October 19, 2006
Note Submitted By the Left Parties to the UPA
Seeking a review of the SEZ Act and calling for corrective steps
The Special Economic Zones Act was passed by the Parliament in 2005. The intended purpose was to provide a stable policy framework for creating Special Economic Zones, which would serve as engines for industrial growth and exports. However, following the drafting of the SEZ Rules and the commencement of the process of granting approvals for the SEZs, a host of issues have surfaced which necessitates a relook at the entire SEZ Policy framework. Agricultural land is being acquired for the setting up of SEZs in several cases resulting in displacement of farmers and other sections of people, which have serious implications. Moreover, several provisions made in the SEZ Rules have raised concerns of misuse of the SEZ Act for creating a speculative real estate bubble instead of building industrial infrastructure. The Reserve Bank of India has warned against the possibilities of uneven development between different regions owing to the SEZ Policy. There are also apprehensions regarding substantial revenue losses on account of the tax concessions provided under the SEZ Act. In view of this, a review of the current SEZ Act and Rules is urgently required. The relevant issues along with some suggested corrective steps are elaborated below, which the Government should consider.
Address the Land Question
A major difference between the Indian SEZ Policy and that of China, which had pioneered the creation of SEZs, is on the question of land. In the Chinese case, the State acquired the land and developed the required infrastructure, where private enterprises were invited to set up units. The land continued to be owned by the State. In the Indian case, private entities are being involved in developing the SEZ infrastructure. Land is being acquired by the State and handed over to private developers. Some of the proposed SEZs involve huge tracts of land, over 10000 hectares in some cases. If private entities are allowed to own such huge tracts of land, it would amount to the reestablishment of the zamindari system sixty years after independence. This is totally unacceptable.
Moreover, a thorough cost-benefit analysis of the SEZs, especially the giant-sized ones, from the point of view of rehabilitation and livelihood security of the displaced people, diversion of agricultural land and its implications for food security, the nature of urbanisation, usage of power and water and environmental impact assessment, is necessary before approving these projects. While land is a State subject and the cost-benefit analyses have to be undertaken by the State Governments before approving the SEZ proposals, the Central Government also needs to take a view on the important issues related to land acquisition, ownership and use. The following measures are suggested:
(a) There should be no transfer of land ownership to the private developer. Private developers should only be allowed to take land on lease or build the infrastructure on a BOT basis. Moreover, the Board of Approval for SEZs at the Centre should only consider those proposals, which have been duly approved by the State Governments.
(b) The Central Government should set an appropriate ceiling on the total land area under a SEZ, which can be developed by a private entity. In Section 5(2) of the SEZ Rules only minimum land area requirements for the different classes of SEZs have been mentioned. The maximum land area also needs to be specified here. Private entities should not be allowed possession or control of land beyond the stipulated ceiling.
(c) SEZs whose land area exceeds the specified ceiling should only be developed by the State (Public Enterprises of the Central or State Governments). The State can undertake Joint Ventures in developing such SEZs; but in such cases majority stake should lie with the public sector. Selection of the private developers in the case of Joint Ventures should be made in a transparent manner.
(d) SEZs should be built on non-agricultural land and acquisition of agricultural land for the purpose of SEZs should be discouraged. A provision limiting the acquisition of agricultural land should be built into the SEZ Act itself.
(e) In case of displacement of farmers and other sections of people, it is important to ensure the livelihood security of the displaced families in addition to providing adequate compensation. The role of the Government in land acquisition should be geared towards protecting the interests of the people, especially the displaced families. The Government should frame a National Rehabilitation Policy, preferably through a Central legislation, in order to address the issues concerning rehabilitation of displaced families. Suitable amendments should also be made to the Land Acquisition Act in order to address these issues.
(f) A model compensation and rehabilitation criteria should be framed by the Central Government and included in the SEZ Rules, following consultation with the State Governments. It should be ensured that the current owners of land are awarded compensation in line with market prices taking into account the expectation of future land development. The suggestion that displaced families be given minor equity stakes in the companies floated for the purpose of building SEZs can be considered as an option. A provision must also be made to compensate those with long-term tenancy rights on the acquired land and farm labourers.
(g) The Government should urgently address the issue of unblocking and recycling of land and other assets of closed industrial units under liquidation. Data from the BIFR shows that recommendations for liquidation of 1254 private sector units, 31 Central PSUs and 41 State PSUs have already been sent to the High Courts. A fast track mechanism should be set up, by changing existing statutes if necessary, for unblocking the land of these closed units so that they can be made available for building SEZs or other industries.
Apply Appropriate Cap on Different Classes of SEZs
The initial cap of 150 on the total number of SEZs was later lifted by the Central Government. Since different classes of SEZs have been envisaged in the SEZ Rules, a cap on the total number of SEZs irrespective of its class and size makes little sense. However, if several large SEZs developed by private entities are allowed to come up in a few States, while many States do not receive any proposal from private developers, this will only aggravate regional imbalances. The RBI has also expressed concern on this issue in its latest Annual Report. It needs to be noted that the total number of SEZs in China stands at six only. Moreover, the proliferation of proposals for setting up IT SEZs is clearly an attempt to take advantage of tax breaks. There is an apprehension of existing units shifting over to SEZs, which will result in loss of revenue that presently accrues to the Government.
Therefore, there should be separate caps for the total number of multi-product and sector specific SEZs. This also provides a further case for fixing an appropriate ceiling on the land area of SEZs developed by private entities. The Central Government should consider setting up of SEZs through public investment in those States where private investment is not forthcoming. This is important from the point of view of regional balance. A cap on the number of IT SEZs should also be set keeping in mind the revenue considerations.
Revise the Criteria for Processing/Non-Processing Area
The purpose of setting up SEZs is to promote foreign and domestic investments and exports of goods and services. However, certain provisions in the SEZ Rules prepared by the Ministry of Commerce and Industry have opened up the possibility of misuse of the myriad exemptions provided by the SEZ Act, which could thereby fuel a real estate bubble. According to Section 6 of the SEZ Act: “The areas falling within the Special Economic Zones may be demarcated by the Central Government or any authority specified by it as- (a) the processing area for setting up Units for activities, being the manufacture of goods, or rendering services; or (b) the area exclusively for trading or warehousing purposes; or (c) the non-processing areas for activities other than those specified under clause (a) or clause (b).” The Central Government had therefore reserved the right to determine how much of the land area under a SEZ should be allowed as non-processing area.
According to Section 5(2) of the SEZ Rules, while at least 50% of the land area needs to be earmarked for developing processing area for sector specific SEZs, the minimum processing area requirement for multi-product SEZs is only 25%. It is noteworthy that while the minimum land area requirement for sector specific SEZs is 100 hectares, for multi-product SEZs it is 1000 hectares. Therefore, while a developer of a sector specific SEZ of 1000 hectares is required to develop at least 500 hectares of processing area, the developer of a 1000 hectares multi-product SEZ is required to build only 250 hectares of processing area. This is a clear anomaly.
The processing area of SEZs should not be less than 50%. Further, 25% of the non-processing area should be dedicated for infrastructure development. Building of residential and commercial complexes should be permitted over 25% of the total land area. The SEZ Rules should be suitably amended in this regard.
Regulate Land Use within SEZ Area
There are certain provisions contained in the SEZ Rules, which have given rise to apprehensions regarding misuse of the SEZ Policy. For instance, Section 5(4) of the SEZ Rules state that “The Developer or Co-Developer shall have at least twenty-six percent of the equity in the entity proposing to create business, residential or recreational facilities in a Special Economic Zone in case such development is proposed to be carried out through a separate entity or a special purpose vehicle being a company formed and registered under the Companies Act, 1956.” However, no guidelines have been provided for the creation of such facilities, either in terms of land use or other essential regulatory parameters of such real estate development. The RBI has recently raised the interest cost of credit for real estate development in the SEZs. In keeping with such an approach, there is a need to regulate real estate development within the SEZs.
The SEZ rules have to clearly lay down norms for the development of infrastructural facilities by private developers within the SEZs, in terms of what is permissible and what is not. The role of the SEZ Authority and the Development Commissioner in this regard needs to be categorically defined. Most importantly, the SEZ Rules should contain a Land Use Plan for the giant SEZs. The issue of housing facilities for the workers in the giant SEZs have to be concretely addressed. Wherever residential complexes would be permitted within the SEZs, they should be built not only for the management and the white-collared employees but also for the workers. A situation where lakhs of workers of the SEZ units would be forced to stay outside the SEZ area leading to a proliferation of shantytowns in neighbouring areas should not be allowed to arise.
Review Tax Concessions
The revenue implications of the tax holidays being given under the SEZ Policy have to be seriously considered. According to media reports, internal estimates of the Finance Ministry suggest a revenue loss of Rs 1,75,487 crore against an estimated investment of Rs 3,60,000 crore. While these projected estimates are based upon certain assumptions, the issue cannot be brushed aside by saying that these revenue losses are “notional”, as the Minister for Commerce and Industry has done in the Parliament. In a context where subsidies on food, fuel and fertiliser are being whittled down and the social welfare schemes promised in the NCMP being either underfunded or abandoned by the UPA Government citing resource constraints, the justifiability of the tax largesse to big business under the SEZ Policy needs to be thoroughly debated. Through the Note on Resource Mobilization submitted to the UPA Government-Left Coordination Committee in January this year, the Left parties had suggested that the Government should revisit the tax concessions under the SEZ Policy. Unfortunately, this has not been considered so far.
Given the concerns expressed from different quarters with regard to revenue loss, tax concessions in some areas in Chapter VI of the SEZ Act, under the “Special Fiscal Provisions for Special Economic Zones” need to be reconsidered by the Government:
(a) While customs and excise duty exemptions for units within the SEZs can be understood as measures to ensure price competitiveness of exports, the case for providing 100% exemption from income tax on profits for the first 5 years and 50% for the next 5 years by modifying the Income Tax Act, as has been provided in the Second Schedule of the SEZ Act, does not seem to be persuasive. Such fiscal incentives for new units, if it is to be given at all, should not be for more than 2 years, as was done in the case of Chinese SEZs. Income tax concessions for a period longer than 2 years should only be provided for the reinvested portion of profits, and that too only for a maximum of five years.
(b) Chapter VI of the SEZ Act provides for similar exemptions, drawbacks and concessions for the entrepreneurs setting up units within the SEZ and the developers of the SEZ. Thus private developers will be able to derive tax benefits without contributing to exports. The positive net foreign exchange earning requirement, specified in Chapter VI of the SEZ rules, is only valid for units within the SEZs and not the developers. Therefore the developers and the entrepreneurs should not be treated on par as far as tax exemptions and concessions are concerned. Fiscal incentives for developers, if they have to be provided at all, should be separately specified and should be considerably lesser than the ones provided for the entrepreneurs for income tax as well as customs and excise duties.
(c) Exemption from Service Tax has been granted to the developers in a Special Economic Zone in the SEZ Act. Moreover, units in the International Financial Services Centre and Offshore Banking Units have been given income tax exemptions equivalent to those of other units in the SEZs. Securities transactions entered into by non-residents through the International Financial Services Centre under a SEZ have also been exempted from the Securities Transaction Tax. These policies will simply encourage investors, including in financial services, to move from other locations in India to SEZ areas, with no benefit to the economy and substantial revenue loss. These exemptions, which are unrelated to exports, should not be granted.
(d) Section 50 of the SEZ Act state: “The State Government may, for the purposes of giving effect to the provisions of this Act, notify policies for Developers and Units and take suitable steps for enactment of any law: – (a) granting exemption from the State taxes, levies and duties to the Developer or the entrepreneur”. Thus the SEZ Act empowers the State Governments to take decisions related to exemptions of State taxes. However, Section 5(5) of the SEZ rules state that “Before recommending any proposal for setting up of a Special Economic Zone, the State Government shall endeavor that the following are made available in the State to the proposed Special Economic Zone Units and Developer, namely: – (a) exemption from the State and local taxes, levies and duties, including stamp duty, and taxes levied by local bodies on goods required for authorized operations by a Unit or Developer, and the goods sold by a Unit in the Domestic Tariff Area except the goods procured from domestic tariff area and sold as it is; (b) exemption from electricity duty or taxes on sale, of self generated or purchased electric power for use in the processing area of a Special Economic Zone”. In effect, the SEZ Rules have imposed the granting of tax and duty concessions upon the State Governments, which is not in keeping with the spirit of the Act. Either this rule has to be amended or the Central Government should fully compensate the State Governments on the loss of revenue on account of these tax and duty exemptions.
(e) The granting of duty concessions to goods sold by a Unit to the Domestic Tariff Area should not be permitted, since such concessions are intended only for exports. This will imply major diversion of productive activities away from the Domestic Tariff Area to the SEZ, with substantial revenue loss for both the Central and State Governments.
Protect Worker’s Rights
Section 5(5) (e), (f) and (g) of the SEZ Rules asks the State Governments to delegate powers under the Industrial Disputes Act to the Development Commissioner and to declare SEZs as Public Utility Services. These are incompatible with the SEZ Act, which does not contain any such provision. Such deviations of the SEZ Rules from the parent Act have to be corrected. The ILO recommendation regarding separation of powers between the Development Commissioner of an Export Processing Zone and the Grievance Redressal Officer should be seriously considered in this regard.
Prevent Enclaves of Speculative Finance
The provision for setting up Offshore Banking Units and International Financial Services Centres within the SEZS needs to be qualified. While the need for efficient financial intermediation and credit delivery for the purpose of industrial and export promotion within the SEZs is understandable, utmost care has to be taken to ensure that these financial entities do not develop as tax havens for speculative finance capital. There is no need for providing tax breaks for the financial entities within the SEZs. All financial activities should be within the regulatory ambit of the RBI and subject to the same tax provisions regardless of whether their offices are physically located within the SEZ or the Domestic Tariff Area. Moreover, the RBI needs to ensure that the financial activities permitted within the SEZs are strictly related to the economic activities within the zone.
Amend SEZ Act and Rules
The suggestions made above involve several amendments to the SEZ Act and the SEZ Rules. The Left Parties believe that unless these changes are brought about, the SEZ Policy would degenerate into a free for all, which would have serious consequences. The UPA Government should therefore initiate a Review of the SEZ Act at the earliest with a view of making appropriate amendments. Amendments to the SEZ Rules can be made consequent to the Amendment of the Act. The Board of Approval should stop granting fresh approvals until the completion of the Review process. The changes suggested in the Land Acquisition Act and the formulation of a National Rehabilitation Policy, preferably through the passage of a Central legislation, should also be considered on an urgent basis.