More than three-and-a-half decades back, the EOU Scheme was announced amidst a lot of fanfare. The idea was to enhance exports and earn ‘precious’ foreign exchange. Considering that an EOU was completely exempted from income tax, the scheme was successful in achieving its initial objectives. Today however, EOUs remain just geographies on paper. Is the scheme nearing its end?

Interview by Manisha Choudhari | May 2016 Issue | The Dollar Business

I ndia had set up Asia’s first Export Processing Zone (EPZ) in Kandla in 1965, making it one of the first off the block amongst Asian countries when it came to recognising the effectiveness of the EPZ model in promoting exports. Since then India has introduced a number of schemes designed to help increase merchandise and service exports – few worth a mention are Biotechnology Parks (BTPs), Software Technology Parks (STPs), Electronic Hardware Technology Parks (EHTPs), and the much-touted Export Oriented Units (EOUs) Scheme, which was announced with a lot of fanfare in 1981. The EOU Scheme among many other benefits allowed for complete income tax exemption on exported earnings and drew a positive response from investors. It had to – about a third of a company’s profits goes to the exchequer as income tax – as an exemption from this tax was bound to attract the industry. 

The Rise of EOUs

True to their name, EOUs are units undertaking the export of their entire production of goods and services (except permissible sales in Domestic Tariff Area, aka DTA) that are set up under the Export Oriented Unit (EOU) Scheme. The ambit of manufacturing includes repair, re-making, reconditioning, re-engineering, etc. The objective of this scheme is to promote exports, enhance foreign exchange earnings, attract investment for export production, and increase employment. A defining criteria for EOUs is that they need to be positive Net Foreign Exchange (NFE) earners. NFE for EOUs is calculated on a lenient five-year block period basis. In fact, if EOUs are unable to meet the criterion due to hardship, the five-year block period can also be extended for another year – but, of course, on case to case basis. Apart from industrial incentives offered by the state governments, EOUs get many more benefits. They require no license for import and are exempt from Central Excise duty in procurement of capital goods, raw-materials, consumables spares, etc., from the domestic market. EOUs are also exempt from Customs duty on import of capital goods, raw materials and consumables. EOUs being export centres can operate in a variety of sectors, from steel to agro-products to software services; have the freedom and flexibility to set up their units anywhere in the country, keeping in mind factors like the proximity to ports and raw materials, and like SEZs that are constrained to government notified areas. But the real attraction of the scheme remained the exemption from ‘Income Tax’ on export earnings. 

In fact, this was the real reason why the EOU Scheme flourished, especially during its early years. According to the report ‘Review & Revamp EOU Scheme’ there was a steady growth in setting up of EOUs – from 1,556 in FY2001 to 2,586 in FY2010, and rapid export growth from them – from Rs.15,912 crore in FY2001 to Rs.84,135 crore in FY2010. 

 And The Sunset

The Income Tax exemption that EOUs were enjoying since they were set up came to an end with the Finance Act 2011. Section 10B of the Income Tax Act, 1961 under which this exemption was allowed came with a sunset clause which was due to lapse on April 1, 2010. This was extended first to April 1, 2011 and then to April 1, 2012. It was made clear that there would be no more extension and the exemption would not be allowed from assessment year 2012. And with this started the decline of EOUs.

While some may argue that even after the withdrawal of the exemption, EOUs were attractive because they keep enjoying Customs and Excise exemptions.But what must be noted here is that these exemptions come with substantial obligations – obligations that at times negate the appeal of the benefits. On the other hand, similar benefits are also available to non-EOUs under various schemes like EPCG and Duty Drawback under the Foreign Trade Policy 2015-20 and come with a lesser burden of obligations. This has made the playing field uneven for EOUs. Indeed, the decision to withdraw tax benefits was an inflexion point. The number of EOUs dropped from 2,200 in FY2013 to 1,977 by mid-December of FY2016, a drastic fall. What’s more? In FY2015 alone, 120 units were shutdown. Many consultants advised their clients to de-bond their EOUs and shift to other beneficial schemes.

Commenting on the scenario, Dr. Guruprasad Mohapatra, Joint Secretary for EOUs & SEZs, GoI, says, “The withdrawal of income tax benefit has led to a decline in the number of functional EOUs. There has also been a decline in exports from EOUs – from Rs.1,71,498 crore in FY2009 to Rs.79,343 crore in FY2012. However, in recent years, we have seen some recovery in exports from EOUs, though FY2009 figure is far from sight.”

SEZs to The Fore

SEZs are another reason for the troubles of EOUs. In FY2009, in the total exports from EOUs and SEZs, EOUs accounted for 63.24% and SEZs for 36.76%. In FY2015, this share dropped to 12.18%, while SEZs accounted for 87.82% of total exports from both zones.

Both SEZs and EOUs have similar objectives – that is to generate employment, get foreign investment, and increase exports. Talking about benefits, SEZs are presently more attractive due to the available infrastructure, the procedure of clearances, and tax exemptions (until the MAT and DDT came into the picture). But, nevertheless, SEZs are doing better because of the extent to which these incentives are given, and due to the government’s focus on the newer SEZs.  

Stemming The Decline

Can we stem the decline? Yes, we can. A CAG (Comptroller and Auditor General) report recommended the same in 2015 in its performance audit of the EOU Scheme stating, “Ministry may initiate necessary corrective measures to arrest the decline with specific timelines and measurable outcomes so that the basic objective of export growth is achieved utilising the uniqueness of the scheme.”

What needs to happen is rationalisation of policies. One step would be to make sales to DTAs easier. Dr. Smita Naram, CMD, Ayushakti Ayurved Pvt. Ltd. shares a letter with The Dollar Business that was sent by Chemexcil to the Prime Minister a few months ago which pointed out the problem stating, “Foreign Trade Policy allows EOUs to sell 50% of their FOB export value into DTAs.

The notification provides charging of duties as if goods are imported into India. The specific provision allows charging of 50% of Basic Customs Duty (BCD), plus Countervailing Duty (CVD) and Special Additional Duty (SAD), or VAT, in lieu of SAD. However, when the same goods are imported under FTAs or any Exemption Notification by domestic users, they are entitled to reduced BCD, including 0% BCD. This duty anomaly makes the DTA sale of any EOU product uncompetitive in domestic market, resulting into capacity underutilisation of such EOUs, thereby increasing overheads on the export product.” This is really a concern and should be addressed if we want to revive EOUs.

Further, EOUs are also not eligible to avail direct tax benefits and exemptions under MEIS. Additionally, EOU products exported via DTAs cannot avail MEIS. EOUs also suffer from having to take multiple levels of approval which need to be expedited.

March was the 16th straight month of decline in exports from India. Should these issues be sorted out, EOUs could possibly stand up to be counted in raising the exports from the country. All it requires is willingness on the part of the policymakers. Need we say more?