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The Supreme Court's emphasis on clarity and consistency in tax laws in the Vodafone case has brought a glimmer of hope to developers of special economic zones (SEZ) who are fighting an unexpected change in the taxation system for the industrial enclaves conceived as a way of boosting India's exports.

Starting this financial year, the finance ministry has imposed a minimum alternative tax (MAT) of 18.5% on SEZ developers and units and a dividend distribution tax (DDT) of 15% on developers.

The developers say this is against the promise the government made while enacting the SEZ Act in 2005, and that the government is changing the law midway after investments were made factoring in the promised tax concessions.

In a landmark judgement on Friday, the Supreme Court said certainty is integral to the rule of law as it ruled in favour of a Netherlands-based subsidiary of Vodafone Group Plc. that was fighting a Rs.11,218 crore tax claim in India.

“Certainty and stability form the basic foundation of any fiscal system. Tax policy certainty is crucial for taxpayers (including foreign investors) to make rational economic choices in the most efficient manner,” the court said.

SEZ developers are hoping this aspect of the judgement will help them in their own fight.

P.C. Nambiar, president of the Association of Export Oriented Units and SEZs, said the industry lobby will cite the Vodafone judgement while arguing a case which is to come up for hearing on 23 February. The association has filed a case against the Union government in the Bombay high court challenging the imposition of MAT and DDT.

“The judgement in Vodafone case has two aspects. One, the accrual of income which was outside the country, hence not taxable. Second, the certainty and stability of tax regulations. While the first aspect is not applicable to SEZs since income is accrued in India, the second aspect is critical to us and will add weight to our argument,” Nambiar said. He added that after additional taxes were imposed, no major investment in SEZs had been made. “Investors have lost confidence in government policy,” he said.

The economic downturn and the uncertainty in tax policy for SEZs have forced many developers to exit plans for setting up the industrial enclaves.

In its latest meeting on 28 November, the board of approval for SEZs under the commerce ministry, the nodal body for approving the zones, denotified four SEZs. On 24 January, the board will take up for discussion a request by Larsen and Toubro Ltd for denotification of sector-specific SEZs for information technology (IT)/IT-Enabled Services in Coimbatore, Tamil Nadu.

Sunil Rallan, president of the Tamil Nadu SEZ Infrastructure Developers, which has filed a similar case opposing the new taxes in the Chennai high court, too, said the Vodafone judgement “might help as the basic concept that the spirit of sovereign commitment has to be honoured is similar in both cases.”

Rallan said the case is likely to come up for hearing on Tuesday though the government is yet to file its reply.

A commerce ministry official, speaking on condition of anonymity, said the high courts may strike down the contentious taxes on SEZs after the Supreme Court’s verdict.

The commerce ministry has been at loggerheads with the finance ministry on the issue and has been opposing any change in the taxation system for SEZs. The finance ministry feels there is large-scale tax evasion by SEZs and the expectation that such zones will drive India’s merchandise exports has been belied.

The finance ministry has also proposed replacing profit-linked incentives with investment-linked incentives once the direct taxes code comes into effect. The ministry has argued that profit-linked incentives promote a tendency to inflate profits as well as to transfer profits from a taxable entity to a non-taxable one.

According to budget documents, the revenue foregone due to export promotion concessions for SEZs stood at Rs.3,987 crore in 2009-10 and is projected at Rs.8,614 crore for this financial year.

Tax experts are divided on the matter.

Hitender Mehta, partner at Vaish Associates Advocates, says the Supreme Court’s decision in the Vodafone case endorses the well-established doctrine of promissory estoppel (act of promise) as well as the doctrine of legitimate expectation insofar as it relates to the issue of stability of tax policy. “After the Vodafone judgement, the SEZ stakeholders now are seeing a ray of hope of reinstatement of the promised fiscal regime,” he said. “I hope the government does not introduce any retrospective amendment to settle the scores.”

Vikram Bapat, executive director (tax and regulatory services), PricewaterhouseCoopers India, however, is of the view that the Supreme Court did not specifically comment on a position of law. “Supreme court’s comment on certainty and stability in tax policy should not be seen as a position of law, but merely a statement made. The government has the power to change laws as it likes,” he said. “While the Vodafone case was about interpretation of law, the matter regarding SEZs is that of change in law.”

Sudhir Kapadia, national tax leader at Ernst and Young, too, said the Vodafone and SEZ issues are materially different. “You can argue that it is bad policy and morally not right to do retrospective amendment to law, but in a democratic system Parliament is supreme. Courts cannot second guess or nullify that unless it is so unconscionable. I don’t think such challenges will be successful,” he added.

According to commerce ministry data, so far, 582 formal approvals have been granted for setting up SEZs, of which 382 have been notified. As on 30 September, over Rs.2.8 trillion was invested in SEZs and about 730,000 jobs generated. During 2010-11, exports by SEZs reached Rs.3.15 trillion, registering growth of about 43.11% over 2009-10.