The new draft direct tax code that seeks to simplify and rationalise the countrys direct tax structure has come under fire from the commerce department for its suggestions on doing away with exemptions for special economic zones (SEZs).

The department has taken up the issue with the finance ministry, pointing out that removing exemptions would render the SEZ Act ineffective, a commerce department official has said.

We have started official consultations with the revenue department on the issue of the proposed withdrawal of exemptions for SEZs. We feel that removal of exemption would shake investor confidence in India and affect flow of investments into SEZs, the official said.

Under the SEZ Act, developers are entitled to 100% tax exemption on profits for ten years in a block for the first fifteen years of operation. SEZ units are entitled to 100% tax exemption on export profits in the first five years of operations. They are eligible for 50% exemption on export profits for the next five years while for the following five years, units get up to 50% exemption on reinvested profits.

Under the proposed direct tax code, SEZ developers would be allowed to only recover capital and revenue expenditure (except expenditure on land) and would be liable to income tax on profits made thereafter.

This means that the new direct tax code, if implemented in its present form, will lead to a total switchover from profit-linked incentives. This is contrary to the provisions of the SEZ Act, LB Singhal, director-general, export promotion council for EoUs and SEZs, told ET.

In the case of SEZ units too, profit-linked incentives would be substituted by a new scheme. All this has created a lot of uncertainty. Our council gets several queries every day from developers, units and international investors seeking clarification on the future of the SEZ policy, Mr Singhal added.

The commerce department official pointed out that the department had pointed out to the finance ministry that SEZs in the country had started doing well only after the SEZ Act was put in place in 2005 and the rules were spelt out in February 2006.

While investments just trickled in the first five years since the SEZ scheme was introduced in 2005, there was a surge in investments only when the act was implemented. SEZs have attracted of Rs 1,00,000 crore in investments so far and have led to the employment of several lakhs of workers, the official said.

The draft direct tax code put in place by the revenue department is being discussed extensively by various departments and ministries of the government and the industry. The finance ministry will hold a meeting with major industry chambers on October 9th to get their inputs on the draft.