RESPONSIBLE INDUSTRIALISATION

Sandeep Banerjee

Last week, while announcing the annual supplement to the Foreign Trade Policy, India’s commerce minister, Kamal Nath, declared that Indian exporters would be exempt from paying service tax. This declaration will undoubtedly make Indian goods and services a little more competitive in the global arena. It would also help push the country’s exports a notch closer to the government’s articulated target — 1.5 percent of global merchandise trade by 2009. But the significance of the announcement lay elsewhere; it once again underlined the government’s reliance on tax incentives to promote economic activity in the country.

Tax breaks have been around in India for quite a while. Nowadays, however, politicians and policymakers of all hues are debating the pros and cons of tax incentives given to industry. This, ever since Special Economic Zones (SEZs) became operational in the country. And there’s good reason for such debate: the SEZ Act of 2005 conceives of these industrial enclaves as specifically delineated duty-free zones, deemed to be foreign territories for trade operations as well as duties and tariffs.

So, these enclaves get a slew of direct tax breaks that are staggered over a fifteen-year period. SEZ units pay no tax on export profits for the first five years; fifty percent of their export profits are eligible for tax exemption for another five years and there are no taxes for a further five years on fifty percent of their reinvested profits. There are benefits on the indirect tax front too — SEZ units can procure, duty-free, all their requirements of capital goods, raw materials, consumables, spares, packing materials and office equipment from domestic sources. Of course, these exemptions are applicable only if the manufactured product is exported; all relevant duties — customs and excise — are levied if the product is sold in the domestic tariff area.

The direct tax breaks granted to the SEZs are now being criticised by various non-governmental organisations (NGOs). They say the central government is indulging in doublespeak — invoking the mantra of fiscal prudence to prune the food subsidy bill while simultaneously doling out tax incentives to industry. They also contend that while the government is ready to lose tax revenue for the SEZs, it is not serious about addressing the questions of displacement and loss of livelihood that are almost always necessary corollaries to industrialisation.

In political circles, similar concerns are being raised by India’s Left parties whose support is crucial for the Congress-led United Progressive Alliance (UPA) to hold on to power in New Delhi. In its many missives to the commerce ministry, the Left has repeatedly asked for a paring — if not a complete scrapping — of direct tax incentives given to units in the SEZs. They also object to the government extending tax benefits to developers who build the physical infrastructure in these enclaves. Their contention: instead of foregoing revenue, the government should collect the taxes and spend them on social-sector schemes for rural India. Interestingly, in their quest for an equitable taxation order in India, the Left has the most unlikely of allies — the country’s finance ministry.

India’s finance minister, P Chidambaram — a man who loves to wear his reformist credentials on his sleeve – and the Left rarely see eye to eye. But the SEZ issue is perhaps that exception which proves the rule. Almost echoing the Left’s stand against tax rebates to SEZs, the finance ministry has repeatedly voiced its concern about loss of tax revenue. In fact, the ministry projects revenue loss of Rs1.76 billion in direct and indirect taxes between 2005 and 2010. The Left has often cited these figures to Commerce Minister Kamal Nath and his ministry officials to bolster their argument.

But the commerce ministry has its own counter-logic. It contends that the finance ministry’s revenue loss figures are notional; the exchequer would eventually earn far more from direct and indirect taxes owing to increased economic activity than the estimated tax loss. As regards concession to developers, the commerce ministry argues such incentives already exist for the infrastructure sector. They also maintain that without sops, no developer would come forward to invest amounts in the range of Rs 20 billion to set up SEZs.

Despite the Left’s opposition and the finance ministry’s tentativeness, the commerce ministry’s line has prevailed in the cabinet. The government sees SEZs as a fast-track to industrialisation. They are crucial to India’s strategy of export-led development that seeks to accelerate economic growth and generate jobs. Within this context, tax incentives are central to the success of SEZs in the country.

But there’s more to tax concessions than meets the eye. They can be extremely effective instruments for promoting equity if used judiciously and with ingenuity. As India industrialises further, the government of the day will be required to tap into this aspect of tax sops to evenly spread the dividends of economic reforms.

Currently, India has opted to industrialise in clusters. These clusters are, more often than not, located near large urban agglomerations. While industries situated near urban clusters have certain locational advantages, the government must also encourage corporates to set up factories and SEZs in less developed areas. Since companies are motivated by little else besides making profit, tax breaks could be an effective way of promoting corporate social responsibility as well as spreading the good cheer of industrialisation. This would ensure that no part of the country falls completely out of the development map in the days ahead.
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This is the second part of a three-part series published in Daily Times, Lahore on April 27, 2007. The original article can be found here.