEZ’s. The proposed bill aims to overhaul the existing SEZ framework and replace the previously proposed ‘Development of Enterprises and Service Hubs (DESH) bill’ that was proposed in 2022. The SEZ framework was established with the SEZ Act of 2005 to promote exports, improve economic growth and attract business investments. However, it has faced several challenges and failed to keep up with the transforming world. This proposed bill seeks to build a new framework that addresses these problems, and is currently under consideration by the Ministry of Commerce.

Background

India was the first country in Asia to establish an Export Processing Zone (EPZ) in Kandla (1965). Afterwards, seven more EPZs were set up, but they failed due to a variety of factors, such as instability, lack of infrastructure, and regulatory issues. As a result, a new SEZ policy was introduced in 2000, followed by the SEZ Act of 2005, which addressed many of these issues. The major objectives of the Act are – ·        

  • generation of additional economic activity       
  • promotion of exports of goods and services         
  • promotion of investment from domestic and foreign sources      
  • creation of employment opportunities        
  • development of infrastructure 

Features and Functioning of the SEZ’s

The SEZ Act of 2005 created a formal structure for businesses with many incentives, such as tax breaks, streamlined procedures and was implemented in February 2006. It’s salient features are as follows :

  1. A designated duty free enclave to be treated as a territory outside the customs territory of India for the purpose of authorised operations in the SEZ;
  2. No licence required for import;
  3. Manufacturing or service activities allowed;
  4. The unit shall achieve ‘Positive Net Foreign Exchange’ to be calculated cumulatively for a period of five years from the commencement of production;
  5. Domestic sales will still be subject to custom duties and taxes;
  6. SEZ units will have freedom for subcontracting;
  7. No routine examination by customs authorities of export/import cargo;
  8. SEZ Developers /co-developers and units enjoy direct tax and indirect tax benefits as prescribed in the SEZs Act, 2005.

Overall, 375 SEZs have been notified as of March 2024. Several amendments have been made to SEZ rules to change incentive structures. However, over time, certain issues have emerged regarding the functioning of SEZs in India. The first major issue emerged with the withdrawal of certain tax incentives that existed earlier. The government removed the “Minimum Alternate Tax” exemptions on book profits for companies in the SEZs, which was important for attracting companies and business investment. Similarly, the “Dividend Distribution Tax” exemption for developers was also removed.  Domestic sales from SEZs also include full customs duties and taxes. This has reduced the interest of major companies and developers in SEZs. 

The Government of India also introduced a sunset clause in the 2016-2017 budget,  which means that the income tax exemption is only applicable to SEZs set up before the cut–off date of March 31, 2020. 

A second problem that emerged with the SEZ Act was its inability to attract industry and manufacturing leading to an imbalance as the service sector increased rapidly at the same time. In particular, the IT sector dominates, accounting for over 60% of the total operational SEZs (169 out of 280) as of 2024. Very few manufacturing companies and industries have been set up in Indian SEZs, and they have failed to strengthen this sector.

Many SEZs also face issues with a lack of world-class infrastructure, logistics and transport facilities, which impedes the establishment of manufacturing and industry in SEZs. Similarly, SEZs also had issues regarding the locations where they were set up. Often SEZs were set up in suboptimal locations due to corrupt politicians, bureaucrats and other local elites. This leads to SEZ being set up in sites that do not have significant development potential. SEZs also suffer from mismanagement and underutilization of land. Of 483 approved SEZs, only 280 are operational.

Finally, the performance of SEZs has also been affected by other international factors, such as mandates from the WTO, global economic slowdowns, competition from other Asian countries, and other such trends.

Due to the declining performance of SEZs, the government in 2022 decided to revamp the SEZ framework by bringing in the DESH Bill in 2022.

DESH Bill 2022 and its Issues

The DESH Bill  2022 aimed to overhaul the existing structure of the SEZ but also to comply with the demands made by the WTO. In contrast to the earlier SEZ Act, the DESH Bill focused on production for both the international and domestic markets, and SEZs were renamed ‘development hubs’. It  would also remove the direct tax incentives, and the necessity for positive foreign exchange that were present in the earlier Act.

Instead of positive foreign exchange, the DESH Bill proposed evaluating the performance of SEZs based on “positive growth criteria” which would be calculated taking into account multiple factors like growth and employment generation. The aim of the bill was to revive the fortunes of the SEZs while simultaneously complying with the demands of international organisations. 

Almost immediately after it was discussed in 2022, it ran into several disputes that led to the DESH Bill falling out of favour with the Government. Niti Aayog in 2022, for one, objected to certain clauses in the bill, including the removal of the Net Foreign Exchange Requirement. However, the major dispute was between the Finance Ministry and the Ministry of Commerce over certain proposals and provisions of the Bill, revolving around tax breaks, exemptions and tariffs.

Since then, the DESH Bill has been in limbo, with no further updates coming in 2024. Rather, it seems that the government is mulling to bring out an SEZ Amendment Bill to amend the SEZ Act as a simpler and faster solution.

SEZ Amendment Bill 2024 – Potential Impact and Issues

The Ministry of Commerce held meetings to discuss proposals related to the bill. Sources have said that the government is considering measures, such as a flexible framework to sell products in domestic markets and to streamline the approval process. The new SEZ Bill is likely to maintain a positive net foreign exchange requirement that was absent from the DESH Bill, but will likely allow sales from SEZs in the domestic market.

The bill has the potential for a net positive impact, especially if it allows for catering to both domestic and international markets, which can lead to increased economic growth. Reforms in the tax regime can attract more business, and, along with amendments to simplify the regulatory process, can help improve the efficiency of the SEZ system. Similarly, enhancing the single-window clearance system and improving the dispute resolution system can help to reduce bureaucratic delays and red tape.

Like with the earlier SEZ Act and DESH Bill, many of these same problems can continue to exist, even after this bill is enacted. The most pertinent of these is overreliance on the IT sector, which is  unlikely to change in the near future. Similarly, issues with land acquisition, land under-utilisation, and misuse are most likely to persist. Disputes between ministries can also occur, which can lead to further implementation delays.

Way Forward

The SEZ Amendment Bill is one of many attempts to reform the existing SEZ framework. However, it must adopt long-term policy measures to deal with recurring problems. These can include changes to the land acquisition process to prevent corruption and promote accountability and transparency, along with a multi-sectoral approach to SEZ planning that will also promote growth in the manufacturing sector. By expanding the domestic market potential of SEZs, introducing tax reforms, and improving governance mechanisms, the Bill can make SEZs more attractive to investors and contribute to India’s economic growth. 

The SEZ Amendment Bill 2024 presents a crucial opportunity to reform India’s SEZ policy framework by building on the lessons learned from the failure of the DESH Bill 2022 and addressing the shortcomings of the original SEZ Act of 2005. It has the potential to revamp the SEZ framework in a way that allows for comprehensive, multi-sectoral and inclusive economic growth and development.  

References

About the Author– Armaan Rawat is a research intern at the Impact and Policy Research Institute, pursuing a B.A. Honours in Political Science at Kirori Mal College. His interests include public policy, policy research, analysis and public administration.

Acknowledgement– The author would like to thank Aasthaba Jadeja, Shivashish Narayan and Ishita Deb for their valuable contributions.

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