GST Bounty For Special Economic Zones

The Special Economic Zones Policy was announced in April 2000 with a view to accelerate the growth rate of exports, with a simultaneous desired decline in the unemployment rate. SEZs are generally perceived to be countries within a country, for the simple reason that the burden of rules and regulations faced companies in the domestic area are generally not applicable to them.

SEZ Taxation: As It Stands Today

The primary reasons for the burgeoning growth of SEZ units in the country were the ease of doing business in these zones coupled with minimum regulations. To ensure minimal tax cost in the supply chain of exports by SEZ units, the central government has time and again introduced provisions and notifications that provide exemptions on procurement of goods and services within the designated zone. Under the current indirect tax laws, the following options are available to the SEZ unit to claim exemptions:

• Upfront or ab-initio exemption on procurement of goods and services, or
• Refund of tax paid on procurement of goods and services.

However, in order to ensure that these exemptions are not misused, procedures have also been introduced through various notifications.

For instance, NN 12/2013 – Service Tax provides for issuance of A1/A2 forms along with other forms for claiming upfront exemption. Further, Notification No. 09/2009 – Service Tax, provides for refund of CENVAT credit on specified services utilized for the purpose of SEZ. Also apart from notifications, Rule 30 of SEZ Rules, 2006 read with Section 26 of SEZ Act, 2005 has been prescribed for Domestic Tariff Area suppliers to clear specified goods without payment of duty under bond or under claim of rebate.

SEZs & GST: A Strained Start

SEZs in India have enjoyed upfront exemptions and refunds in the current tax regime. In the early days of the proposed Goods and Service Tax, lawmakers were reluctant to provide upfront exemptions. The primary logic for government to remove upfront exemptions was based on the rationale that GST should be an exemption-free regime and that the country needed a wider indirect tax base .

As a result of this thought process, the report of the Thirteenth Financial Commission Task Force on GST’, released in December 2009, recommended discontinuing exemptions of every kind.

The report of the Joint Committee of the State Finance Ministers on the refund process in the GST regime too recommended removal of upfront exemptions of any kind and proposed that exemptions should only be granted through a refund mechanism.

This stand got further cemented in the Economic Survey report for financial year 2014-15, which recommended elimination of all exemptions granted to countervailing duty, in order to encourage the government’s Make in India initiative.

Deliberations Under The First Model GST Law

The Ministry of Finance released the first draft of the Model GST Law on June 14, 2016. Since the law was silent on continuation of upfront exemptions to SEZ units, it seemed likely that GST could be applied to domestic procurement by such units, which could be later claimed as a refund from the government. This led to a huge confusion in the industry as the SEZs until then always remained outside the ambit of taxes in the history of indirect tax legislation.

Levy of GST on supplies that are exempt (SEZ supplies) under the current regime would have lead to an increase in the cost of procurement of goods and services as it would have disturbed the cash flow management of companies. Under the current regime, SEZs had the option of both upfront exemption and refunds at the same time, but upfront exemption was usually preferred. Delay and denial of refund has always been a huge issue for the industry from the perspective of working capital requirement.

SEZ units argued strongly against the first Model GST Law’s reading, with a stand that the refund mechanism was ultimately revenue neutral.

On one end, the government was collecting taxes and on the other end, the government was ultimately refunding the same tax back to the suppliers.

Then why not prefer upfront exemptions instead?

The SEZs also argued that refund mechanism would lead to manifold increase in the number of refund claims, and eventually only increase the administrative burden of the government. The industry players and trade associations addressed their concerns to the government via representations and discussion forums.

SEZs And GST: An Improving Relationship

After much deliberation and consideration, the government finally heard the plea of SEZ units with the release of the revised Model GST Law on November 26, 2016. The revised Model GST Law served as a respite for the industry by considering supplies made to SEZ as zero-rated supplies – such supplies will now attract a zero rate of tax under GST.

Further, in case GST is levied by a person by mistake while supplying goods or services to SEZ units, then these units shall be eligible to claim refund for the same from the government. Thus, the revised Model GST Law has ensured that benefits provided to SEZ units under the current indirect tax laws will continue under the GST regime as well. Additionally, it has been stated that provisions of the SEZ Act which deal with exemptions provided to SEZ units from excise duty, service tax and central sales tax respectively, could be amended in line with the GST regime.

Jigar Doshi is an indirect tax partner and Ravi Soni is an Executive at consulting firm SKP Group. The authors often contribute to BloombergQuint.

The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.