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The direct taxes code (DTC) approved by the Cabinet gives a reprieve to special economic zones, or SEZs, till 2014 from the proposed regime, but has imposed a 20% minimum alternative tax, which is likely to be opposed by the industry.

The SEZ developers say the tax regime approved by the Cabinet on Thursday does not reduce the uncertainty, which will make it difficult for them to attract units.

“We have clients who have developed SEZs and got into serious talks with interested investors, only to have them back out when the first draft of the DTC was circulated,” says Hitender Mehta, partner, Vaish Associates Advocates, a Gurgaon-based consultancy firm.

Developers are not sure whether investments that they have already made in zones under construction will attract units though the direct taxes bill approved by the Cabinet retains the tax exemptions available to them under the SEZ Act.

Developers and the units located in the SEZs are particularly opposed to the provision in the code that links tax exemptions to investments made rather than profits earned.

For sectors such as IT, where investments made is relatively low, it would definitely lead to lower exemptions. The finance ministry proposes to implement the DTC by April 1 2012.

The industry says the regulation were never settled. There have been nine amendments to the SEZ rules since they were notified in February 2006 and 64 instructions brought out by the commerce department.
“The instability in the policy regime is the main reason we have not been able to attract many foreign investors,” a commerce department official said.

The bill approved by the Cabinet may not be the last word on tax laws for SEZs as it may be opposed by various interest groups once it is presented to the Standing Committee of Parliament for discussions.

“The uncertain environment continues as the draft DTC Bill will now be discussed in the Standing Committee of Parliament,” a commerce department official pointed out adding that investments in SEZs slowed down sharply after the first draft was put out in August 2008.

SEZ developers may also take legal recourse against the provisions of the new tax code if they are adversely affected by it.

“The DTC Bill may violate the doctrine of promissory estoppel (which disallows governments from going back on promises made), as investments were made by developers based on certain tax relief promises made by the government,” Mr Mehta said.

Under the present regime, SEZ units get 100% tax exemption on profits earned for the first five years, a 50% exemption for the next five years and another 50% exemption on re-invested profits in the following five years. SEZ developers, on the other hand, get 100% tax exemption on profits for ten years, which they can choose in the block of the first fifteen years.

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