Section 10AA of the Income Tax Act: Taxation For Special Economic Zones

Section 10AA of the Income Tax Act is a special provision allowing entrepreneurs to get income tax deductions for manufacturing or providing services in Special Economic Zones (SEZs). It was introduced in April 2000 under the Foreign Policy Act and was fully formulated in 2006 under the SEZ Act to provide tax concessions to businesses in SEZ.

Read along to know the provisions, eligibility, and amount of tax deductions u/s 10AA. 

A Brief Overview of Section 10AA

Section 10AA of the Income Tax Act offers deductions to newly-established businesses in SEZs engaged in manufacturing or providing services. SEZs are special regions in India offering high-grade infrastructure, tax incentives, no duty on exports, etc., to resident businesses.

The provisions of this Act are applicable for companies that operated from April 1 2006, to April 1 2021. The amount of deduction applicable u/s 10AA is as follows:

• 100% of the profits from the export for the first 5 consecutive assessment years 
• 50% of such profits for 5 assessment years after the above period
• For the next 5 assessment years, not more than 50% of the profit is eligible for tax deduction (This deduction gets debited from an assessee’s profit and loss statement and is credited to his/her ‘Special Economic Zone Re-investment Reserve Account’.) 

A company may avail deductions from the year previous to the one in which it started manufacturing or providing services. These deductions cannot be more than the taxpayer’s total income and are applicable to the industrial undertaking’s total income. 

Eligibility Criteria for Claiming Deduction under Section 10AA

• Section 2(j) of the Special Economic Zone Act defines the term ‘entrepreneur’ under Section 10AA.
• The SEZ unit must have commenced operations on or after April 1 2006. 
• This unit was not formed by splitting up or reconstructing an already existing business. 
• Transfer of plant or machinery from a previous company to form a new one makes it ineligible u/s 10AA.
• A unit that availed deductions u/s 10A for ten consecutive years before the SEZ Act 2005 is not eligible. 
• A business could be previously located in a free trade zone or an export processing zone, which the government later converted into an SEZ. In this case, computation of tax deductions u/s 10AA will start from the previous assessment year when they started operations in the free trade/export processing zone.
• If its profits were computed under sub-section (7B) of Section 10A, only gains for the unexpired period of 10 years are eligible u/s 10AA.
• The assessee cannot claim deductions under Section 80HH, Section 80HHA, Section 80I, Section 80IA and Section 80IB. 

Also Read: Short Term Capital Gains Tax

How to Compute Deductions under Section 10AA?

Profits and gains from the export of articles, things or services determine a taxpayer’s total taxable income. Profit from export is equal to the profits from the undertaking multiplied by the ratio of its export turnover to total business turnover.

The formula for calculating this is as follows:

Profit from export = (Profits of business x Export turnover of the unit) / Total turnover of the business

Export turnover refers to what a business operating in India receives for its exports. This amount does not include insurance, freight, telecommunication or foreign exchange expenses incurred for delivering items/products or rendering services. 

Special Economic Zone Re-investment Reserve Account

Business owners of units in SEZ need to create this reserve account to receive deductions u/s 10AA for 5 years after the initial 10 years of tax benefits. Up to 50% of their export profits is debited to their profit and loss account and credited to the SEZ Re-Investment Reserve Account. 

The following conditions are applicable for utilisation of this amount:

• Businesses can utilise the amount in a reserve account only for buying new plants or machinery.
• You cannot use the amount in your ‘SEZ Re-investment Reserve Account’ for creating assets outside India, distributing profits for dividends or remittance of profits outside the country.
• They have to put the newly acquired plant/machinery to use before 3 years from creating this reserve account. 
• You have to furnish the particulars of purchase of machinery/plant in Form No. 56FF for computation of taxable income. 

If you use the reserve account for any other purpose, your utilised amount will be deemed to be profits and charged as per applicable IT laws. Moreover, if you do not use this amount within 3 years, it will expire, and taxes will be applicable on it. 

Provisions Regarding Amalgamation or Merger

The following are the results when an SEZ unit has transferred to another business before the expiry of its deduction period u/s 10AA:

• The benefits of Section 10AA of the Income Tax Act are not available for an amalgamating or demerged company.
• Deductions are applicable at the hands of the amalgamated or resulting company. Its taxation would be the same as for a demerged company if no amalgamation/merger took place.

Also Read: Section 148 Of the Income Tax Act

Final Word

Under the existing provisions of Section 10AA, entrepreneurs operating in SEZ can claim deductions for profits and gains from exports. Eligible companies, firms, and individuals can claim 100% of their profits as deduction for 5 years and 50% of profits for the next 5 years. After this, they can receive tax deduction in a special reserve account and utilise it subject to certain conditions. 

Frequently Asked Questions

1. What is a special economic zone in India?

A Special Economic Zone (SEZ) is a region where business, trade and taxation laws are different from the rest of India. These are tax havens within this country for attracting new investments and increasing the balance of trade.  

 2. What infrastructure facilities do SEZs in India provide?

Besides various financial incentives, SEZs offer plotted development, including infrastructure utilities for manufacturing SEZ units. Service sector SEZs must have ready-made office spaces which are fully furnished along with 24×7 power supply, water, gas, telecommunications, etc. 

3. Why would companies want to set up offices and industries in Indian SEZs?

The following are some of the incentives to set up units in an SEZ:

• Income tax exemption u/s 10AA
• Duty-free import and domestic procurement of goods required for operations
• Complete exemption from GST and other State-levied taxes.
• Exemption from MAT (Minimum Alternate Tax)
• Presence of customs officers for faster trade processing

4. What are the differences between the provisions of Section 10A and Section 10AA?

Unlike Section 10AA, which is applicable for businesses in SEZ, Section 10A is applicable for all industrial undertakings related to export of certain things, articles or software. Currently, it allows 100% tax deductions in the first 5 years and 50% deductions for the next 2 years. 

For the next three years, Section 10A allows 50% deduction subject to certain conditions. Moreover, a ‘SEZ Reinvestment Allowance Reserve Account’ is required to receive tax deduction. 

5. What are the rules for carrying forward losses for business units u/s 10AA?

SEZ units cannot carry forward business-related losses incurred before April 1 2006. However, after this period, they can carry forward and set off losses under Section 72(1) or capital gains under Section 74(1) and Section 74(3). For losses due to depreciation, Section 10AA presumes that the assessee has claimed depreciation allowance.

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