Tax Implications of Setting up Business in an SEZ

Tax Implications of Setting up Business in an SEZ - An analysis of Recent Rulings . In the vibrant landscape of India's economic development, Special Economic Zones (SEZs) stand out as lucrative hubs for businesses seeking growth opportunities. Boasting an array of enticing incentives and tax benefits, SEZs have emerged as favored destinations in India for both domestic and international investors looking to establish or expand their operations in the country. From income tax exemptions to customs duty waivers, these designated zones offer a conducive environment for businesses to thrive, fostering innovation, competitiveness, and job creation. In this article by Compliance Calendar, we delve into tax advantages that SEZs in India offer, and analyze recent rulings that help entrepreneurs leverage economic benefits of Special Economic Zones in India.
Special Economic Zones - Unlocking India’s economic potential
A Special Economic Zone (SEZ) in India is a designated geographical area with specific economic regulations and policies aimed at promoting industrial growth, exports, and foreign investment. These zones are established by the government to create a conducive environment for businesses to flourish by offering various incentives, including tax benefits, streamlined regulatory processes, and infrastructure support.
What specific advantages are available to businesses established and operating in SEZs in India?
The following are the distinct advantages of operating a business in a special economic zone:

Designated duty-free enclaves : SEZs are legally treated as a territory outside the customs territory of India. Thus, entry and exit of goods within and from SEZ is duty-free.

No license required for import - Units operating in SEZs do not require import license

Manufacturing or service businesses have unique advantages - SEZs in various states are equipped with state of the art plug and play facilities, integrated logistics, warehousing and excellent connection facilities. Thus, SEZs are focusing on specific industries such as manufacturing, IT/ITES (Information Technology/Information Technology Enabled Services), biotechnology, and electronics, among others.

The Units in SEZs are required to achieve Positive Net Foreign Exchange to be calculated cumulatively for a period of five years from the commencement of production. They also have complete freedom for subcontracting, and are usually not burdened with routine examination by customs authorities of export/import cargo.

Taxation exemptions available to units located in Special Economic Zones in India
Section 26 of the SEZ Act read with Rule 31 of SEZ Rules gives a wholesale exemption from payment of duties under the Central Excise Act, Customs Act and from Service Tax under the Finance Act, 1994 on taxable services provided to SEZ units and developers for carrying on authorized operations within the SEZ.
The other tax exemptions available to units located in SEZs are listed below:

Income Tax exemption - Income tax is exempted on income derived from the business of development of the SEZ in a block of 10 years in 15 years under Section 80-IAB of the Income Tax Act. 100% Income Tax exemption on export income for SEZ units under Section 10AA of the Income Tax Act for first 5 years, 50% for next 5 years thereafter and 50% of the plowed back export profit for next 5 years. (Sunset Clause for Units will become effective from 01.04.2020)

Sales tax and Service Tax exemption - Exemption from Central Sales Tax (CST). Exemption from Service Tax (Section 7, 26 and Second Schedule of the SEZ Act). However, these have now been subsumed into the Goods and Service Tax

Zero rated supplies - Supplies to SEZ are zero rated under IGST Act, 2017

Duty free import/domestic procurement of goods for development, operation and maintenance of SEZ units.

Levies and approvals - Other levies as imposed by the respective State Governments are exempted. SEZ units also have special provisions for Single window clearance for Central and State level approvals.

Tracing the regulatory and judicial precedents on tax exemptions available to business units in SEZ Parliament itself has provided for no customs, excise and service tax for SEZ units 
- In the case of SRF Ltd., Vs. Commissioner of Customs, Excise & Service Tax, LTU New Delhi 2022 (64) GSTL 489 (Tri. Del.) which dealt with the issue of entitlement of refund of service tax where some of the services were directly provided to and paid for by the SEZ unit while certain other services were provided to the head office which was registered as an Input Service Distributor (ISD), it was held that the SEZ Act itself provides for exemption of Central excise duty, Customs duty and the Service tax.
Hence, the charge of excise duty under Section 3 of the Central Excise Act, the charge of Customs Duty under Section 12 of the Customs Act and the charge of service tax under Sections 66, 66A and 66B of the Finance Act, 1994 will not apply to goods and services supplied to developers and units for authorized operations in the SEZ areas by virtue of the overriding provisions of the SEZ Act. Any exemption notifications and conditions therein are therefore, redundant because, the Parliament itself has, through Section 51 of the SEZ Act, overridden the charge in the other laws.
Lupin Limited vs Commissioner of Central Goods and Service Tax and Central Excise, order passed on March 23, 2023
This landmark case held that a delay beyond one year in filing a claim for refund of input tax credit by an Input Service Distributor would not be time-barred.
Brief Facts -

Lupin Limited is a manufacturer and exporter of pharmaceutical products located in SEZ, Pithampur.

The applicant filed Form A-4 to claim refund of service tax paid on input services received in the SEZ for sums amounting to 17 crores and 95 lakhs in 2017.

The adjudicating authority as well as Commissioner (Appeals) rejected the same on ground of being time barred, as under Notification No 12/2023 only a limit of one year is available.

The arguments of the appellant (Lupin Limited) were:

SEZ Act, 2005 is a special act and hence it prevails over other acts.

An SEZ unit that is engaged in providing services as an Input Service Distributor, and would only come to know of taxes after receiving the Input Service Distributions Invoice.

Hence, the date of these invoices should be considered for calculating the time period of one year and not the date of payment of service tax.
The order passed by CESTAT, New Delhi
Liberal and beneficial provisions must be extended to the appellant - The tribunal held that once an appellant is found to be eligible to claim the refund, the substantive conditions are complied with and the condition of time limit for making the claim under the notification being only a procedural requirement, needs to be construed liberally. Considering the beneficial object of establishing the SEZ tax free, without any burden of duties, the procedural lapse, if any, cannot be the basis to deny the refund to the appellant.
Service tax exemptions to unit in SEZ cannot be denied merely on ground of procedural lapses - In eClerx Services Limited Versus Commissioner of CGST & Central Excise decided on September 1, 2022
Brief facts -

The Commissioner passed an order for the recovery of 11.89 crores as tax payable under section 73 of the Finance Act, 1994 for the period from 2008-09 to 2012-13 along with applicable interest under section 75 of the Finance Act, 1994.

The assessed had submitted that the adjudication order had failed to appreciate that the services rendered by them to M/s Credit Suisse Services (India) Pvt. Ltd were not taxable owing to the privileges conferred upon the recipient by the Special Economic Zones Act, 2005.

Order of the Mumbai Bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT)
The tribunal quashed the service tax demand and held that the exemption afforded by section 26 of the Special Economic Zones Act, 2005 is overriding in nature and the breach of conditions is procedural. Even if the required documentation was not available for the entire period of the dispute it cannot be denied that at some point, the eligibility did exist. Hence, the demand for recovery was set aside.
Movement of goods in SEZ is within ‘customs territory’, SEZ is not an area outside India, and movement of goods from SEZ to anywhere in the country is export on which duty is exempted In RHC Global Exports Private Limited versus Union of India decided on June 6, 2023, it was clarified that Section 53 provides that the Zone would be deemed to be a territory outside the customs territory of India for the purposes of undertaking the authorized operations. The term 'customs territory' cannot be equated to the territory of India and in fact, such term has been defined in the General Agreement of Tariffs & Trade, to which India is a signatory, to mean an area subject to common tariff and regulations of commerce and that there could be more than one customs territory in a country. Moreover such an interpretation would lead to a situation where a Special Economic Zone would not be subject to any laws whatsoever. The entire SEZ Act 2005 would be rendered redundant since it is stated to extend the whole of India. In any case, various provisions of the SEZ Act would be rendered redundant and unworkable if the Special Economic Zone was to be considered an area outside India. This is apart from the fact that such a declaration would be constitutionally impermissible.
In the Essar Steel Limited case, it was held that movement of goods from the Domestic Tariff Area to the Special Economic Zone has been treated as export by a legal fiction created under the SEZ Act, 2005. A legal fiction is to be restricted to the statute which creates it. Such movement has been treated as export under the SEZ Act 2005 for the purpose of making available benefits as in the case of actual exports like duty drawback, DEPB benefits, etc. to the Special Economic Zone Unit / Developer or the Domestic Tariff Area supplier at their option. Construing this movement of goods as entailing a liability of payment of duty runs absolutely counter to the purpose of the legal fiction created under the SEZ Act, 2005
Refund of full IGST credit allowed when zero rated supplies made by units located in SEZ M/S. Ipca Laboratories Ltd vs Commissioner, Gujarat High Court (dated Feb 18, 2022)
In this landmark case, the Gujarat High Court ordered to grant the petitioner refund of input tax credit on inward supply charged by the supplier and IGST credit lying in the Electronic Credit Ledger.
Brief facts

The Applicant was a pharmaceutical company and one of its manufacturing facilities was located in the SEZ Kandla (Special Economic Zone).

The Applicant was authorized to operate in the export of goods under the Letter of Undertaking from the SEZ unit.

In the 2017-18 year, it accumulated ITC worth INR 21,66,887. This ITC was received by the Applicant basis the integrated tax from its ISD (Input Service Distributor) and ITC inward supply charged by the supplier was as permissible under law.

Grounds for denial of input tax credit by GST authorities:

No circular or notification or guidelines had been issued by the Board for processing GST refund claim applications of units situated in SEZs regarding tax paid on inward supplies.

The Applicant, situated in Kandla SEZ as per CGST Act where the supply of goods/services to SEZ units were Zero Rated, hence, the Applicant was not eligible for a refund under Section 54 of the CGST Act.

Consequently, the refund claim of INR 21, 66, 867 was rejected under Section 54 of the Act.

The Applicant contended that because it is an SEZ Unit which was making Zero Rated Supplies under the GST Act, the Applicant did not utilize the credit which was lying unutilized in the Electronic Credit Ledger.
 
The court while referring to landmark decisions such as M/S Britannia Industries Ltd vs UOI, quashed the order of the tax authorities and directed refund of the input tax credit.
For businesses with multiple units, benefits available to SEZ units are unique and distinct - Units located in a SEZ shall be treated as a distinct entity than other units that are a part of the same business but located outside the SEZ area. (CESTAT Ahmedabad). Hence, it is advisable for medium and large businesses to diversify their units and evaluate the economic advantages of distributing manufacturing and service supplying units across SEZs.
Conclusion
With infrastructural access and tax advantages, setting up a successful business in India through the SEZ route is a worthwhile alternative to explore. As we have seen, the courts have largely adopted a business friendly approach towards tax issues involving units located in SEZs.
Having advised diverse corporate clientele in direct and indirect taxation , incorporating a company in India and securing refunds for input services, Compliance Calendar’s bouquet of services are unparalleled in helping you setting up your business in Special Economic Zones in India.

In the vibrant landscape of India's economic development, Special Economic Zones (SEZs) stand out as lucrative hubs for businesses seeking growth opportunities. Boasting an array of enticing incentives and tax benefits, SEZs have emerged as favored destinations in India for both domestic and international investors looking to establish or expand their operations in the country. From income tax exemptions to customs duty waivers, these designated zones offer a conducive environment for businesses to thrive, fostering innovation, competitiveness, and job creation. In this article by Compliance Calendar, we delve into tax advantages that SEZs in India offer, and analyze recent rulings that help entrepreneurs leverage economic benefits of Special Economic Zones in India.

Special Economic Zones - Unlocking India’s economic potential

A Special Economic Zone (SEZ) in India is a designated geographical area with specific economic regulations and policies aimed at promoting industrial growth, exports, and foreign investment. These zones are established by the government to create a conducive environment for businesses to flourish by offering various incentives, including tax benefits, streamlined regulatory processes, and infrastructure support.

What specific advantages are available to businesses established and operating in SEZs in India?

The following are the distinct advantages of operating a business in a special economic zone:

Designated duty-free enclaves : SEZs are legally treated as a territory outside the customs territory of India. Thus, entry and exit of goods within and from SEZ is duty-free.
No license required for import - Units operating in SEZs do not require import license
Manufacturing or service businesses have unique advantages - SEZs in various states are equipped with state of the art plug and play facilities, integrated logistics, warehousing and excellent connection facilities. Thus, SEZs are focusing on specific industries such as manufacturing, IT/ITES (Information Technology/Information Technology Enabled Services), biotechnology, and electronics, among others.
The Units in SEZs are required to achieve Positive Net Foreign Exchange to be calculated cumulatively for a period of five years from the commencement of production. They also have complete freedom for subcontracting, and are usually not burdened with routine examination by customs authorities of export/import cargo.

Taxation exemptions available to units located in Special Economic Zones in India

Section 26 of the SEZ Act read with Rule 31 of SEZ Rules gives a wholesale exemption from payment of duties under the Central Excise Act, Customs Act and from Service Tax under the Finance Act, 1994 on taxable services provided to SEZ units and developers for carrying on authorized operations within the SEZ.

The other tax exemptions available to units located in SEZs are listed below:

Income Tax exemption - Income tax is exempted on income derived from the business of development of the SEZ in a block of 10 years in 15 years under Section 80-IAB of the Income Tax Act. 100% Income Tax exemption on export income for SEZ units under Section 10AA of the Income Tax Act for first 5 years, 50% for next 5 years thereafter and 50% of the plowed back export profit for next 5 years. (Sunset Clause for Units will become effective from 01.04.2020)
Sales tax and Service Tax exemption - Exemption from Central Sales Tax (CST). Exemption from Service Tax (Section 7, 26 and Second Schedule of the SEZ Act). However, these have now been subsumed into the Goods and Service Tax
Zero rated supplies - Supplies to SEZ are zero rated under IGST Act, 2017
Duty free import/domestic procurement of goods for development, operation and maintenance of SEZ units.
Levies and approvals - Other levies as imposed by the respective State Governments are exempted. SEZ units also have special provisions for Single window clearance for Central and State level approvals.

Tracing the regulatory and judicial precedents on tax exemptions available to business units in SEZ Parliament itself has provided for no customs, excise and service tax for SEZ units

- In the case of SRF Ltd., Vs. Commissioner of Customs, Excise & Service Tax, LTU New Delhi 2022 (64) GSTL 489 (Tri. Del.) which dealt with the issue of entitlement of refund of service tax where some of the services were directly provided to and paid for by the SEZ unit while certain other services were provided to the head office which was registered as an Input Service Distributor (ISD), it was held that the SEZ Act itself provides for exemption of Central excise duty, Customs duty and the Service tax.

Hence, the charge of excise duty under Section 3 of the Central Excise Act, the charge of Customs Duty under Section 12 of the Customs Act and the charge of service tax under Sections 66, 66A and 66B of the Finance Act, 1994 will not apply to goods and services supplied to developers and units for authorized operations in the SEZ areas by virtue of the overriding provisions of the SEZ Act. Any exemption notifications and conditions therein are therefore, redundant because, the Parliament itself has, through Section 51 of the SEZ Act, overridden the charge in the other laws.

Lupin Limited vs Commissioner of Central Goods and Service Tax and Central Excise, order passed on March 23, 2023

This landmark case held that a delay beyond one year in filing a claim for refund of input tax credit by an Input Service Distributor would not be time-barred.

Brief Facts -

Lupin Limited is a manufacturer and exporter of pharmaceutical products located in SEZ, Pithampur.
The applicant filed Form A-4 to claim refund of service tax paid on input services received in the SEZ for sums amounting to 17 crores and 95 lakhs in 2017.
The adjudicating authority as well as Commissioner (Appeals) rejected the same on ground of being time barred, as under Notification No 12/2023 only a limit of one year is available.

The arguments of the appellant (Lupin Limited) were:

SEZ Act, 2005 is a special act and hence it prevails over other acts.
An SEZ unit that is engaged in providing services as an Input Service Distributor, and would only come to know of taxes after receiving the Input Service Distributions Invoice.

Hence, the date of these invoices should be considered for calculating the time period of one year and not the date of payment of service tax.

The order passed by CESTAT, New Delhi

Liberal and beneficial provisions must be extended to the appellant - The tribunal held that once an appellant is found to be eligible to claim the refund, the substantive conditions are complied with and the condition of time limit for making the claim under the notification being only a procedural requirement, needs to be construed liberally. Considering the beneficial object of establishing the SEZ tax free, without any burden of duties, the procedural lapse, if any, cannot be the basis to deny the refund to the appellant.

Service tax exemptions to unit in SEZ cannot be denied merely on ground of procedural lapses - In eClerx Services Limited Versus Commissioner of CGST & Central Excise decided on September 1, 2022

Brief facts -

The Commissioner passed an order for the recovery of 11.89 crores as tax payable under section 73 of the Finance Act, 1994 for the period from 2008-09 to 2012-13 along with applicable interest under section 75 of the Finance Act, 1994.
The assessed had submitted that the adjudication order had failed to appreciate that the services rendered by them to M/s Credit Suisse Services (India) Pvt. Ltd were not taxable owing to the privileges conferred upon the recipient by the Special Economic Zones Act, 2005.

Order of the Mumbai Bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT)

The tribunal quashed the service tax demand and held that the exemption afforded by section 26 of the Special Economic Zones Act, 2005 is overriding in nature and the breach of conditions is procedural. Even if the required documentation was not available for the entire period of the dispute it cannot be denied that at some point, the eligibility did exist. Hence, the demand for recovery was set aside.

Movement of goods in SEZ is within ‘customs territory’, SEZ is not an area outside India, and movement of goods from SEZ to anywhere in the country is export on which duty is exempted In RHC Global Exports Private Limited versus Union of India decided on June 6, 2023, it was clarified that Section 53 provides that the Zone would be deemed to be a territory outside the customs territory of India for the purposes of undertaking the authorized operations. The term 'customs territory' cannot be equated to the territory of India and in fact, such term has been defined in the General Agreement of Tariffs & Trade, to which India is a signatory, to mean an area subject to common tariff and regulations of commerce and that there could be more than one customs territory in a country. Moreover such an interpretation would lead to a situation where a Special Economic Zone would not be subject to any laws whatsoever. The entire SEZ Act 2005 would be rendered redundant since it is stated to extend the whole of India. In any case, various provisions of the SEZ Act would be rendered redundant and unworkable if the Special Economic Zone was to be considered an area outside India. This is apart from the fact that such a declaration would be constitutionally impermissible.

In the Essar Steel Limited case, it was held that movement of goods from the Domestic Tariff Area to the Special Economic Zone has been treated as export by a legal fiction created under the SEZ Act, 2005. A legal fiction is to be restricted to the statute which creates it. Such movement has been treated as export under the SEZ Act 2005 for the purpose of making available benefits as in the case of actual exports like duty drawback, DEPB benefits, etc. to the Special Economic Zone Unit / Developer or the Domestic Tariff Area supplier at their option. Construing this movement of goods as entailing a liability of payment of duty runs absolutely counter to the purpose of the legal fiction created under the SEZ Act, 2005

Refund of full IGST credit allowed when zero rated supplies made by units located in SEZ M/S. Ipca Laboratories Ltd vs Commissioner, Gujarat High Court (dated Feb 18, 2022)

In this landmark case, the Gujarat High Court ordered to grant the petitioner refund of input tax credit on inward supply charged by the supplier and IGST credit lying in the Electronic Credit Ledger.

Brief facts

The Applicant was a pharmaceutical company and one of its manufacturing facilities was located in the SEZ Kandla (Special Economic Zone).
The Applicant was authorized to operate in the export of goods under the Letter of Undertaking from the SEZ unit.
In the 2017-18 year, it accumulated ITC worth INR 21,66,887. This ITC was received by the Applicant basis the integrated tax from its ISD (Input Service Distributor) and ITC inward supply charged by the supplier was as permissible under law.

Grounds for denial of input tax credit by GST authorities:

No circular or notification or guidelines had been issued by the Board for processing GST refund claim applications of units situated in SEZs regarding tax paid on inward supplies.
The Applicant, situated in Kandla SEZ as per CGST Act where the supply of goods/services to SEZ units were Zero Rated, hence, the Applicant was not eligible for a refund under Section 54 of the CGST Act.
Consequently, the refund claim of INR 21, 66, 867 was rejected under Section 54 of the Act.

The court while referring to landmark decisions such as M/S Britannia Industries Ltd vs UOI, quashed the order of the tax authorities and directed refund of the input tax credit.

For businesses with multiple units, benefits available to SEZ units are unique and distinct - Units located in a SEZ shall be treated as a distinct entity than other units that are a part of the same business but located outside the SEZ area. (CESTAT Ahmedabad). Hence, it is advisable for medium and large businesses to diversify their units and evaluate the economic advantages of distributing manufacturing and service supplying units across SEZs.

Conclusion

With infrastructural access and tax advantages, setting up a successful business in India through the SEZ route is a worthwhile alternative to explore. As we have seen, the courts have largely adopted a business friendly approach towards tax issues involving units located in SEZs.

Having advised diverse corporate clientele in direct and indirect taxation , incorporating a company in India and securing refunds for input services, Compliance Calendar’s bouquet of services are unparalleled in helping you setting up your business in Special Economic Zones in India.