SEZ incentives - "Reinvestment Reserve", the new bone of contention in litigation?

January 05,2016
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K.R. Sekar (Partner, Deloitte Haskins & Sells)

SEZ incentive was one of the most talked about incentive ten years ago when it was launched. It also gave an opportunity for companies to house their expansion into these unit as the tax holidays for STPI/EOU was being phased out by 2011.

From a tax perspective, the routine issues faced by a STPI/EOU unit are expected to be faced by the SEZs as well. But wait, could there be more to add? Yes, the tax holiday in year 11 to 15 of operation of SEZ is available only on creation and utilisation of the SEZ reserve. So yes, this could throw up a Pandora’s Box of tax litigation.  

In this article, we have discussed the potential issues the tax payer could face in interpreting the reserve related provisions.

An ‘Unit’ in Special Economic Zone (“SEZ Unit”) claiming tax holiday benefit under section 10AA enjoys the tax incentive for a period of 15 years. This is an additional 5 years of benefit when compared to that offered for STPI/EOU claiming benefit under section 10A/10B of the Act.

How does the incentive work? The incentive is a staggered one, spread over a period of 15 years. An SEZ Unit does not have to pay income tax on entire export profits for the first 5 years. In the next block of 5 years, a SEZ unit is not required to pay tax on half of its export profits. In the last block of 5 years (Year 11 to Year 15), a SEZ unit can claim deduction which is determined by the amount transferred to the reserve account.

To explain this further, the law reads “so much of the amount not exceeding fifty per cent of the profit as is debited to the profit and loss account of the previous year in respect of which the deduction is to be allowed and credited to a reserve account (to be called the "Special Economic Zone Re-investment Reserve Account") to be created and utilized for the purposes of the business of the assessee in the manner laid down in sub-section (2).”

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