Article: Special economic zones

One of the most prominent yet generally lesser known legal regimes or policy initiatives for benefit of business and investment attraction in recent time in Pakistan has been the introduction of special economic zones (SEZs) regime through the Special Economic Zones Act, 2012 (“SEZ Act”). The enactment was introduced at a time when the country desperately needed to provide incentives for, or, to attract not just foreign direct investment but also retain the domestic entrepreneurs from fleeing abroad, owing to amongst others, unfavourable business climate in general, law and order situation, energy crisis and lesser fiscal incentives.

Under the SEZ Act, SEZ has a specific statutory definition however, the term as no universally agreed definition and includes/or is an umbrella term for; export processing zones (EPZ) including traditional and hybrid EPZs, free trade zones, commercial free zones, enterprise zones, free zones etc. Generally SEZs are demarcated areas of a country whereupon business, trade and laws differ, in favour of the enterprises operating therein.

Astonishingly, according to a study by World Bank (2008) there are approximately 3000 SEZs in 138 countries accounting for 68 million direct jobs and over $500 billion direct trade related value added within zones. SEZs have been there since centuries but the earliest modern day models include Gibraltar (1704), Singapore (1819), Hong Kong (China; 1848), Hamburg (1888), and Copenhagen (1891).

Before we actually analyse the topic ie amendment to the SEZs Act, 2012 (“SEZ Act”) in Pakistan, let us comprehend the broader scenario. The SEZ Act essentially provides certain income tax and customs tax exemption for developers of SEZs and the enterprises established therein, however, further benefits can also be allowed on case to case basis. At the time of enactment of SEZ Act the only other similar available legal framework in Pakistan was the Exports Processing Zones (EPZs) regulated by the EPZ Authority functioning under Export Processing Zones Ordinance, 1980 (EPZ Act). The EPZ Act was essentially designed and limited to increase and improve the exports of the country and enhancing the volume of exports by creating an enabling environment for investors, as it provided certain fiscal incentives the “industrial undertakings” in such EPZs. As per the said law, such industrial undertakings ostensibly can only sell their goods up to 20% to the domestic market. Hence, Pakistan’s investment regime did not provide diverse framework or incentives for domestic or foreign investors as compared with other jurisdictions like China, India, Eastern European countries, Central Asian and Middle Eastern African countries.

Speaking of China and India, amongst others, SEZs may arguably be the most prominent feature in their industrial growth in the recent history which may be substantiated by the following few facts. In China, SEZs at national level accounted for about 22% of national GDP, 46% of FDI, and 60% of exports and generated in excess of 30 million jobs (Douglas Zhihua Zeng, Trade and Competitiveness Global Practice, World Bank- 2015). In India, up until the year 2000, India did not have SEZs and instead had a number of EPZs (like Pakistan in 80s), which, although similar in structure to the modern SEZs, failed to attract many firms/businesses. India then introduced SEZ, similar to that of China, in 2000 and within 10 years of the enactment of Indian SEZ Act in 2005, India had 200 operational SEZs and over 560 approved for operation with a total investment in the SEZs amounting to whooping Rs 373,445 crores and providing jobs to over 1.5 million people (Source: Ministry of Commerce & Industry, India). Having said all that, SEZs are not always successful and analysis of studies show a mixed record. There are many examples of investments in zone infrastructure resulting in “white elephants,” or zones that largely have resulted in an industry taking advantage of tax breaks without producing substantial employment or export earnings, thus, success of SEZs is dependent on number of factors and has no hard and fast rules.

This leads to the core of this discussion; that amongst other factors of success of SEZs, which includes the applicable investment incentives, location, infrastructure in place and government commitment etc, it is most imperative that there be in place an immaculate legislative, policy and regulatory framework. According to a report of Asian Development Bank (2015) “governance issues” are often behind SEZ’s failure. It also critically points out that “a well-developed and comprehensive legal framework with stable, transparent and unambiguous rules is a critical foundation for any successful SEZ program. While this may not be sufficient for the success of SEZs, the absence of good laws and regulations almost inevitably leads to failure in the zone programme as well as in ensuring broader nation-wide impact of SEZs”.

One of the reasons that Pakistan already lags behind as preferred business destinations in the world is the complex and archaic business legal regime which discourages entry and doing business in Pakistan when compared to the successful competitors.

Passing the SEZ Act was indeed a positive initiative; however, the legislation had, effectively, contradictory provision resulting in massive confusion within the stakeholders. The SEZ Rules 2013 were passed by the Board of Approvals (BOA) in 2013, however, the same are certainly not comprehensive enough to provide efficient framework leading to smooth establishment and operations of SEZs and the enterprises therein. It is worthwhile noting that it took about two years since passing of SEZ Act that first SEZ application (Khairpur SEZ) was approved, that too was a principle approval. Also to be noted is the fact that Khairpur SEZ was an existing industrial zone established by Sindh Government and merely applied for conversion / status of SEZ, as allowed under Section 15 of SEZ Act. While till June 2016 only three existing SEZs located in Sindh were approved, whereas it was only in June 2016 when three existing SEZs of Punjab and one from KPK were approved by the Approvals Committee.

Amongst others, a prime reason why no SEZ application was received from private investor, or even other provincial industrial estates, was the lacunas in SEZ Act itself (inter alia the definition of “SEZ” under the SEZ Act). The original Section 2(n) of the SEZ Act is stated as follows “special economic zone or SEZ means a geographically defined and delimited area notified and approved by the BOA. The SEZs shall be deemed to be outside the customs territory of Pakistan only for purposes of this Act”. Similarly Section 33 (Extraterritoriality of SEZ) inter alia provided that any transport of goods or provisions of services from customs territory of Pakistan into extraterritorial zone (SEZ) shall be considered as an export from Pakistan and any goods from extraterritorial zone (SEZ) into customs territory of Pakistan of goods brought into Pakistan.

The consequence of the above referred provisions when read in tandem is that an SEZ would be nothing more than an EPZ, in fact provide lesser advantage to the zone enterprises, which itself proved to be an unsuccessful model. However, it was at the initiation of Punjab Board of Investment & Trade (PBIT), Government of Punjab’s investment promotion agency, the discrepancies were highlighted to the Federal Board of Investment (which under the SEZ Act is the Secretariat of BOA and Approvals Committee). The matter was deliberated in detail by all federal and provincial governments and the private sector stakeholders and it was result of the said consultation eventually SEZ (Amendment) Ordinance, 2015 was promulgated wherein the definition of SEZ was amended as follows “special economic zone or SEZ means a geographically defined and delimited area notified and approved by the BOA.” while Section 33 was omitted. Furthermore, amendments were made in Section 36 (Benefits for Developers) and Section 37 (Benefits for Zone Enterprises) whereby exemption from income tax was reduced from ten years to five years and broader exemption on customs duties on import was curtailed. In order to make the amendments permanent, the Government introduced the SEZ amendment bill which has already been passed by the National Assembly on 19th May, 2016.

The amendments in SEZ Act though appear to have curtailed the fiscal incentives which as compared to the original law, however; on the contrary it has actually made the SEZ Act / legal regime functional by removing the basic glitches and differentiating it from EPZ regime. Having said the same, the SEZ Act and Rules still may require some improvements if analysed from the perspective of international best practices and compared with successful jurisdictions. A number of key subordinate legislation and policies under the SEZ Act are yet missing.

To state a few such pertinent rules/regulations may include but not limited to regulations for approval of zone applications by BOA, regulations for approval of development agreements by BOA, zone regulations for approval of existing zones, zone approval criteria for SEZs compatible with Pakistan’s obligations under multilateral and bilateral trade agreements.

From the analysis it may be summarised that consequential of government’s step of amending the SEZ Act we should expect a thrust in development of SEZs in Pakistan by not only public but private sector developers as well owing addressing basic glitches in the SEZ Act which also depicts government’s intention for promotion thereof. The amendments may also be very relevant vis-a-vis the China Pakistan Economic Corridor (CPEC) under the umbrella whereof numerous SEZs are envisioned, 26 to be precise, as per a Planning Commission’s report.

However, the rapid investment in development and smooth operations of such SEZs, and expected consequential boost in foreign and domestic investment, is much dependent on enforcing complete and refined SEZ framework by the government as identified/proposed above.

HAMMAD ALTAF KHAN
Advocate, former head legal of Punjab Board of Investment & Trade

Source: Business Recorder