The commerce department has opposed bringing tax-free special economic zones (SEZs) under the ambit of the proposed direct taxes code, arguing that it could hit the development of such zones and ultimately hurt exports.

SEZ developers and units in these zones at present enjoy benefits under a special Act passed by Parliament and are spared from paying taxes on profits.

However, under the code, that has been circulated by the revenue department and which seeks to streamline the countrys tax regime by minimising exemptions and lowering rates, tax benefits will be linked to investments made by developers.

The code is also unclear about the tax treatment to units that operate out of SEZs and could erode the attractiveness of SEZs for businesses. It could particularly cut tax benefits enjoyed by SEZs, especially in sectors like IT where investments are low.

The commerce department therefore wants SEZs to be kept outside the new overarching code and has indicated this in a communication to the finance ministry, a department official told ET, requesting anonymity.

Such a demand signals a hardening in the stance of the department, which had earlier sought only a written assurance from the finance ministry that the new tax regime will not be applicable on the zones where developers have already started making investments.

Director general of export promotion council for export-oriented units (EoUs) and SEZs LB Singhal said that while the proposed code contradicted provisions of the SEZ Act, ambiguities in the new proposal was making things worse and investors were shying away from taking investment decisions.

The proposed code allows so-called grandfathering of incentives, under which SEZs enjoying tax breaks under present rules would continue to do so. But there is no clarity on whether tax exemptions on export income available to SEZs and the exemption from minimum alternate tax would continue, Mr Singhal said.

He added that the government could not wait until 2011 to make clarifications as investors, both domestic and foreign, were hesitating from making investments in SEZs amid apprehension that these would fail to attract units if tax laws changed.

SEZ projects are typically long-gestation projects and lack of certainty about tax laws could make developers of these zones apprehensive about the returns that they would expect from prospective units coming up in them.