In April 2000, the Government of India introduced a policy to set up Special Economic Zones (SEZs) to provide an internationally competitive and trouble-free environment for exports. The policy was modified in November 2005 and ratified in February 2006. Interest in SEZs has picked up among Indian corporates recently, as, after 2009, SEZs will be the only World Trade Organization (WTO)-compliant mechanism through which to provide financial incentives to exporters. All other mechanisms currently in force in India (for example, the Duty Entitlement Pass Book scheme) will be noncompliant after 2009. Units in an SEZ can manufacture goods or render services.
The current SEZ policy has the following stipulations: 1) All imports/exports to/from SEZs are on a self-certification basis. 2) The units in SEZs have to be net forex earners over a five-year timeframe, but are not subject to any predetermined value addition or minimum performance requirements. 3) Sales in domestic tariff areas (DTA) by units in SEZs are subject to full customs duty and import policies. 4) SEZs can be set up by the public sector, the private sector, joint public/private sector collaboration, or by state governments in association with the private sector. 5) Minimum sizes for SEZs are 2,500 acres for a multi-product SEZ, 250 acres for a sector-specific SEZ; and 25 acres for SEZs in certain specific industries (Biotech, IT services, Gems, and Jewellery). For SEZs of 25 acres or 250 acres, the minimum processing area is 50%. For SEZs of 2,500 acres, the minimum processing area is 35% (25% under certain conditions).
The April 2000 SEZ policy provided several tax incentives for SEZ developers. The government modified the policy to include several tax incentives for the units within an SEZ as well. The latest policy provides the following notable financial incentives for the developer of, and the units in, an SEZ: 1) the developer may import or procure goods without paying import duties or excise duties, if the goods are to be used for the development, operations, or maintenance of the SEZ. 2) The developer is exempt from income tax for a block of 10 years in a 15-year period. 3) The developer is exempt from service tax for the services rendered in developing the SEZ. Services available within the SEZ (for example, electricity) are exempt from service tax. 4) Units in an SEZ can import capital goods and raw materials duty free from abroad and also from DTAs without paying terminal excise duty. 5) Units in an SEZ are exempt from income tax for the first five years of operations and liable to pay 50% income tax for the next five years. For five years thereafter, 50% of profits reinvested in the business are exempt from tax.
The February 2006 policy simplified the application procedure for setting up SEZs by providing single-window clearance; that is, a developer need only approach one approving authority, and permitting SEZs to have a processing area as small as 25% of the SEZ. These simplifications led to significant interest among corporates and real estate companies in creating SEZs. There are 13 SEZs in operation in India and 150 more have been approved. A further 100 applications are in various stages of approval.
The SEZ projects require funding in the initial years. Typically, investors favor a better capital structure than 100% equity-funded projects, especially in the case of long gestation projects such as SEZs. These projects will have to rely on internal cash flow generation from the sale of land to fund development and to meet working capital requirements. A shortfall in internal cash flow generation or lower-than expected debt funding could result in the need for additional equity infusion and the consequent dilution of promoter stake in the project.
Following agitations against land acquisition in West Bengal, the central government was to introduce new land use patterns and a new rehabilitation policy for farmers displaced by such conversion. There are several landowners in the case of the SEZ, and it cannot be predicted if or when final approval will be granted because of political/local resistance or legal challenges. Investors are best advised to considered these inherent risks before allocating capital to SEZs.
Thanks UBS Investment Research, July 2007
The current SEZ policy has the following stipulations: 1) All imports/exports to/from SEZs are on a self-certification basis. 2) The units in SEZs have to be net forex earners over a five-year timeframe, but are not subject to any predetermined value addition or minimum performance requirements. 3) Sales in domestic tariff areas (DTA) by units in SEZs are subject to full customs duty and import policies. 4) SEZs can be set up by the public sector, the private sector, joint public/private sector collaboration, or by state governments in association with the private sector. 5) Minimum sizes for SEZs are 2,500 acres for a multi-product SEZ, 250 acres for a sector-specific SEZ; and 25 acres for SEZs in certain specific industries (Biotech, IT services, Gems, and Jewellery). For SEZs of 25 acres or 250 acres, the minimum processing area is 50%. For SEZs of 2,500 acres, the minimum processing area is 35% (25% under certain conditions).
The April 2000 SEZ policy provided several tax incentives for SEZ developers. The government modified the policy to include several tax incentives for the units within an SEZ as well. The latest policy provides the following notable financial incentives for the developer of, and the units in, an SEZ: 1) the developer may import or procure goods without paying import duties or excise duties, if the goods are to be used for the development, operations, or maintenance of the SEZ. 2) The developer is exempt from income tax for a block of 10 years in a 15-year period. 3) The developer is exempt from service tax for the services rendered in developing the SEZ. Services available within the SEZ (for example, electricity) are exempt from service tax. 4) Units in an SEZ can import capital goods and raw materials duty free from abroad and also from DTAs without paying terminal excise duty. 5) Units in an SEZ are exempt from income tax for the first five years of operations and liable to pay 50% income tax for the next five years. For five years thereafter, 50% of profits reinvested in the business are exempt from tax.
The February 2006 policy simplified the application procedure for setting up SEZs by providing single-window clearance; that is, a developer need only approach one approving authority, and permitting SEZs to have a processing area as small as 25% of the SEZ. These simplifications led to significant interest among corporates and real estate companies in creating SEZs. There are 13 SEZs in operation in India and 150 more have been approved. A further 100 applications are in various stages of approval.
The SEZ projects require funding in the initial years. Typically, investors favor a better capital structure than 100% equity-funded projects, especially in the case of long gestation projects such as SEZs. These projects will have to rely on internal cash flow generation from the sale of land to fund development and to meet working capital requirements. A shortfall in internal cash flow generation or lower-than expected debt funding could result in the need for additional equity infusion and the consequent dilution of promoter stake in the project.
Following agitations against land acquisition in West Bengal, the central government was to introduce new land use patterns and a new rehabilitation policy for farmers displaced by such conversion. There are several landowners in the case of the SEZ, and it cannot be predicted if or when final approval will be granted because of political/local resistance or legal challenges. Investors are best advised to considered these inherent risks before allocating capital to SEZs.
Thanks UBS Investment Research, July 2007
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