Understanding SEZ Units' RCM Exemption: Key Legal Insights and Litigation

A Special Economic Zone (SEZ) is a specifically delineated a duty-free enclave, deemed to be foreign territory for trade operations, duties, and tariffs. The Reverse Charge Mechanism (RCM) requires the recipient of goods or services to pay and deposit GST with the government, instead of the supplier. Normally, the receiver pays GST to the supplier, who then deposits it with the government.

However, services imported by SEZs are exempt from IGST as per Notification No. 18/2017 - IT (R) dated 05.07.2017. This exemption applies to services imported for authorized operations within the SEZ. A question arises whether RCM is applicable to this scenario. Although the matter is not free from litigation, let's delve into the details to determine if SEZ units are exempt from tax under RCM.

Whether RCM provisions are applicable to SEZ Units?

This article discusses the legal aspects and litigation concerning the applicability of the Reverse Charge Mechanism (RCM) and IGST exemptions for services imported by SEZ units for authorized operations.

A cohesive reading of the CGST/IGST Act along with the SEZ Act/Rules reveals several key points:

• Authorized Operations in SEZs: Units set up inside SEZs carry out authorized operations listed in the Letter of Approval (LOA) issued by the Development Commissioner. The SEZ laws do not levy taxes on these authorized operations, as the SEZ Act, 2005 lacks any charging section.

• Geographical Applicability: Section 1(2) of the SEZ Act, 2005 applies to the entire territory of India. Similarly, Section 1(2) of the CGST Act, 2017 extends GST applicability to services rendered within India.

• Inter-State Supplies: Section 5 of the IGST Act, 2017 mandates IGST on the value of inter-state supplies of goods and services.

• Taxable Territory: The taxable territory includes regions where the provisions of the CGST Act, 2017 apply.

• Overriding Provisions: Section 51 of the SEZ Act, 2005 states that SEZ provisions override any inconsistent laws. Section 53 deems SEZs as territories outside the customs territory of India for authorized operations.

• A cumulative reading of Sections 51 and 53 indicates that SEZ territories are considered outside the Customs territory of India for authorized operations.

• Benefits and Exemptions: Section 26(2) of the SEZ Act, 2005 lists fiscal benefits extended to SEZ units and developers, including exemptions from service tax on taxable services provided to SEZ units/developers. This exemption extends to the context of GST.

Liability of RCM  

Notification No. 10/2017-IT(Rate) dated 28.06.2017 states that the recipient of specified services is liable to pay GST under the reverse charge mechanism (RCM). However, this applicability to SEZ units requires further examination.

Legislative Intent and Zero-Rated Supplies

The legislature's intent is not to tax "zero-rated supplies" to SEZ units or SEZ developers, which are zero-rated under Section 16(1) of the IGST Act, 2017.

SEZ Rules and GST Exemptions

• Rule 5(5)(a) of the SEZ Rules, 2006, provides exemptions from State and local taxes for SEZ units.

• Rule 30(1) allows Domestic Tariff Area suppliers to clear services to SEZ units as zero-rated supplies.

• Notification No. 18/2017-Integrated Tax (Rate) dated 5.7.2017 exempts services imported by SEZ units for authorized operations from IGST. Receipt of services by SEZ units from DTA is treated as imports, and Section 51 of the SEZ Act, 2005, overrides inconsistent laws.

Clarifications

1. TRU, CBIC, vide letter F. No. 334/335/2017-TRU dated 18.12.2017, clarified that SEZ units can procure services under RCM without paying integrated tax if they furnish a Letter of Undertaking (LUT). The intention of the legislature is not to tax zero-rated supplies to SEZ units or developers.

2. On a similar issue, wherein clarification was sought , as to whether the SEZ unit is liable to pay GST in respect of legal services, sponsorship services etc received by an SEZ unit in IFSC, Gandhinagar, from a unit in DTA, which are chargeable to GST under RCM, Tax Research Unit, CBIC, New Delhi, clarified as under:

“3. Since the intention of the Legislature is not to tax supplies to a unit in SEZ or a SEZ Developer which have been zero rated under clause (b) of section 16(1) of the IGST Act, by virtue of deeming provision under section 5(3) of the IGST Act, 2017, levy for procurement of input services specified under notification No. 13/2017-CT (Rate) falls upon the unit in SEZ or the SEZ developer. It is, therefore clarified that a unit in SEZ or the SEZ developer can procure such services, where they are required to pay GST under reverse charge, without payment of integrated tax provided the actual recipient, i.e. unit in SEZ or SEZ developer, furnishes a Letter of Undertaking in place of a bond as specified in condition no. (i) in para 1 of Notification No. 37/2017 —Central Tax dated 4.10.2017. The actual recipient of service is the deemed supplier/registered person for the purpose of fulfilling other conditions in para 1 of notification ibid including the manner of furnishing of Letter of Undertaking.”

FAQ cannot override the Notification:

The said FAQ is reproduced below for ease of reference: -

“Q 41. Whether SEZ unit or developer needs to pay IGST when it received supplies which are under reverse charge mechanism?

Ans. All supplies to SEZs are zero rated. However, the suppliers are given two options. In this case, the supplier is not liable to pay GST as the supply is under reverse charge mechanism. The recipient is considered as deemed supplier. Therefore, SEZ has to pay GST in this case.”

It can be noted from the CBIC Clarification dated 15.12.2018 that a SEZ unit recipient of RCM services is required to pay IGST on procurement of supplies on which GST is required to be paid by the recipient. However, since the above clarification was issued as FAQ by the CBIC, it can be interpreted as being merely clarificatory in nature and not binding. Hence the Notifications have a legal force as the same are issued by exercising the powers conferred under the Act and the Notification No 18/2017-IGST (Rate) dated 05.07.2017 is issued in exercise of powers conferred under sub-section (1) of section 6 of the Integrated Goods and Service Tax Act, 2017.

Several legal cases provide clarity on RCM exemptions for SEZ units:

• Waaree Energies Limited (GST AAR Gujarat): This case clarified that SEZ units are exempt from GST liability under RCM for specified services if they comply with LUT or bond requirements.

Other Relevant Cases:

• Damodar J. Malpani vs. CCE: 2002 (146) ELT 483 (SC)

• Ralli Engineering Ltd. vs. UOI: 2004 (4) TMI 590 —Guj. HC

• Steel Authority of India vs. CC, Bombay: 2000 (115) ELT 42 (SC)

• M/s Portescap India Pvt Ltd.: Order No. MAH/AAAR/DS-RM/15/2022-23 dated 13.01.2023

• Darshan Boardlam Ltd. vs. Union of India

• GMR Aerospace Engineering Limited vs. Union of India: 2019 (8) TMI 748

RCM and SEZ: An evolving tax tale – where will the next chapter lead?

The legal framework and interpretations surrounding SEZ units and the applicability of RCM highlight that SEZ units are generally exempt from GST liability under RCM for specified services. This exemption is subject to compliance with furnishing an LUT or bond, ensuring SEZ units can operate without the burden of GST on imported services for authorized operations. However, as litigation continues to evolve, will future rulings further clarify or complicate the tax obligations for SEZ units under the RCM? How will the balance between legislative intent and practical enforcement shape the future of SEZ operations in India?