India’s journey from Export Processing Zones (EPZs) to Special Economic Zones (SEZs) marked a significant shift in its approach to promoting economic growth and attracting investments. However, over time, the SEZ framework faced challenges and failed to achieve the desired outcomes. This article explores the transformation from EPZs to SEZs, the erosion of SEZ attractiveness, and the emergence of the Development of Enterprises and Services Hubs (DESH) Bill as a potential solution to address the shortcomings of SEZs.
History of EPZ and SEZ
India was at the forefront in understanding the importance of having dedicated zones to boost manufacturing and exports. Hence, Asia’s first export processing zone came up at Kandla, India in 1965. However, due to the numerous regulations and approvals, the lack of top-notch infrastructure, and an unstable fiscal system, the export processing zones were unable to become effective tools for export promotion. Hence, the Special Economic Zones (SEZs) Policy, which was introduced in April 2000 under the provisions of the Foreign Trade Policy, included several new elements while addressing the EPZ model’s weaknesses. Recognizing the need for a more comprehensive framework, India shifted towards SEZs.
Features of SEZs
The SEZ Act of 2005 provided a more structured and formal environment for businesses by offering tax incentives, customs duty exemptions, streamlined procedures, and infrastructure support. The SEZ Act of 2005 came into effect in February 2006 with the formulation of the SEZs Rules, 2006. Some of the salient features of the SEZ scheme are:
- It is a designated duty free enclave treated as a territory outside the customs territory of India for the purpose of authorised operations in the SEZ;
- Duty free import/domestic procurement of goods is allowed for development, operation and maintenance of SEZ units
- SEZ units can borrow externally upto US $ 500 million in a year without any maturity restriction through recognized banking channels.
- SEZ units will have full freedom for subcontracting;
- Customs authorities will not routinely examine export/import cargo;
- 100% Income Tax exemption on export income for first 5 years, 50% for next 5 years thereafter and 50% of the ploughed back export profit for next 5 years
However, a Unit has to achieve positive net foreign exchange (to be calculated cumulatively) for a period of five years from the commencement of production. This means that the unit had to export more than what it could import in terms of value of the goods/services. Furthermore, domestic sales are subject to full customs duty and import policy in force.
There were other benefits which were provided apart from the ones listed above. Over the years, there have been a few changes made in the incentives provided to SEZ units and amendments to the SEZ Rules.
Erosion of SEZ Attractiveness
Over time, SEZs encountered several challenges that impacted their attractiveness. The introduction of the minimum alternate tax (MAT) and the sunset clause for tax benefits diminished the tax advantages for companies operating within SEZs.
The purpose of MAT was to bring “zero tax companies” into the tax system, who, while having made significant book profits and paying out big dividends, do not pay any tax as a result of various tax breaks and incentives offered under the income tax code. It is assessed at a rate of 18.5% on book profit, plus any relevant surcharges and cess.
In addition to that, the NDA government announced a sunset date for SEZs in the 2016-17 budget. The sunset provision states that the income tax exemption is only applicable to SEZ units that start operating on or before March 31, 2020.
The Partial Failures of SEZs
Apart from the introduction of the MAT and sunset provision, the SEZs also partially failed on one important aspect. Based on the sector-by-sector distribution of approved SEZs (as of 29.02.2020), 2, the IT/ITes electronic hardware, semiconductor, and telecom equipment sectors account for the majority of operational SEZs (145 out of 240 operational SEZs), accounting for 60.42 percent of SEZs in India. As a result, the initial plan to strengthen the manufacturing industry was not achieved, and service exports saw an unusually large increase.
In fact, the share of IT/ITES in SEZs have gone up from 2015, when it stood at 57%.
Source: Lok Sabha Secretariat
Furthermore, there are other factors which led to the low efficiency of Indian SEZs. In recent years, a number of ASEAN nations have relaxed their regulatory restrictions, which enticed companies to relocate their units over there. With India having thirteen free-trade agreements (FTAs) and six preferential trade pacts so far, with the intention to have more such agreements, importers outside of SEZs can increasingly access zero-rated imports, which diminishes the appeal of SEZs.
Also due to sector-specific constraints, the enormous swaths of land under the Indian SEZs are also underutilized and lying idle. About 20,000 hectares of SEZ land and approximately 10 crore square feet of built-up area is vacant in SEZs (as of Feb 2022). Only 267 of the 427 SEZs approved under the SEZ Act, 2005, are operational.
After the US challenged India’s export subsidy programme at the World Trade Organization (WTO), the commerce ministry established a committee under the leadership of Bharat Forge chairman Baba Kalyani to make its special economic zone (SEZ) policy compliant with WTO standards. The Development (Enterprise and Service) Hubs Bill is based on the recommendations of this committee.
Introduction of the DESH Bill
The government proposed the DESH Bill in 2022, which aims to establish and manage development hubs that are not only focused on exports but also on serving the home market, in contrast to the SEZ ecosystem. Under the DESH bill, all customs duty exemptions allowed in the SEZ acts will also be available. To comply with WTO regulations, the bill incorporates two significant adjustments: the elimination of the necessity for positive net foreign exchange, and giving access to local markets.
Since the system of positive net foreign exchange has been eliminated, a unit’s success will be assessed on the basis of net positive growth (NPG) under the proposed Bill, which will be determined by a number of factors, including economic activity and employment creation.
There are numerous advantages in this bill. According to real estate experts, this measure will help real estate developers by lowering vacancies in SEZs by denotifying unused spaces and leasing them to domestic businesses. This will help in keeping the rental prices under check. (Denotification by the developer also entails surrendering to the government all benefits received as a result of tax exemptions and subsidies for the development of the asset)
The Bill also aims to incorporate current industrial parks like food and textile parks by rebranding them as development hubs. Moreover, the widening of the range of service sector units that can operate in development hubs is another important benefit of the draft DESH Bill. Earlier, only specific services, like IT and ITeS, were now permitted in special economic zones (SEZs).
Delay in Passing the DESH Bill
The DESH Bill has not been passed in Parliament yet, primarily due to disagreements and tussles between the Ministries of Finance (Revenue Department) and Commerce. These disputes revolved around the provisions of the bill, including tax breaks and exemptions.
The two provisions under dispute were – (i) allowing units to sell in the domestic tariff area (within the nation but outside development hubs) in exchange for paying duties waived on imported raw materials , and (ii) offering all greenfield and some brownfield units in the development hubs that will be established under DESH a reduced corporate tax rate of 15% for an extended period.
The finance ministry was also actively considering another proposal of the commerce ministry – enabling SEZ units to receive payment in rupees for services rendered to the DTA.
According to former finance secretary Subhash Chandra Garg, “Now we also have lowered the tax rates on the manufacturing companies, we have PLI schemes for neutralising the additional cost of doing business in the country, so over and above all this if you ask for more and more of tax concessions and in a manner which is distortive of domestic competition then it is quite understandable that the finance ministry will object to it.”
The last official update on the Bill’s status came on the first of February 2023. The drafting of the “Development of Enterprises and Services Hubs (DESH) Bill, 2022” to replace the SEZ Act had been completed, according to the status of the implementation of 2022–23 budget announcements. The Cabinet Note was being finalised.
Confusion and Transitional Challenges
The 2005 SEZ regulation placed a strong emphasis on “export”. The SEZ Act made sense since, according to the Constitution (List 1 to the Seventh Schedule), exports are under the purview of the Central Government.The DESH bill 2022 pervades “Industry,” something that falls under the authority of States (List 2 to the Seventh Schedule), with regard to the establishment, development, and management of “Development Hubs.” This will create confusion regarding the primary stakeholder in this process.
India’s transition from EPZs to SEZs represented a significant shift in its approach to promoting economic growth. While SEZs initially offered attractive benefits, over time, their appeal eroded due to various challenges. The emergence of the DESH Bill reflects a renewed focus on comprehensive development, including a wider range of enterprises and services. However, the delay in passing the DESH Bill and the ongoing tussle between ministries pose hurdles to its implementation. Resolving these issues and addressing the confusion surrounding DESH are crucial steps towards leveraging the potential of development hubs and fostering inclusive economic growth in India.
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Yuvaraj Mandal is a Research Intern at IMPRI.
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