What is Section 10AA of Income Tax Act?, Eligibility Criteria and Calculation for deduction under Section 10AA

Introduction

Section 10AA of the Income Tax Act 1961 lets taxpayers deduct expenses for Special Economic Zone (SEZ) businesses. This article explains what Section 10AA is and who is eligible. Before discussing Section 10AA, we’ll briefly explain what an SEZ is.

SEZ (Special Economic Zone)

A special economic zone is a part of the country with distinct business and trade legislation than the rest of the country. SEZs are placed within a country’s national borders, and its goals include improving the raising of investment, creating jobs, trade balance, and ensuring efficient administration.

What is Section 10AA of Income Tax Act?

Section 10AA of the Income Tax Act allows businesses in Special Economic Zones (SEZ) to deduct certain expenses from their taxes. To attract foreign investment, the government announced in April 2000 that tax benefits would be given to entrepreneurs who start businesses in SEZs.

Assesses that are eligible for deduction under Section 10AA

• Companies

• Individuals

• Firms

• Any other entity who is indulged in the export activity

Eligibility Criteria for Deduction under Section 10AA

• The entrepreneur must be covered by Section 2 (j) of the Special Economic Zone Act, 2005.

• The SEZ unit must have started manufacturing or providing services during the previous year relevant to any assessment year beginning on or after April 1, 2006.

• The SEZ unit cannot be formed by splitting up or reconstructing an existing business.

• The SEZ (Special Economic Zone) unit cannot be formed by transferring plant or equipment.

• Units that have previously benefited from a deduction under Section 10A of the Income Tax Act for a period of 10 years are ineligible to claim a deduction under Section 10AA of the Act.

Exemption Limit on Section 10AA of Income Tax Act

• All profits from exports are eligible for a tax deduction for the first five consecutive years.
• Half of the export profit qualifies for a deduction over the next five years.
• Whichever is lower between 50% of export profits or the amount allocated to the SEZ Reinvestment Allowance reserve.

Time-period for which deduction under Section 10AA of Income Tax Act is Available

The deduction needs to be taken out of the Profit and Loss Statement and added to the ‘Special Economic Zone Reinvestment Reserve Account’ to be accepted. Also, a Section 10AA deduction is allowed for the year the SEZ unit starts manufacturing or providing services, whichever is first. Let’s understand the role of the Special Economic Zone Reinvestment Reserve Account in deductions under Section 10AA of the Income Tax Act.

The calculation for Section 10AA deduction under Income Tax Act

Section 10AA of Income Tax Act 1961, the following formula must be used to compute the deduction:

(Profit of the unit’s business x Unit’s Export Turnover) / Total Turnover of the Business

The consideration connected to export by the enterprise received in or brought into India is referred to as the unit’s export turnover. Freight, communications charges, or insurance expenses incurred for the delivery of a product or consumable item beyond India, as well as any other foreign exchange expense incurred for the rendering of services outside India, are not included in this turnover/consideration.

Related read: ITR Filing and Process to file ITR

Condition to utilize the amount in Special Economic Zone Reinvestment Reserve Account

In order to claim a deduction for the previous five years (i.e. an amount not exceeding 50% of the export earnings), the assessee must meet specific criteria, as outlined above. The following are the conditions for using the funds credited to the ‘Special Economic Zone Reinvestment Reserve Account’:

• The funds deposited in the ‘Special Economic Zone Reinvestment Reserve Account’ must be used solely for the purchase of plants and machinery. Such freshly purchased plant or machinery shall be put to use within three years of the year in which the reserve was established.

• Furthermore, until the acquisition of the plant or machinery stated in point 1 above, the money credited to the ‘Special Economic Zone Reinvestment Reserve Account’ can be used for the undertaking’s activity. However, it cannot be utilized for dividend or profit distributions, the transmission of profits outside India, or the formation of assets outside India.

Consequences if not Utilized the amount as per set rules by Income Tax Act

• If the sum credited to the ‘Special Economic Zone Reinvestment Reserve Account’ is not used for the acquisition of plant or machinery as intended, it will be considered profitable in the year following the three-year period.

• Furthermore, the sum credited to the ‘Special Economic Zone Reinvestment Reserve Account’ would be considered profitable in the year in which it was used for a purpose other than that for which it was intended.

Conclusion

SEZs were established to operate under the terms of the Foreign Trade Policy. However, starting in 2006, the SEZ Act and SEZ rules were gradually developed and implemented. SEZ is eligible for an income tax advantage or Section 10AA deduction, and the associated provisions are found in section 10AA of the Income Tax Act.