Businesses established in Special Economic Zones (SEZs) can claim deductions under section 10AA of the Income Tax Act. For entrepreneurs who set up their businesses in Special Economic Zones, the Government announced tax concessions in April 2000 to encourage foreign investment in India. The Foreign Trade Policy initially guided the creation of SEZs.
Nevertheless, gradually, the SEZ Act and SEZ rules were drafted and became effective in 2006. A section 10AA deduction or income tax benefit is available to SEZs under the Income Tax Act. Various conditions must be met in order to claim a deduction under Section 10AA, the amount of deduction available under the section, and other salient features.
Eligibility for Section 10AA Deduction
The following conditions must be met by SEZ units in order to claim deductions under section 10AA of the Income Tax Act:
- Special Economic Zone Act, 2005, section 2 (j) should apply to the entrepreneur;
- For any assessment year commencing on or after 1st April 2006, the SEZ unit must have commenced its manufacturing activity or provision of services during the previous year;
- It is not possible to split up or reconstruct an existing business in an SEZ;
- Any machinery or plant used for any purpose before it is transferred to a new business in an SEZ does not constitute a SEZ unit; and
- Tax deductions under Section 10AA of the Income Tax Act cannot be claimed by units that have already enjoyed deductions under Section 10A for a continuous period of 10 years.
Amount of Deduction
The amount of deduction available under this section shall be as follows:
- For the first five years, export profits are eligible for deductions at 100%.
- For the next five years, 50% of export profits can be deducted.
- Within the next five years, taxpayers can deduct an amount not exceeding 50% of export profits.
A deduction may only be allowed if the amount is deducted from the Statement of Profit and Loss and credited to the ‘Special Economic Zone Reinvestment Reserve Account’. section 10aa of income tax act deductions are also available from the assessment year in which the SEZ unit commences manufacturing or providing services, as the case may be.
Special Economic Zone Reinvestment Reserve Account
The assessee must follow certain conditions for claiming the deduction of the last 5 years (i.e. a maximum of 50% of export profits). In order to utilize amounts credited in this account, you must meet the following conditions:
- The amount credited to ‘Special Economic Zone Reinvestment Reserve Account’ is required to be utilized only for the purpose of purchase of plant or machinery. Such newly acquired plant or machinery should be first put to use before the expiry of 3 years following the previous year in which the said reserve has been created.
- Further, the amount credited to ‘Special Economic Zone Reinvestment Reserve Account’, until the acquisition of the plant or machinery as mentioned in point 1 above, can be used for the purpose of the business of the undertaking. However, the same cannot be used for distribution by way of dividend or profits or for remittance of profits outside India or for creation of any assets outside India.
The following are the consequence in case the reserve fund is not used as per the directions of the Income Tax Act:
The amount credited to ‘Special Economic Zone Reinvestment Reserve Account’ would be deemed to be profitable in the year immediately following the period of three years in case the amount is not utilized for the purchase of plant or machinery as directed. Further, the amount credited to ‘Special Economic Zone Reinvestment Reserve Account’ would be deemed to be profitable in the year in which the amount has been utilized for a purpose other than directed.
Calculating Section 10AA Deduction
Section 10AA Deduction has to be calculated on the basis of the following formula:
(Profit of business of the unit x Export turnover of the unit) / Total turnover of the business.
Export turnover of the unit means consideration relating to export by the undertaking received in or brought into India. Such turnover/consideration does not include freight, telecommunication charges or insurance expense incurred for the delivery of a product or consumable item outside India or any other expense incurred in foreign exchange for the rendering of services outside India.
Amalgamation or Merger
Following would be the consequence in case the unit entitled for deduction under section 10AA has been transferred to another undertaking, before the expiry of deduction period, in a scheme of amalgamation or demerger –
- The deduction will not be available under section 10AA to the amalgamating or demerged unit, as the case may be, for the previous year in which the amalgamation or demerger has taken place; and
- Further, provisions of section 10AA should be applied to the amalgamated or demerged unit assuming no amalgamation or demerger has taken place.