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Two words that cause a tax glitch in SEZ
April, 14th 2007
Despite the controversies over the future of SEZs, the tax holiday being provided by Section 10AA appears the best attraction for entrepreneurs to set up their business units in an SEZ.

MR SANDIP MUKHERJEE, Associate Director, PricewaterhouseCoopers.

SEZ is a `fact of life', says the Prime Minister, Dr Manmohan Singh. Protests against the special economic zone (SEZ) concept have similarly become a fact of life, given the competing demands for the use of land. For instance, doubts are in the air about Posco's proposed steel plant at Jagatsinghpur in Orissa, because the proposed site is said to be fertile land. Land acquisition notification issued for DLF's SEZ project in Amritsar is allegedly running into rough weather. And confusion hovers around the Reliance SEZ in Panvel.

Silently, tax professionals too have been agitating: over controversies that SEZ holiday computation stirs up, even as every corporate house wants to jump onto the SEZ bandwagon to cash on the tax breaks provided to developers and units. One such controversy is about two words assessee and unit. The way these words have been deployed in the tax law has given rise to a possible anomaly of treating companies with multiple units less advantageously than those with a single unit, says Mr Sandip Mukherjee, Associate Director, PricewaterhouseCoopers.

Business Line interacts with Mr Mukherjee to know more about the niggling incongruity.

First, the law.

Section 10AA of the Income-tax Act, 1961 provides for a complete tax holiday to SEZ units for a period of five years, from the year in which the unit begins its manufacture or production. The tax holiday is limited to 50 per cent of the profits of the unit for subsequent 10 years (subject to creation of appropriate reserves in the last 5 years).

Is that attractive enough, as a tax incentive, in the context of the prevailing ground situation?

Notwithstanding the current socio-political controversies surrounding the future of SEZs in India, the tax holiday being provided by Section 10AA appears to be the best attraction driver for entrepreneurs to set-up their business units in an SEZ.

However, the tax benefit may not, in reality, be as beneficial as it looks, prima facie. Unit has been defined in Section 2(zc) of the SEZ Act 2005 to mean a unit set up by an entrepreneur in a SEZ and includes inter alia an existing unit, whether established before or established after commencement of the SEZ Act. Entrepreneur means a person who has been granted a letter of approval by the Development Commmissioner to set up an unit in the SEZ.

Why so?

Because of an apparent drafting anomaly is Section 10AA(7), which deals with the computation of the profits of the unit eligible for deduction. As per the Section, the profits of the unit eligible for deduction under Section 10AA, should be in the same proportion, which the export turnover of the unit has with total turnover of the assessee.

An `assessee' has been defined as a person, who is liable to pay tax under the Act. Further, a `person' has been defined to include individuals, HUF, company, firm, AOP, etc.

Can you illustrate the anomaly through an example?

If an SEZ unit has earned profit of, say, Rs 100, which is entirely from eligible exports, the deduction available to the unit under Section 10AA would also be Rs 100. However, the situation could be different in case of an assessee having multiple units (where one or some of the units are not SEZ/tax holiday units). The computation mechanism provided by Section 10AA(7) may not give the desired result in such a situation.

An illustration for the multiple unit case.

Suppose a company has a non tax-holiday (that is, DTA unit) and an SEZ unit. And, say, the total turnover of the company is Rs 100, of which the DTA unit contributes Rs 50 and the SEZ unit, Rs 50 (entirely from exports). The profit of the DTA unit is, say, Rs 25 and the profit of the SEZ unit is also Rs 25. In such situation, going by a strict technical interpretation of Section 10AA(7), the profit eligible for deduction under Section 10AA in the case of the SEZ unit, could, arguably, be limited by the Revenue authorities, to Rs 12.50 (25*50/100), which otherwise should have been the entire Rs 25 (25*50/50).

The above anomaly could thus, unintentionally, put companies under SEZ tax holiday regime and having multiple units, in a disadvantageous position, compared to a company with a single unit.

What is the remedy?

To overcome the above harsh treatment, there is an apprehension that a new entity has to be incorporated for establishing the SEZ unit, such that the turnover of the new entity and the unit becomes aligned to each other. Thus, the entire profits of the SEZ unit can then be deductible for tax holiday.

Do you think the Government would have intended the SEZ tax holiday provision to work that way?

Doubtful. It may be pertinent to refer the provisions of Section 10A and 10B of the Act, which provide for similar tax holiday benefits to units engaged in exports. Unlike Section 10AA, both these Sections categorically provide for a comparison of export turnover of the undertaking with the total turnover of the undertaking.

With more and more entrepreneurs planning to set-up SEZ units, the above apprehension in minds of taxpayers needs to be clarified by the CBDT immediately, so as to avoid unnecessary litigation. The word `undertaking', though, has not been defined in the Income-Tax Act.

D. Murali

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