Factories, Business Processing Units and software development firms inside Special Economic Zones (SEZ) will lose all income tax benefitsthe most crucial incentive for the tax free industrial enclaves if the direct taxes code replaces the Income Tax Act of 1961 without any change.

The proposed norms also talk of tightening tax incentives to developers of SEZs, which are notified after the new income tax law is operationalised.

The underlying principle behind not allowing income tax incentives to the SEZs is that new code discourages profit-based exemptions of any kind. Instead, it calls for linking tax benefits to investment related expenditure in nine activities, including development of SEZs.

The SEZ Act of 2005 doles out a slew of direct and indirect tax exemptions for units and developers of SEZs. These exemptions are implemented through various provisions in the existing Income Tax Act.

The code does not mention anything about units inside SEZs, but has a separate chapter on proposed guidelines that specify how developers of the tax-free industrial enclaves will be treated in the new tax regime.

If the provisions of the code get translated in to the new Income Tax Act, it is clear that SEZ units set up after the new law is implemented, will not enjoy any direct tax exemptions.

At the moment, there are 2,279 functional units inside the zones, out of which only 478 have been set up after February 2006, when the SEZ Act became operational. There are 98 operational SEZs while the board of approval under the commerce ministry has formally approved over 570. As many as 325 SEZs are notified.