DTA Sale of Services by SEZs

Indian contribution to the global trade is just around 2.6 percent, which in early 2000 used to be dismal 1 percent (approx), most of which comprised of our imports resulting in the huge trade deficit. In an endeavor to increase Indian contribution to the world trade and a favorable trade balance, the Government of India introduced the concept of Special Economic Zones (‘the SEZ’). The SEZs were introduced/setup with two primary objectives:

 

 

(i)                            to earn Foreign Exchange by enhancing export through a world-class hassle-free

(ii)                  attract foreign direct investment (‘FDI’) into the country

 

 

The SEZ is a specifically delineated duty-free enclave and conceptualized to be foreign territory for the purposes of duties, taxes, and other regulatory measures. In other words, the SEZ is a geographical region that has economic laws different from a country’s typical economic laws.

After initial operations under Chapter 7 of the Foreign Trade Policy, a full-fledged independent law was enacted under the name of the Special Economic Zones Act,2005 (‘the SEZ Act’) along with underlying Rules, namely The Special Economic Zones Rules,2006 (‘the SEZ Rules’). The SEZ Act appointed the Development commissioner (‘the DC’) as the nodal officer to facilitate, control, and monitor operations of the SEZ. The DC, inter alia, exercising the powers given to him under the SEZ Laws, grants permission to operate as a unit to provide goods or services from an SEZ.

Further, units under the SEZ are authorized to operate as per the terms and conditions mentioned in the letter of approval (‘the LOA’). It is mandatory for the units under the SEZ to adhere to the conditions mentioned in the LOA including restricting to the authorized operations mentioned therein.

As discussed, (supra), the SEZ operates as a special status and has been granted various special concessions, e.g. procurement of goods and services without payment of duties/ taxes. With these concessions, the SEZs are obligated to achieve positive Net Foreign Exchange earnings – during their 5-year tenure (which are eligible for extensions). In fact, it can be said that the sole/primary criteria for measurement of success of an SEZ unit are the Foreign Exchange Earnings. It would be important to note here that the SEZ regulations do not prescribe a minimum threshold of foreign exchange to be earned, which is a stark distinction from the STPI regime (which requires the unit to reach a minimum threshold before allowing DTA sales).

The SEZ units are authorized to supply goods or services in the Domestic Tariff Area ( DTA) subject to prescribed procedures and payment of due taxes/ duties. Here comes the dispute. Though the SEZ laws do not provide specifically that DTA sale has to be in the convertible foreign currency but the definition of services under the SEZ Act provides otherwise, or at least the SEZ authorities have concluded/think so. It would be better to go through the definition of service under the SEZ Act to appreciate this

 

 

(z) “services” means such tradable services which, -

(i)    are covered under the General Agreement on Trade in Services annexed as IB to the Agreement establishing the World Trade Organisation concluded at Marrakes on the 15th day of April, 1994;

(ii)    may be prescribed by the Central Government for the purposes of this Act; and

(iii)    earn foreign exchange;

 

 

A perusal of the above definition reveals that the definition of services under the SEZ Act is different from the common understanding of services or the definition provided under the allied statute. In addition to being specific prescribed services, it also requires that services must earn foreign currency. On the contrary, there is no definition/restriction in relation to the supply of goods under the SEZ Act and the allied act. Accordingly, while a unit can sell goods into the DTA against INR remittance, a unit can supply services locally only if it is remunerated in foreign exchange by the local recipient. This view by the authorities leads to services being put a disadvantaged and discriminatory position vis a vis supply of goods, which cannot be legally tenable.

However, as discussed, section 2(1)(z) of the SEZ Act makes it mandatory to earn foreign exchange to qualify any service as service for the purpose of SEZ Act. In such a scenario, as per the SEZ authorities, the sale of services by the SEZ unit to the DTA in INR would not qualify as services at all under the SEZ Act. The authorities are therefore concluding that the provision of services to the DTA against payments in INR is, in fact beyond the authorised operation of the unit, a violation of the SEZ regulations and liable to penal actions, including cancellation of the LOA.

The Reserve Bank of India (‘the RBI’) vide it's Master CircularNo. 14/2013-14 dated 01 July 2013 (para B.20 (II)) (‘the circular) allowed the DTA to purchase foreign exchange from authorized banks for making payments towards services rendered by the

SEZ Unit. It is important to note that, barring a few specific circumstances, buying foreign exchange for transactions within India is not permitted. It is important to note here that while the aforementioned definition of Services came into force with the introduction of the 2005 Act, the RBI approval ( to allow payment for such services in Forex) came only in 2013 While the SEZ authorities may consider the RBI clarifications as an endorsement of their stand, the fact that there was a 8-year gap in the alleged critical condition of earning Forex and RBI enabler warrants a debate on whether this was an endorsement (of the view taken by the SEZ authorities) by the RBI or a mere relaxation pursuant to lobbying by the SEZ units to allow such payments in view of the unfair position taken by the authorities.

There could be a contrary view that a harmonic reading of the definition of services along with Rule 53 of the SEZ Rules (providing for positive NFE) makes it clear that be it goods or services the SEZ unit must achieve positive NFE. The condition to earn foreign exchange against the supply of services is not on each transaction but a consolidated basis in the form of achieving positive NFE. In such a case where units are in any case required to earn foreign exchange as per the formula prescribed and as mentioned in the LOA, the interpretation that foreign exchange has to be earned on each transaction is a farfetched interpretation and contrary to the basic scheme of the SEZ.

However, without getting into the argument as to which view is correct it would be better to analyze whether the views being adopted by the authorities are adding any value to the objective for which SEZs have been set up.

As discussed, (supra) the major objective of the SEZ was to earn foreign exchange and attract FDI by demonstrating the ease of doing business in India. Unfortunately, the views adopted by the SEZ authorities fail on both the parameters. Since transaction remains within the country there is no new foreign exchange being earned by the country. Further, putting a restriction that SEZ can supply services to DTA only in a foreign currency might force DTA to look for alternatives resulting in loss of business for the SEZ unit.

One must be mindful that allowing DTA sale by the SEZ units is for a purpose. It serves various objectives, e.g. allowing SEZ units to stand on its own feet at the initial stage, make use of the extra capacities available with the unit. Further, many times supply from SEZ units are alternatives to the imports and ultimately results in the saving of valuable foreign currency for the country.

The SEZ authorities are going ahead with the coercive actions in all such cases. It is important to note that before issuance of the circular in July 2013 allowing DTA to pay SEZ in foreign currency, there was no mechanism by which DTA could have paid SEZ in the foreign currency. In most such cases the jurisdictional DCs have issued a show-cause notice and coercive actions are being taken which are being confirmed by the appellate authorities as well.

As per the information available in the public domain, the SEZ Units have already approached the government to issue a clarification in this regard and the Government has assured that SEZ services units would be allowed to accept payment in INR from DTA. However, even after the years and assurance on various occasions, the actions are still awaited.

In the times when the government is providing procedural relaxation to the industries to come out of the negative impact of COVID-19, clarification or amendment in the law to clarify or remove this anomaly would go a long way in the success of SEZ in the country. Further, to give relief to units already going through the litigation, it would be generous on part of the government if section 2(1) (z) could be modified appropriately, with retrospective effect, to benefit the units who supplied services before July 2013 when there was no mechanism for the DTA to pay SEZ in the foreign currency.