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After sunset: What’s in store for Export Oriented Units?

The Income Tax benefits that Export-Oriented-Units (EOUs) have been enjoying over the last couple of decades have finally come to an end at the hands of the Finance Act, 2011. Section 10B of the Income Tax Act, 1961 allowed an EOU to claim deduction of its profits and gains derived from export of goods for a period of ten years from the year of commencement of manufacture. This section contained a sunset clause and it was due to lapse from 1st April 2010, which was extended to 1st April 2011 at first and then again by yet one more year to 1st April 2012. At the conclusion of the Finance Minister’s Budget Speech for the year 2011-2012, it was obvious that no further extensions would be made and the benefit will not be allowed from the assessment year 2012 onwards.

While an EOU enjoys incentives from the levy of various taxes, it was the complete exemption from income tax on export turnover that drew the biggest crowd. Corporate taxes account for one-third of the net profit, and companies, especially the ones with huge export turnover, jumped at the opportunity of the EOU scheme. However, as it is true that all good things must come to an end, it appears that the income tax benefits will no longer be available on export turnover of the EOU. It must be mentioned that income tax benefits was not the sole reason for the growth of EOUs. The additional benefit available to an EOU is to procure raw materials and capital goods without payment of customs or central excise duty also provided a strong incentive. With this in mind, the question that needs to be pondered is: is there any commercial prudence in continuing to remain within the EOU scheme when the biggest attraction of income tax deduction has been rolled back?

At first glance it may appear that, even without the income tax benefit, the customs and excise duty exemptions are strong justifications to continue business operations as an EOU. However, the obligation that goes along with these exemptions is substantial in itself. An EOU is bound to maintain a positive Net Foreign Exchange over a block of five years, which in today’s uncertain economy, cannot be guaranteed. The Foreign Trade Policy provides various alternatives to avail identical benefits, such as the Advance Authorisation scheme, Duty Drawback scheme, EPCG scheme, etc. The EOU scheme, sans the income tax benefit, is now on level playing field with the other schemes under the Foreign Trade Policy, and it is imperative for existing EOUs to take a decision on whether to stay under the EOU scheme or move to another scheme that could prove more advantageous.

A company desirous of switching from EOU to another scheme under the Foreign Trade Policy will have to first and foremost exit the EOU scheme by a process known as de-bonding of EOU. As per Para 6.18(a) of the FTP, an EOU may opt out of the scheme with the approval of Development Commissioner. Such exit from the scheme shall be subject to payment of Excise & Customs duties. De-bonding of the EOU is a rather tricky procedure involving certain complicated questions of law.

Broadly, the de-bonding can be described as a three step process; step one is to obtain ‘in-principle approval’ from the Development Commissioner. While the time limit for granting this approval is seven days, in practical terms it may take up to 14 days after submitting an application for exit.

Step two would be to intimate the Excise Department and obtain a no-objection certificate (NOC) after payment of duty on raw materials, work-in-progress and finished goods lying in stock. Customs duty at the rate prevailing on the date of de-bonding will be payable on the raw materials lying in stock which were imported against a ‘Procurement Certificate’. Similarly, raw materials that have been domestically procured against ‘Form CT-3’ will attract excise duty at the rate prevailing on the date of de-bonding. Capital goods, whether imported or procured domestically, will be subject to customs or excise duty, respectively on the depreciated value. The depreciation is calculated on straight line method and the rates for depreciation are provided in Para 4 of Notification 52/2003-Cus dated 31/03/2003 read with paragraph 6.35.3 of the Handbook of Procedure.

The levy of duty on finished goods and work-in-progress (WIP) lying in stock at the time of de-bonding is still hazy, and no clear cut solution can be found in the law. Proviso to Section 3 of the Central Excise Act, 1944 deals with levy of excise duty on goods manufactured in EOU and brought to any other place in India. This provision was amended with effect from 11.05.2001 by the Finance Act, 2001 wherein the expression ‘allowed to be sold’ was substituted by the words ‘brought to any other place in India’. The question to ponder is whether finished goods and WIP lying in stock at the time of de-bonding would be subject to excise duty under proviso to Section 3. The phrase ‘brought to any other place in India’ in the proviso to Section 3(1) of the Excise Act cannot apply to de-bonding of an EOU for the reason that the finished goods and WIP lying in stock at the time of de-bonding are not physically brought to any other place in India by virtue of de-bonding. The goods continue to remain at their factory of manufacture. The logical conclusion would be to, therefore, levy duty under the proviso only to the extent of raw materials that have gone into the manufacture of the finished goods or form a part of the WIP, as the benefit of duty free procurement of the raw materials ought to be restored. Subsequently when the finished goods are cleared from the factory, excise duty under Section 3 of the Central Excise Act would be levied.

The last step in the de-bonding process will be to obtain final de-bonding letter from the Development Commissioner’s office. During the interim period of obtaining in principle approval and NOC certificate from Excise authorities, it must be borne in mind that the unit still operates as an EOU and will be subject to all the regulations under EOU scheme. The NOC is then submitted to the Development Commissioner, who is authorised to issue the final de-bonding certificate, after due enquiry into the compliance with all the provisions of the EOU scheme, including the obligation to attain positive NFE.  

The process may appear cumbersome, but in light of the fact that income tax benefits are no longer available, it may be wise to de-bond the EOU and seek greener pastures elsewhere.

(The author is an Associate, Lakshmi Kumaran & Sridharan, New Delhi)
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