India proposes New Special Economic Zone Legislation - Summary of tax incentives provided

A few months ago, the Government released the Special Economic Zones Bill, 2004 ("Bill") to provide for the establishment, development and management of Special Economic Zones in India ("SEZs"). It is proposed that SEZ units would be exempt from payment of taxes, duties or cess under certain specified central acts on exports and imports of goods and services. Further, these units would also be granted certain income tax benefits. We have summarized in this hotline, some of the important tax benefits.

The Bill proposes the insertion of section 10AA to the Income Tax Act, 1961 ("ITA") for granting tax exemption to any unit, which begins its operations on or after April 1, 2005 in any SEZ. The conditions for availing the exemption are similar to those available to units in software technology parks, i.e. the unit must not be formed by the splitting up, or reconstruction, of a business already in existence, the unit cannot be formed with used plant and machinery constituting more than 20% of the total value of its plant and machinery, etc. The SEZ unit would be able to claim a 100% tax holiday on profits derived from the export of goods and services for a period of 5 consecutive years beginning with the year in which it begins its operations, and for the next ten years, a deduction of upto 50% of the profit credited to a Special Economic Re-investment Reserve Account to be utilized for the purchase of plant and machinery or for any other business in accordance with the conditions laid down under the Bill.

The Bill also proposes to exempt any capital gains arising from the transfer of a capital asset used for the purposes of business by an industrial undertaking due to the shifting of such undertaking from an urban area to a SEZ. The undertaking would be required to fulfill certain conditions for this exemption. The Bill also proposes insertion of an additional section in the ITA under which a deduction for 100% of the profits derived from any business of developing/ developing and operating/ developing, operating and maintaining a SEZ would be allowed. Such tax holiday would be available for a period of 10 years out of first 15 years beginning from the year in which the developer develops and begins to operate the SEZ, provided it develops and begins such operations between April 1, 2004 and March 31, 2014.

The Bill also proposes to exempt SEZ units from paying dividend distribution tax on payment of dividends. Such dividends will also not be subject to tax in the hands of the shareholders. A manufacturer located in a SEZ can sell goods produced in the SEZ unit in the domestic market upto a limit of thirty percent of the value of exports. However the manufacturer will be required to pay all the applicable duties under the customs and excise acts in respect of these sales.

Additionally, the Bill proposes that any taxable services will be exempt from service tax, where such services are provided to the SEZ unit.

Source: The Special Economic Zones Bill, 2004.

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