By S Sivakumar, CA

NEW DELHI, FEB 28, 2011: IT appears that post-Budget, the SEZ scheme would cease to be an attraction. The FM has withdrawn the two major benefits that SEZ Developers and SEZ Units are currently enjoying and which have largely contributed to the success of the scheme.

Sub-Section (6) of Section 115JB of the Income tax Act, 1961, had exempted SEZ Developers and SEZ Units from the operation of the Minimum Alternate Tax (‘MAT’) Scheme. In a very major setback, this Sub Section is being amended to remove the exemption given to SEZ Developers and SEZ Units. Consequently, SEZ Developers and SEZ Units would now be required to pay MAT @ 18.5%, with effect from April 1, 2011.

In terms of an amendment to Section 115-0 of the Income tax Act, the exemption given to the SEZ Developers and SEZ Units in respect of Dividend Distribution Tax (‘DDT’) is proposed to be withdrawn with effect from June 1, 2011.

Of course, as we know, under the Direct Taxes Code, the draft of which has already been tabled in the Parliament, there is no exemption for the SEZ Units from MAT and DDT. While many of us were believing that the Government would not go back on the existing benefits given to the SEZ Units, the provisions withdrawing the exemption come as a major setback.

With this negative development, the whole SEZ scheme might lose its benefit, post Budget. With the withdrawal of the tax holiday benefit for the 100% Export Oriented Units including the STP Units, it was expected that the Budget would facilitate the migration of the STP Units to the SEZ scheme, by withdrawing the statutory provisions in Section 10AA of the Income tax Act, which disallow the tax holiday for units which are set up due to re-structuring, etc. While these provisions continue to exist, making the process of conversion of existing STP Units into SEZ Units extremely unattractive from the tax holiday point of view, the withdrawal of the exemption given to SEZ Units, in respect of MAT and DDT, could well kill the SEZ scheme.

The Direct Taxes Code Bill has proposed that, SEZ Units set up till March 31, 2014, would be entitled for the tax holiday. However, with the withdrawal of the exemption from MAT and DDT and with the MAT rate also steadily increasing (the MAT rate has gone up to 18.5% in this Budget), the tax holiday for the SEZ Units might mean little.

In my view, the proposal to withdraw the MAT exemption for SEZ Units, is a case of promissory estoppel and is completely unjustified vis-à-vis the existing SEZ Units, which have been set up, interalia, on the basis of the promise that they would not be asked to pay MAT. Moreover, where is the justification for the Finance Ministry to use the Income tax Act to levy tax on SEZ Units, in utter disregard of the fact that it is the Special Economic Zones Act, 2005, which is applicable to the SEZ Units?

In another development in the Budget, in terms of Notification No. 17/2011, the SEZ Units, importing taxable services which are ‘wholly consumed’ within the SEZ are to be exempted from the payment of service tax, under Section 66A of the Finance Act, 1994, under the “Reverse Charge” mechanism. However, if these imported services are not ‘wholly consumed’ within the SEZ, the SEZ Units can go in a refund of the service tax paid on the reverse charge mechanism. This is a small benefit considering the fact that, which input service is to be considered as ‘wholly consumed’ is still left to the whims and fancies of the Development Commissioners.

One does hope that the Finance Minister would do a rethink on the withdrawal of the exemption from MAT, given to SEZ Units, which could kill the very scheme. If at all it is deemed necessary, the MAT rate for SEZ units could be fixed at a lower rate of about 5%.

(The Author is Director, S3 Solutions Pvt Ltd, Bangalore)