By S Sivakumar, CA
THE revised Discussion Paper on the Direct Tax Code (�DTC’), released on June 15, 2010 would seem to have broken the hearts of the tens of thousands of the IT companies, across the country, as it makes it clear that the tax holiday for the units operating under the Software Technology Parks Scheme (�STP’) would not get extended beyond March 31, 2011 with the new Code expected to come into effect from April 1, 2011. What however remains clear, at least as of now, is that, the tax holiday for the SEZ Units would be protected under the Direct Tax Code. The fact that the SEZ scheme is far superior to the STPI scheme, hardly needs to be emphasized. Apart from enjoying all the direct and indirect tax benefits that STPI units enjoy, the SEZ Units have two major tax related advantages as contrasted to the STP Units. SEZ Units are exempted from the applicability of the minimum alternate tax under Section 115JB of the IT Act, as well as the Dividend Distribution Tax, apart from a 15 year tax holiday, a benefit too hard to resist.
With the STPI scheme expected to get an official burial as of March 31, 2011, the eye is all set on the SEZ scheme, especially in the light of the statement in the revised discussion paper that the tax holiday for the existing SEZ Units would be protected under the DTC. These circumstances could and should lead to the automatic conclusion that only SEZ Units set up on or before March 31, 2011, would be able to enjoy the tax holiday under the DTC. While the new SEZ Units getting set up prior to March 31, 2011 would have no problems, what would happen to the tens of thousands of STP Units which are presently enjoying the tax holiday under Sections 10A and 10B of the ITA? Can they shift their operations to the SEZ and claim the tax holiday under Section 10AA of the ITA?
Not quite so. This is because of the restrictions contained in Sub-Section (4) of Section 10AA of the ITA, which is applicable with effect from 10-2-2006 and is reproduced below :
[(4) This section applies to any undertaking, being the Unit, which fulfils all the following conditions, namely:-
(i) it has begun or begins to manufacture or produce articles or things or provide services during the previous year relevant to the assessment year commencing on or after the 1st day of April, 2006 in any Special Economic Zone;
(ii) it is not formed by the splitting up, or the reconstruction, of a business already in existence:
Provided that this condition shall not apply in respect of any undertaking, being the Unit, which is formed as a result of the re-establishment, reconstruction or revival by the assessee of the business of any such undertaking as is referred to in section 33B , in the circumstances and within the period specified in that section;
(iii) it is not formed by the transfer to a new business, of machinery or plant previously used for any purpose.
Explanation. -The provisions of Explanations 1 and 2 to sub-section (3) of section 80-IA shall apply for the purposes of clause (iii) of this sub-section as they apply for the purposes of clause (ii) of that sub-section.]
In terms of this Sub-Section, an SEZ Unit which is �formed’ by the splitting up, or the reconstruction, of a business already in existence is not entitled to the tax holiday. Nor is an SEZ Unit which is formed by the transfer to a new business, of machinery or plant previously used for any purpose, entitled to tax holiday, under Section 10AA. These provisions could work as major dampeners for STP Units trying to move to SEZs to avail of the tax holiday.
We do not have the benefit of the exact wordings to be used in the DTC vis-a-vis the tax holiday for the SEZ Units, which is expected to be tabled during the monsoon session of the Parliament. Given the overall view that the Government would protect the tax holiday for the SEZ Units set up prior to March 31, 2011, here are some thoughts emanating from a mind that is not that well trained in direct taxes, on some typical questions that could arise, vis-a-vis the tax holiday under DTC for the SEZ Units…
– Is tax holiday under Section 10AA available to an existing STP Unit, which shifts to an SEZ?
No. An SEZ Unit formed by the shifting of an STP Unit could get hit by Sub-Section (4) of Section 10AA and consequently lose the tax holiday.
– Can a Company having an STP Unit, set up an SEZ Unit and claim tax holiday?
Of course, yes. It would be a safe option for the SEZ Unit to be started on the basis of export orders which are not linked to those executed by the STP Unit. While it is not absolutely necessary that the SEZ Unit and the STP unit should not have common customers, it would greatly help if the SEZ Unit handles new customers and/or orders, which would go to establish the existence of the �new business’ in the SEZ Unit, independent of the STP Unit.
– Can a Company, operating as a back end operation STP Unit for its parent company set up an SEZ Unit in respect of the same back end operation?
As aforesaid, this could mean that the SEZ Unit has been formed by the splitting up of an existing business. However, an SEZ Unit can be formed with a new order from the parent company, with new people and new plant and machinery. The fact that the STPI Unit and the SEZ Unit serve the parent company may not mean that the businesses are the same.
– Will it be enough if the approval to set the SEZ Unit is obtained prior to March 31, 2011, in order to avail of the tax holiday?
Not quite so. The SEZ Unit should have started operations as of March 31, 2011, as evidenced by the raising of a commercial invoice, to be able to avail of the tax holiday.
– Are the restrictions imposed by Sub Section (4) of Section 10AA applicable only in the year the SEZ Unit is formed, or are these restrictions applicable for each year comprised in the tax holiday?
A unit can be said to be formed only once, in its lifetime, i.e. at the time the unit comes into existence, in terms of the decision of the Apex Court in Bajaj Tempo Ltd v. CIT 2002-TIOL-763-SC-IT. Hence, the negative covenants contained in Sub Section (4) are applicable only in the year, in which the SEZ Unit is �formed’. Further, per se, any subsequent restructuring or reconstruction of the business carried on by the SEZ Unit, would not affect the tax holiday enjoyed by the SEZ Unit, as these are not linked to the �forming’ of the SEZ Unit.
– Can an SEZ Unit, which is formed as a small unit, subsequently expand its business and still be eligible to claim the tax holiday?
Yes. In terms of the decision of the Supreme Court in State of Gujarat v. Saurashtra Cement & Chemicals reported in 260 ITR 181, the substantial expansion of an existing unit would not result in the creation of a new unit/industrial undertaking. Hence, the SEZ Unit can continue to avail of tax holiday, even after expanding its operations.
– Are the current exemptions to SEZ Units in terms of the Dividend Distribution Tax and the Minimum Alternate Tax likely to be protected under the DTC?
This is a million dollar question. If the DTC is to remove these exemptions to SEZ Units, the whole purpose of extending the tax holiday, would fall flat, as is the case under the current dispensation with the STP Units, which are required to pay MAT despite being allowed tax holiday.
– How can one be sure that the Government would not tinker with the tax holiday for the SEZ Units, under the DTC?
We must bear in mind that, the tax holiday for SEZ Units is governed by the Special Economic Zones Act, 2005 (unlike the STP scheme) which overrides the provisions of the Income tax Act. Given the flak that the Government has already received for its proposal to tinker with the tax holiday provisions, it is unlikely that the Government would amend any tax holiday related provisions vis-a-vis SEZs, once these are passed by the Parliament. Any such move could completely shake the confidence of the foreign investors.
Before concluding …
It does look like that the only guys who would enjoy tax holiday under the DTC would be the SEZ Developers and SEZ Units. Given the fact that the tax holiday covers a 15 year period, exporters who miss the bus in terms of moving into the SEZ, vis-a-vis the deadline set by the introduction of the DTC, would find it very difficult to pardon themselves at a later period of time.
The tens of thousands of STP Units, which have been � the ‘ reason for India’s success story in the global exports, might find life tough post the DTC, as they would be required to pay income tax on their profits.
While most of the large IT exporters have already shifted to SEZs or are in the process of shifting to the SEZs, it is the small and medium players who will be left, high and dry, as they could find the process of shifting to the SEZ, an uneconomic and impractical solution, given the fact that the SEZ projects require larger area to be taken apart from being located at far off places.
One would expect that the DTC is tabled at the earliest in the Parliament so that, the exporters are given enough time to plan and implement their strategies, vis-a-vis the SEZ scheme.
(The Author is Director, S3 Solutions Pvt Ltd, Bangalore)