Why SEZs in India have failed

Of the 564 SEZs formally approved, only 192 were operational as of June this year.

Special Economic Zones (SEZs) are likely to be central to realising Prime Minister Narendra Modi’s ambitious Make in India agenda.

But the withdrawal of tax incentives has made SEZs an unattractive proposition, say industry experts.  

Under the original scheme, businesses in SEZs were exempted from the minimum alternate tax (MAT) on book profits and developers were exempted from payment of the dividend distribution tax (DDT).

But with indications that companies were misusing the policy for real estate arbitrage and that information technology companies were using the policy to recoup tax benefits that they lost when the Software Technology Parks of India (STPI) scheme ended, these exemptions were withdrawn.  

From 2011-12, MAT exemptions for SEZ units and developers were withdrawn and DDT exemptions for developers were terminated.

MAT was levied on book profits at the rate of 20 per cent, while DDT was levied at 20 per cent on dividends distributed to shareholders.  

According to Neeru Ahuja, partner at Deloitte Haskins & Sells, a key attraction for corporate houses was the income- tax holiday.

“With taxes being levied, the savings for companies on account of tax concessions was reduced, impacting interest in SEZs,” Ahuja said.  

Vivek Mehra, partner at PricewaterhouseCoopers, argues DDT and MAT should be scrapped, while Kavita Rao, professor at the National Institute of Public Finance and Policy (NIPFP), a Delhi-based think tank, disagrees.

She argues “as companies have been given incentives, toning those down through MAT is not a bad idea, per say. What can be debated is the level at which the tax is levied”.  

Arpita Mukherjee, a professor at the Indian Council for Research on International Economic Relations (Icrier), another Delhi-based think tank heading a study on analysing the cost benefit analysis of the SEZ policy, says the imposition of MAT has made SEZs unattractive and adversely impacted investor sentiment.

This is because MAT exemptions are punishable under WTO (World Trade Organization) rules; there is a need to provide better business facilitation packages and incentives that comply with WTO rules.

Though the issue of taxation is contentious, it is the unpredictability of the tax regime that has had an impact on investments.

In their study on trade and investment barriers, Anwarul Hooda and Durgesh Rai, economists at Icrier, argue “predictability in taxation policies is a sine qua non for making the environment conducive for investment, whether foreign or domestic, so the withdrawal of direct tax benefits has been a setback for the SEZ programme and has affected its future prospects”.  

Of the 564 SEZs that have been formally approved so far, only 192 were operational in June this year.

Total employment in these enclaves was 1,277,645 in 2014, as against an expectation of 1,743,530 by 2009. While the share of SEZs in total exports rose from six per cent in 2006-07 to 28 per cent in 2010-11, it is believed to have declined in subsequent years.

The total area under SEZs currently stands at 61,624 hectares, while Shenzhen in China alone covers 49,300 hectares.  

However, Mehra says “the SEZ policy continues to be relevant from a Make in India perspective but several policy initiatives are necessary to get those going”.

Mehra argues that for improving their viability “manufacturers should be allowed to sell goods in the domestic market but duty should be imposed on individual parts imported and not on the entire product, which would make it unviable. No Customs duty should be imposed on domestic value added”.       

India has signed a number of free trade agreements (FTAs), with countries such as Sri Lanka, Japan and the Association of Southeast Asian Nations (Asean), under which import duties have been slashed to zero for several product lines. This impacts local sales of SEZ units, which are taxed at higher rates.

Mehra proposes that “manufacturers in India should have the ‘most favoured nation’ status that implies lowest tariff under the FTAs”. Rao concurs, saying “such reductions should be extended to all manufacturers, not simply the ones in SEZs”.

But experts contend that taxation issues are not the only ones impeding SEZs.

According to Mukherjee, “Despite offering over 300 incentives and schemes for promotion of manufacturing at the Centre and state levels, manufacturing growth has not risen substantially."

"Therefore, incentives need to be carefully evaluated and studied. Incentives should not be the only reason for units to be located in SEZs. Success depends on the business facilitation measures adopted. Location, infrastructure, logistics and professional zone management are four key factors determining success of SEZs.”  

A major reason for the success of SEZs in China was the creation of complementary infrastructure, power, roads and ports; these are lacking in India.

According to Rao, “To get SEZs and manufacturing going in India, the focus should be on creating the necessary infrastructure which will require a more holistic approach.”  

Anwarul Hooda and Durgesh Rai, in their study, also point out: “Another major reason for the SEZs languishing is the absence of external infrastructure support."

"The SEZs have to be connected with ports and airports with world-class roads and rail; ports and airports, too, have to be world-class, with Customs authorities adopting international best practices in trade facilitation. This is not the case at present. Deficiencies in the availability and quality of power are an equally important constraint.”