Special Economic Zones & Service Tax – Issues & Implications

1. Special Economic Zones & Service Tax – Issues & Implications
Special Economic Zones (SEZs) are designated duty free enclaves which are considered as deemed foreign territories for the
purpose of trade operations, duties and tariffs. Several exemption and concessions to SEZ developers and SEZ units from
various taxes and duties have been granted by the Government with a view to boost exports and investments. Tax benefits
promised to SEZs by the Government has never been free from ambiguities.
As regards service tax, the perception has been that SEZ developers and SEZ units enjoy complete exemption from service tax
and that there are no service tax implications. However, it would be interesting to note that there are certain restrictions to this
exemption and the provisions of SEZ Act and the Service Tax legislations are not in consonance with each other.
Service tax implication on services rendered by a DTA Unit to SEZ
Unit/ Developer
Position under the Finance Act, 1994
Under section 93 of the Finance Act, the Government had issued Notification No. 4/2004 S.T., dated 31.3.2004 in respect of
SEZs. In terms of the said Notification, taxable services provided to SEZ units or SEZ developers are fully exempt from
service tax subject to certain conditions. Among other conditions, one such mandatory condition to avail service tax exemption
under the said notification is that the services so provided must be consumed within the SEZ.
In view of the above notification it is construed that taxable services which are availed by the unit or the developer outside the
SEZ (even though such services are related to authorized operations) are not exempt from service tax. For instance, rent-a-cab
service or transport services provided to employees of SEZ to bring employees to and from place of work would not be
entitled to exemption from service tax since the said service is partly provided outside the SEZ. Similarly, services provided by
CHA to SEZ at customs port may be denied exemption on the ground that the service is provided outside SEZ.
Position under the SEZ Act, 2005
Under the SEZ Act, rendering of services from Domestic Tariff Area (DTA) to SEZ unit or SEZ developer is termed as export
[section 2(m) (ii)]. The SEZ Act read with the SEZ Rules, 2006 provides specific provisions for exemption to SEZ developers
and units from service tax. Section 26(1)(e) of the SEZ Act provides exemption to SEZ developers and units from service tax
under Chapter V of the Finance Act, 1994 on taxable services provided to a developer or unit to carry out authorized
operations in SEZs.
Further, rule 31 of SEZ Rules provides exemption from payment of service tax on all taxable services specified under section
65 of the Finance Act, 1994 as amended from time to time, rendered to a developer or unit by any service provider for the
authorized operations in SEZs.
The conjoint reading of the above said section and rule clearly implies that the services rendered to SEZs shall be entitled to
exemption from service tax if such services are received in relation to authorized operations within the SEZ. From the above
provisions, it is evident that no such condition of consumption of services within the SEZ is required to be fulfilled for the
availment of exemption of service tax by the SEZ units or developers.
SEZ Act versus Notification No. 4/2004-ST
The SEZ Act has an overriding effect by virtue of section 51 which provides that the said Act shall have effect notwithstanding
anything inconsistent therewith contained in any other law for the time being in force or in any instrument having effect by
virtue of any law other than this Act.
As discussed above, nowhere in the SEZ Act or the rules there under, is it provided that the exemption from service tax would
be available to SEZ developers or units, only if the taxable services are consumed within the SEZ. Since the provisions of the
SEZ Act read with the rules are inconsistent with the provision of the said notification, therefore, the provisions of SEZ Act
should prevail over Notification No. 4/2004-ST issued under the Finance Act.
Purposive Interpretation
The rule of purposive interpretation was introduced by Lord Denning. According to the said rule, interpretation of statute
should be done having regard to the purpose of the Statute. The provisions of the SEZ Act and the Service tax legislations
should be interpreted according to the rule of purposive interpretation in order to fulfil the objective of these legislations.
In the backdrop of this rule of interpretation, it could be argued that the purpose of the exemptions provided under the SEZ
Act read with the Rules is to enhance export. Hence, supplies to SEZ are to be treated as export and accordingly appropriate
exemption must be made available to the SEZ units/ developers. This purpose cannot be defeated by any narrow
interpretation.

2. Support can also be drawn from the decision of the Apex Court in the case of Nathi Devi vs Radha Devi Gupta1[1] and
Prakash Kumar vs State of Gujarat2[2] (5-Member Bench) wherein it was held that if there exists some ambiguity in the
language or the same is capable of two interpretations, it is trite that the interpretation which serves the object and purpose of
the statute must be adopted. In such a case, the doctrine of purposive construction should be adopted.
The Supreme Court has also taken the view that the wordings of exemption notification have to be construed keeping in view
the object and purpose of the exemption and an exemption notification cannot be read in a narrow manner so as to defeat the
object of the notification. [Messrs Oblum Electrical Industrial vs Collector of Customs Bombay3[3], Commissioner, Trade Tax
vs DSM Group of Industries4[4]]
In relation to statutes enacted specifically for growth and development, the Supreme Court has taken the view that provision in
the statute granting incentives for promoting growth and development should be construed liberally, so that real object of such
encouragement is not frustrated. [Vadilal Chemicals vs State of Andhra Pradesh5[5]; State of Jharkhand vs Tata Cummins
Ltd.6[6]; State of Orissa vs Tata Sponge Iron7[7]; CIT vs Baby Marine Exports8[8]]
Accordingly, the term consumption used in the Notification 4/2004-ST should also be interpreted liberally. It would be
interesting to note that the words used in the said Notification are for consumption of the services within such Special
Economic Zone. No phrase such as entire consumption or consumption only within the SEZ or services exclusively consumed
within the SEZ has been used. Therefore, it can be construed that there are no restrictive clauses used in the said notification.
In the case of CC vs Shefali Arts9[9], it was held that where notification made exemption from duty subject to imported
machine being used for purpose of export, it was held that exemption is available even if part of production was sold locally,
since the words exclusively, only or entirely were not used in the notification. Quoted with approval in Indian Charge Chrome
vs CC,10[10] it was held that an EOU which imported power plant can transmit the surplus power to DTA as there is no
restrictive clause in notification that imported goods must be used exclusively for manufacture of goods for export.
In view of the relevant legal provisions and judicial pronouncements, it is evident that for the purposes of exemption from
payment of service tax under the SEZ Act read with the Rules and the Finance Act, the provisions must be interpreted liberally
such that the object and purpose of the Statute i.e. SEZ Act is not defeated. Therefore, services provided to SEZ developers or
units shall be exempt from payment of service tax as long as the services are used in relation to authorized operations in SEZs.
It is not necessary for the services to be consumed within the SEZ.
Practical tips for DTA service providers
As explained above, exemption from service tax is available if it is established that the services are provided to SEZ developers/
units in relation to authorized operations in SEZs. It is not a mandatory requirement that the services should be provided
within the SEZ or that services should be exclusively consumed (used) in SEZs. Therefore, in order to substantiate the fact that
services rendered are in relation to authorized operations, it is advisable that the DTA suppliers should either obtain a certificate
from the SEZ developers/ units on above lines or should have a specific clause on the above lines incorporated in the service
agreements entered into with the SEZ developer/ unit.
Further, since the authorities usually take a narrow view of any provision, it is also advisable to inform the department suitably
about rendering of services to SEZ developers/ units in relation to authorized operation in SEZs in advance, to avoid charge of
suppression of facts etc.
Service tax implication on services rendered by a SEZ Unit to
DTA Units
Taxable services rendered by SEZ unit to any unit in DTA are subject to service tax. The Ministry of Finance vide Circular
No.105/08/2008-ST dated 16.9.2008 has confirmed this position. Service tax is applicable where SEZ units provide taxable
services to units/ persons outside the SEZ.

3. It would be interesting to note that rendering of services from SEZ to DTA does not qualify as import in terms of section 2(o)
of the SEZ Act. Therefore, service recipient i.e. the DTA unit would not be liable to deposit service tax under the Finance Act
under the reverse charge method. Hence the liability of payment of service tax would be on the service provider, i.e., the SEZ
Unit. Accordingly, in the said Circular it has also been clarified that the SEZ units providing technical services to any persons
for consumption in DTA (or providing any taxable services which is otherwise not exempt) or is otherwise liable to pay service
tax should take registration with the jurisdictional service tax authorities and discharge service tax liability in terms of the
Finance Act 1994.
Rule 6 of the CENVAT Credit Rules
Rule 6 of the CENVAT Credit Rules, 2004 provides for obligation of manufacturers of dutiable goods and exempted goods
and provider of taxable and exempted services. If service provider is taking CENVAT credit in respect of common input
services, the service provider has following three options (with effect from 1 April 2008)
1. Maintain separate inventory and accounts of receipt and use of inputs and input services used for exempted
goods/ exempted output services - Rule 6(2) of CENVAT Credit Rules.
2. If the service provider opts not to maintain separate inventory and records, pay amount equal 8 per cent of
value of exempted services Rule 6(3)(i) with effect from April 1, 2008.
3. Pay an amount equivalent to the CENVAT credit attributable to input and input services used is or in
relation to provision of exempted services Rule 6(3)(ii) with effect from April 1, 2008.
The service provider should study its CENVAT credit pattern and decide which option is suitable. If proper care is not taken,
the service provider may have to pay 8 per cent amount on exempted services provided to SEZ units.
Further, sub-rule (6) to Rule 6 provides exceptions to the above. In terms of the said sub-rule the provisions of sub-rule (1), (2),
(3) and (4) shall not be applicable in case where the excisable goods are removed without payment of duty in certain situations.
One such case is when the excisable goods are cleared to a unit in SEZ.
It is pertinent to note here that the said sub-rule mentions only about the exempted goods and not the exempted services.
Further, it talks about the clearance of goods to SEZ units only and not the SEZ developers. The above uncertainty calls for
necessary amendments in CENVAT Credit Rules, 2004.
(Author is an Advocate in Gurgaon)
[1] AIR 2005 SC 648
[2] AIR 2005 SC 1075
[3] 1997 INDLAW SC 2746
[4] AIR 2005 SC 271
[5] [2005] 142 STC 76 (SC)
[6] [2006] 145 STC 340 (SC)
[7] [2007] 9 VST 415 (SC)
[8] [2007] (211) ELT 12 (SC)
[9] 1999 (114) ELT 928 (Trib.)
[10] 2001 (138) ELT 609 (Tri-Kolkata)