SEZ Legislation and Policy Paper

8/14/2019 SEZ Legislation and Policy Paper

1/42


2/42

SEZs - Legislation & PolicyDiscussion Material


3/42

Infrastructure Advisory3

Discussion Backdrop (1/2)

SEZ is a geographical region that has economic laws that are more liberal than a country's typicaleconomic laws and is typically created to serve one or more of the following purposes

To enhance foreign investment

To promote exports from the country

To create a level playing field for the domestic enterprises and manufacturers to be competitive globally

Since the end of WW II, SEZs / EPZs / FTZs have been handed over as solutions to the

developing nations to jumpstart economic development

China, which started experimenting with SEZs from 1980 onwards, has shown great success inintegrating its economy to the worlds through these zones

India, which had earlier followed the EOU / EPZ route for export promotions, came out with aSEZ policy in 2000 followed by an act in 2005 on the lines of the Chinese model


4/42


Discussion Backdrop (2/2)Though controversial both inside and outside the government, the act has been a runaway success with thedeveloper community With more than 600 applications

Over 2200 sq. km. of promised development

Over USD 500 billion (Rs 22,00,000 crore) in annual revenues targeted

More than USD 120 billion in development investments (Rs 5,50,000 crore)

Today, the debate on SEZs is reaching a crescendo and the entire SEZ landscape is in a state of flux. Themajor issues of the SEZ debate are:

Policy and macroeconomic debate

Direction, consistency and impact of policy

Policy objective

Public good

Resource grabbing

Creation of private oligopolies

Microeconomic debate

SEZ formatsEconomics inherent in the SEZ concept for the various stakeholders

Land acquisition and R&R

Drain on public exchequer

Administration and regulation debate

Debate on alternatives


5/42


SEZs: Legislation & Policy - Agenda

SEZs Legislative Landscape

Central Laws

SEZ Policy Topical Issues

SEZ Policy State Comparison

State Laws

Summary

Policy exploitation for Real Estate

Revenue losses due to tax exemptions

Over-capacity creation

Diversion and locking of land

Tenability of private local government

Underserved domestic markets

Fate of EOUs and STPs post 2009

Undefined exit for units & developers


6/42




Central Laws



State Laws

Summary










7/42


Constitutional Backdrop

Section 1: India shall be a Union of States

Executive and legislative powers across allmatters in the country have been divided

between the Union and states

Section 73: The Executive Power of theUnion shall extend to matters which respect

to which the Parliament has the right tomake laws provided that it shall not,except as provided in the Constitution,extend in any State to matters with respectto which the Legislature of the State has alsopower to make laws

Schedule 7 of the Constitution defines thedistribution of legislative and executivepowers between the Central and State

Governments

The 74 th Constitutional Amendment Actprovides for devolution by the State

Legislature of powers and responsibilitiesupon Municipalities with respect topreparation of plans for economicdevelopment and social justice, and for theimplementation of development schemes


8/42


Distribution of Responsibilities

UNION LIST Railways, National Highways Foreign exchange and foreign loans Trade and commerce with foreign countries Definition of customs frontiers Income taxes, excise duties, customs duties

STATE LIST Public order & police Local government Public health & sanitation Roads, bridges, etc. Water Land, incl. Colonisation Industries Gas & gas works Taxes on:

Land & buildings Entry of goods into a local

area Consumption / sale of

electricity Sale / purchase of goods Professions, trades, etc. Luxuries & entertainments Stamp duties

CONCURRENT LIST Registration of births & deaths Ports, other than major ports Factories Boilers Electricity

12 th SCHEDULE FUNCTIONS OF

MUNICIPALITIES Urban planning Regulation of land use and construction of

buildings Planning for economic and social

development Water supply for domestic, industrial and

commercial purposes Public health, sanitation & solid waste Fire services Provision of urban services & amenities

parks, street lighting, parking lots, Burial / cremation grounds Registration of births & deaths


9/42


Regulatory Framework: CentralCentral SEZ Act:

The Special Economic Zone Act, 2005 defines regulation for SEZs within the domain of unionsubjects:

Stipulations regarding size and scope of SEZs

Approval and notification of Special Economic Zones

Institutional framework for the same

Institutional framework for the discharge of various regulatory functions at zone level DevelopmentCommissioner, Approval Committee

Delegation of powers under the Union list of subjects

Fiscal regime applicable to SEZ developers and units, under various subjects within the Union list

FDI approvals, establishment of units subject to industrial licensing

Definition of customs procedures, establishment of zone level customs facilities

Environmental laws and local rules regarding land planning etc apply on SEZs


10/42


Regulatory Framework: StateState Legislations:

Institutional facilitation mechanisms e.g.,

Empowered Committee in Maharashtra

Project Evaluation Committee; and Project Approval Committee

Zone-level administration mechanisms e.g.,

Industrial Township Authority in Maharashtra constitution, functions

Empowerment of developer for the discharge of various planning and infrastructure services within thezone:

Urban planningDelivery of infrastructure services, including electricity generation and distribution, water supply, waste watertreatment and solid waste, ports, roads / bridges and transportation services, gas distribution, telecommunicationand data distribution

Recovery of user charges for services above

Fiscal benefits to developer and units under various state legislations

Delegation of powers on various subjects within the state list to the Development Commissioner at zonelevel

Relaxation of the applicability of various state legislations to the zone


11/42


SEZ: Physical Concept

Notified Areaof SEZ

Non-Processing Area

FTWZIFSC

Entry / ExitPoint(s)

To be fully secured by taking suchmeasures as approved by the

Board of Approval

The DC of the SEZ is responsible for demarcating processing/non-processing areas

Land / built-up space in the processing areato be leased:

To entrepreneurs holding valid letters of

approval, with lease period co-terminus withLOA

For facilities for exclusive use of the Unitssuch as canteens, public telephone booths,first aid centres, creches, etc.

To a person desiring to create infrastructure

facilities for use by prospective Units

Facilities such as Free Trade & Warehousing Zones, International FinancialServices Centre may be approved forestablishment within the Processing Area

Developer may allot the land in the non-processing area for business and socialpurposes such as:

Educational institutions

Hospitals

Hotels

Recreation and entertainmentfacilities

Residential and business complexes

DTA units not allowed to set up


12/42


Flavors of SEZs Indian ContextSpecial Economic Zone for

Multi-Product

Special Economic Zone forMulti-Services

Minimum size = 1,000 hectares; Maximum size = 5000 hectares Contiguous area required Minimum size of processing area = 50%

Minimum size = 100 hectares Contiguous area required Minimum size of processing area = 50%

Special Economic Zone forSpecific Sector

Minimum size = 100 hectares Contiguous area required

Minimum size of processing area = 50%

Special Economic Zone inport / airport


Special Economic Zone forIT, Biotech, Non-

conventional Energy orGems & Jewellery

Minimum size = 10 hectares Contiguous area required

Minimum size of processing area = 50% Minimum built-up space (for IT SEZ) = 1 mn sq feet.

Special Economic Zone forFree Trade & Warehousing


Minimum built-up space of 100,000 sq. m. May be set up as part of an SEZ for multi-products

May be set up as part of an SEZ for specific sector, with area notexceeding 20% the zone area


13/42


SEZ Entity Landscape

ProjectExecution

BD, Mktg.& Sales

Servicedelivery

BusinessSupport

functions

Co-developers Providers

Board of Approvals

DevelopmentCommissioner

Unit ApprovalsCommittee DCs Office

Single Window

State Govt .

Residents Residential Industrial Commercial

CentralGovt.

Customs

Regulatory bodyDispute settlementtribunal

TownshipManagement

Developer

Utility & Infrastructure

Outsourced servicedelivery

Urban Planning& design

Oversight and facilitationcommittees

Industrial Township

AuthoritySPA


14/42


SEZ Institutional Framework - Overview

DevelopmentCommissioner

Grant all local and state level clearances,etc. delegated by the Central / StateGovernment. Monitor such approvals,licenses, registrations, etc.Make town planning regulations

Board of Approval

Approving proposals to set up SEZs Approval of authorized operations inan SEZFDI Approvals to Developers, Units

Approvals for infrastructure provision(through co-developers, etc.)

Approval Committee

Approve imports of goods and services intothe SEZ

Approve proposals forestablishment of SEZunits

Allow foreign

collaborations / FDIproposals duly cleared bythe Board of ApprovalMonitor compliance bySEZ Developer, units DeveloperPlanned development of SEZ

Prepare development plan Demarcate and develop sites

Allocate and transfer plots,buildings Regulate the erection of

buildings in accordance withthe plan

Develop, operate, maintaininfra

Demarcate Zone boundary

Regulator

Monitoring of infrastructureservices and O&M of the SEZ

Proper Officer

Customs

administration

Entity

SPV for delivery of Developer / Co-Developer Services

Co-Developer

Provider of infrastructure facilities

SEZ Development Authority

Governing body in the caseof state run SEZs(Equivalent to thedeveloper)

State oversight &

facilitation committees

Coordinates between the DCsoffice single window and thestate administrationEvaluates and approves SEZproposals at the state level


15/42


Central Government SEZ Legislative landscape

Central SEZ Act

Electricity Act

Rules accompanying the Central SEZ Act

Model Municipal Law

Acts & Policies

Board of Approvals

Development Commissioner

Entities

73 rd & 74 th Amendments

Unit Approval Committee

Regulatory Bodies

EOU / EHTP / STP Acts

SEZ Development Authority


16/42


States Typical SEZ Legislative landscape

State SEZ Act

State Land Policy

State Municipal Policy

State Labour Policy

Acts & Policies

State oversight & Facilitation Committee

Entities

State Town Planning Policy


17/42


18/42


19/42


State SEZ Policies (2/3)


20/42


Municipal PowersIndustrial Township Authority should be constituted

Developer should be the given control over the ITA

Model Provisions (1/2)

Planning Powers Developer should be given the power of a Special Planning Authority

Single Window

The state government should constitute an organization to facilitate between the SEZs and the

state government machinery in a transparent manner

Process Re-engineering at the state government department level is a must

Public UtilityService

Special Economic Zones should be declared Public Utility Service to ensure continuity of seamless operations



21/42


Labor PolicyState Labor union acts should be abrogated

Hire & fire

Model Provisions (2/2)

EnvironmentalPolicy Self certification should be allowed for non-polluting industries

Deemed ClearanceRoute

The state government should allow for deemed clearance route for approvals from stategovernment bodies

Land AcquisitionModel land acquisition policy should be formulated at the central level

R&R should be handled by a dedicated government body that collects user charges



22/42




Central Laws



State Laws

Summary










23/42


1 Policy exploitation by real estate developers who have no track record in economic activity / export promotion andassociated infrastructure creation / development scale

SEZ Policy Topical Issues (1/8)

Issues

2 Tax exemptions to drive significant revenue losses to state and central governments

3 Over-built SEZ capacity leading to under-performance

4 Diversion of large volumes of land from agriculture and other productive uses into potentially under-utilised SEZcapacity

5 Constitutional and moral tenability of large-population industrial-urban townships with non-elected, privately-runlocal governments with monopoly over utility and infrastructure provision

6 Under-served domestic markets, as industrial capacity is diverted to export use

7 The fate of STP units, EOUs, etc., post March 31, 2010

8 Undefined exit for units


24/42



Issue I: Policy Exploitation by Real Estate Developers (1/3)

Policy Highlights

at least fifty percent of the area shall be earmarked for developing processing area

A Developer may import or procure from the DTA without payment of duty, taxes or cess all

type of goods required for authorized operations

import of duty free material for setting up residential and / or business complex or any other

facilities in the non-processing area of the SEZ shall be as approved by the Board


25/42


Policy Analysis Quantum of Non-Processing Area

Is a 50% area for non-processing activities justifiable?

100%Total

Balance Agriculture & Water Bodies

12-14%Transportation12-14%Public & Semi-Public

18-20%Recreational

10-12%Industrial

4-5%Commercial

35-40%Residential

% Area Allocation

Land Use

UDPFI* Guidelines , issued by the MoUD,GOI, recommend the following areaallocations for large-scale projects

* Urban Development Plan Formulation & Implementation

Empirical evidence: Greater NOIDA

Land use breakup of Outline Development Planyear 2021 for Projected urban population of 12LakhsAs a model of smart town planning, landhas been appropriated for various activities asunder:

19%Industrial

6%Commercial

25%Residential12%Public and semi utilities

13%Transportation

25%Recreational




26/42


Low value addition 20-50%on land cost

Limited price appreciation 3-5% p.a. including overthe long term

Limited project returns 10-15%

Value addition 600-1000% on

land cost

Attractive long-term price trends e.g., 27% p.a. in Gurgaonover a 22 year period

Project returns of 45%+ arecommon

IndustrialEstate

RealEstate

Developer Incentive Structures

Developer incentives predominantly impelled by market forces have driven the view of SEZs as real estateopportunities

A combination of regulation, competitive forces and reduction in tax breaks for real estate activity required toreinforce policy objectives of export promotion

The solution is not to reduce the quantum of non-processing areas




27/42


SEZ Act Highlights: every Developer and the entrepreneur shall be entitled to the following exemptions, drawbacksand concessions, namely:

exemption from any duty of customs, to carry on the authorised operations

exemption from any duty of excise, on goods brought from Domestic Tariff Area to a Special Economic Zone orUnit, to carry on the authorised operations

drawback or such other benefits as may be admissible from time to time on goods brought or services providedfrom the Domestic Tariff Area into a Special Economic Zone

exemption from service tax on taxable services provided to a Developer or Unit to carry on the authorisedoperations

exemption from the levy of taxes on the sale or purchase of goods under the Central Sales Tax Act, 1956 if suchgoods are meant to carry on the authorised operations

Income Tax Act (Section 80-IAB):

Income tax exemption for Developers:100% for a period of 10 years (within a block of 15 years)

Income tax exemption for Units: 100% for a period of 5 years, 50% for a further 5 years, followed by another 5-year period where certain exemptions are allowed if reinvestment reserve is created out of profits


Issue II: Tax Breaks & Associated Revenue Losses to Central, State Governments (1/3)


28/42


A policy debate between the Ministry of Finance and Ministry of Commerce is underway key

concerns:

Continuing exemptions on various taxes and duties will be availed by exporting units (including EOUs, STP

units, etc.) that relocate to SEZs

Real Estate developers will benefit from tax exemptions to activities in the non-processing area, that arenot necessarily linked to export promotion

MOF estimates revenue losses of Rs. 100,000 cr p.a.

MOC projects revenue enhancement of Rs. 44,000 cr p.a. on account of enhanced economic activity




29/42


Not all of the available fiscal benefits are allowable under the WTO Agreement on Subsidies & CountervailingMeasures:

Tax exemptions to EOUs, STP Units, EPZ Units against export activity are to be phased out in April 2010 (sunset clause)

Prohibited subsidies under WTO, such as the full or partial exemption remission, or deferral specifically related to exports,

of direct taxes, will continue to be available to SEZ units even after the sunset period

Sectors where the country has reached export competitiveness e.g., textiles & clothing will require phasing out of

export subsidies

Countervailing remedies available to trading partners under WTO may nullify part of the benefits to exporters

Some benefits will not be countervailed e.g., those driven by superior / cheaper infrastructure, lower transaction costs inan SEZ, etc. leading to greater trade volume

The net effect of fiscal benefits will be determined by a complex interplay between the scale of countervailing

action, residual increases in competitiveness to exporting units, and the impact of these on incrementalexport-focused investment

Partial re-distribution of tax revenues from India (exporting country) to importing countries, due to the impact of

countervailing

Enhancement in trade volume, and therefore economic activity, indirectly enhancing government tax revenues




30/42


More than 600 applications for Special Economic

Zones at various stages of processing

Investment absorption capacity of Rs. 4,000,000 cr

Between 1991 and 2005, cumulative investment

intentions countrywide totaled Rs. 1,894,200 cr

Conversion of ~ 30% into physical investment on the

ground

Conclusion: severe over-capacity being planned in

the SEZ space


Issue III: Over-built SEZ capacity, leading to under-performance (1/2)

% of Formal & In-principle Approvals

Note: values in the order of Number, Percentage

Website: http://sezindia.nic.in/ ; Data as on 1 st May 2007

28, 7%6, 2%

31, 8%

19, 5%

17, 4%

167, 42%

75, 19%

53, 13%

Apparel and Textile Auto Sector

Biotech & Pharma Electronics

Engineering IT/ ITES

Multi Product / Multi Services Others


31/42


Large number of competing SEZs will limit success for all zones

Empirical evidence: China, which today has only 6 special economic zones

Shenzhen, near Hong Kong is the only zone to have reached significant levels of success

Pudong, near Shanghai, identified recently as a SEZ, is the other emerging star performer

Key inferences:

Only a limited number of zones will be successful

Very likely, these will be in close proximity to the countrys largest and most economically vibrant centres,

such as Mumbai, Pune, Bangalore, Delhi

Large tracts of land could be locked into non-performing SEZs


Issue III: Over-built SEZ capacity, leading to under-performance (2/2)


32/42


Significant over-capacity in SEZs will lead to under-utilisation of land

Industrial estates, especially in land-locked states such as Punjab, UP, etc. are characterised by

occupancy levels of 35-40% or less

Taxation structures applicable to SEZ units make them non-competitive in servicing the DTA

market

SEZ Act envisages no mechanism for de-notification of unsuccessful Zones

Even if such a mechanism is put in place, de-notification will be a challenge with reference to the fate of

any units located in such unsuccessful zones

Continuation of the EOU scheme in its current form or in a modified version may be necessary to

provide the flexibility to de-notify zones


Issue IV: Locking of large land tracts into under-utilised SEZ space


33/42


Constitution of India, Section 243Q

There shall be constituted in every state a municipal council (corporation) for a smaller (larger) urban

areaProvided that a Municipality may not be constituted in such urban area as the Governor may, havingregard to the size of the area and the municipal services being provided specify to be an industrialtownship

SEZ Bill, MaharashtraThe State Government may notify such (special economic) zone as an Industrial Township

The Authority for such township shall comprise the following members, namely:

The Chairman to be nominated by the Developer

Two members to be nominated by the Developer

One member to be nominated by the Development Commissioner

One member to be nominated by the State Government


Issue V: Privatized local government (1/2)


34/42


Key implications of prevailing policy environment:

Urban townships of whose populations could run into millions will not have a democratic process of election of local government

Private monopolies will be responsible for provision of a wide range of services falling into the third tierof government such as water supply, solid waste, sanitation,

Our expectation:

This will be a highly litigated element of SEZ policy, where the Supreme Court will probably need tointervene in coming years

In the meanwhile, a sector regulator is likely to be put in place, at least for tariff regulation


Issue V: Privatized local government (2/2)


35/42


-395

-395

-395

-39

5

-395

-395

-395

-39

5

-395

-39

5

-39

5

DTA Unit SEZ Unit D u t i e s / t a x e s o n D T A S a l e s ( % o f s a l e p r i c e )

Case II: Import Content of raw materials = 100%

Policy SEZ Act

Any goods removed from a SEZ to the DTA shall be chargeable to duties of customs including anti-dumping, countervailingand safeguard duties, as leviable on such goods when imported

The effect of this policy: to make servicing the DTA market non-competitive from within an SEZ location, especially whereproduction is based on local raw materials

D u t

i e s o n

R M

C u s t o m s o n

F G

E x c i s e

/ C V D o n

F G #

S a l e s

T a x

/ S A D

I n c o m e

t a x

O t h e r

t a x

e s *

-395

-395

-395

-39

5

-395

-395

-395

-395

-395

-395

-395

DTA Unit SEZ Unit D u t i e s / t a x e s o n D T A S a l e s ( % o f s a l e p r i c e )

Case I: Import Content of raw materials = 0%


Issue VI Under-served Domestic Market (1/2)


36/42


Key implications:

Separation of DTA and SEZ operations enforced by the prevailing policy regime, may lead to sub-optimalscale manufacturing facilities, as well as duplication of infrastructure

The creation of fresh infrastructure for a growing domestic market has taken a backseat

Policy expectations:

Review of domestic market access for SEZ goods produced with raw materials substantially sourced fromdomestic sources


Issue VI Under-served Domestic Market (2/2)


37/42


Exporting units located in the DTA EOUs, STP Units, etc. account for a large proportion of the countrysexports

EOU exports in 2005-06: Rs 47,426 cr (Rs 37,035 cr from April - Dec 2006)

STP exports in 2005-06: ~Rs. 95,000 cr

These units will be subject to a competitive shock come March 2010, when fiscal exemptions available to theseunits will cease

Other exporting units not under SEZ / EOU regime are already subject to a full tax regime

The Ministry of Finance seeks to prevent relocation of existing units into SEZs, to prevent their continuing toavail tax exemptions

Key implications:

The existence of multiple regimes for exporting firms is not an efficient situationExporting firms likely to be forced to close down DTA operations and relocate to SEZ locations

This will especially hold true for industries like apparel and software, where capital intensity is low relative to sales


Issue VII: The fate of EOUs, STP Units, etc. post March 2010 (1/2)


38/42


EOU

NFEP to be 20+% for most products

50% exports allowed as DTA sales @ concessional duty

Duties applicable on goods used to set up units

Retention of up-to 70% earnings in EEFC a/c allowed

Export proceeds to be realized & repatriated to India

within 6 monthsMaterial can be stocked for 1 year

Development commissioner to attest import of Capitalgoods

Customs examination in import & export cargo

FIPB approval required for some FDI

SSI reservation policy applicable

Jewellery units cannot subcontract work to DTA units

NFEP to be > 0

Unlimited DTA sales @ full duty

No customs/excise duties applicable on goods used to setup units

Retention of full earnings in EEFC a/c allowed

Export proceeds to be realized within 12 months

Material can be stocked for 5 years

All imports on self certification

No routine customs examination in import & export cargo

100% FDI automatic

SSI reservation policy not applicable

Jewellery units are can subcontract work to DTA units


Issue VII: The fate of EOUs, STP Units, etc. post March 2010 (2/2)SEZ


39/42


SEZ Policy:

land or built up space in the processing area shall be given on lease only to the entrepreneurs holdinga valid Letter of Approval and the lease period shall be co-terminus with the validity of the Letter of

Approval

The Letter of Approval shall be valid for five years from the date of commencement of production and,after the completion of five years from the date of commencement of production, the DevelopmentCommissioner may, at the request of the Unit, extend validity of the Letter of Approval for a further

period of five years

The Unit may opt out of Special Economic Zone with the approval of the Development CommissionerProvided that if the unit has not achieved positive Net Foreign Exchange, the exit shall be subject topenalty that may be imposed under the Foreign Trade (Development and Regulation), Act, 1992

Key implications:Units not fulfilling NFE criteria as per the Letter of Approval may be required to exit

The fate of fixed assets created by the unit in such a situation is undefined

This is likely to discourage the establishment of capital-intensive operations within the SEZ


Issue VIII: Undefined exit mechanisms


40/42




Central Laws



State Laws

Summary


Revenue losses due to tax exemptionsOver-capacity creation







41/42


Summary

The policy regime for special economic zones has some way to go before itapproaches perfection. Key lacunae are likely to result in:

Promotion of inefficiencies, through duplication of infrastructure investments,promotion of DTA unemployment, locking in of land into unproductive uses

Substantial revenue losses to the Government, with less than proportionalbenefits in the form of economic gains from increased activity

Legal and constitutional challenges


42/42


Indias Leading IntegratedInfrastructure Development Company

www.feedbackventures.com

Documents

SEZ Legislation and Policy Paper