SEZs Get A Breather As Government Allows Leasing Out Certain Office Space For Non-SEZ Use

The amendments would allow floor-wise conversion of space meant for information technology and IT-enabled services at SEZs for non-SEZ use. There are about 190 million square feet in IT/ITeS SEZ space spread across India's top seven technology hubs -- Delhi NCR, Bengaluru, Hyderabad, Mumbai, Chennai, Pune and Kochi. Of this, 19.4 per cent were vacant as in September 2023, compared to 9.7 per cent in December 2020.

The government has allowed the demarcation of a part of the built-up area in an IT/ITeS SEZ as a non-processing area, with a caveat that this would be done after the repayment of tax concessions availed. The non-processing area may then be used for other non-SEZ purposes. This implies that the vacant floors in the SEZs can now be unlocked and up for leasing by developers, explained a Commerce Ministry official who spoke on condition of anonymity.

The rules also specify that demarcation will not be piecemeal and will involve at least a full floor of built-up area, a Commerce Ministry notification said.

The demarcated areas are expected to have better occupancy and higher rental income, the same as non-SEZ spaces. Experts say some of the companies that are already working in the field will benefit from the Special Economic Zone Amendment Act, 2023.

The Context

SEZs are areas where certain tax and fee exemptions are given to the owners for producing goods and offering services. They offer competitive infrastructure, duty-free exports, tax incentives, and other measures, making it easier for business. Accordingly, SEZs in India are a popular investment destination for many multinationals, particularly exporters.

Encouraged by the success of SEZs in China, policymakers pushed for developing similar platforms in the wake of economic liberalisation in the 1990s. The first SEZ began operations on April 1, 2000. An act governing SEZs was introduced and enacted in 2005 to boost exports through tax breaks to companies in the SEZ. The main aim was to enhance foreign investment and provide an internationally competitive and hassle-free ecosystem for exports.

There are currently 424 formally approved SEZs in the country, according to Commerce and Industry Ministry data. Of this, the number of notified SEZs are 376, which includes seven central and 12 state government SEZs set up before the 2005 Act. As on December 31, 2023, 278 SEZs were operational with 5,713 approved units. The cumulative investment in SEZs is estimated at Rs 6.7 lakh crore.

Why The 2023 Amendment?

Tax incentives are critical to the viability of SEZs. Accordingly, following the 2005 Act, the government gave 100 per cent tax exemption on export income for the first 5 years under Section 10AAT of the Income Tax Act. The exemption was extended for another five years at a lower rate of 50 per cent, which was further extended by five years under the condition that the exemption would apply to export profits ploughed back for reinvestment.

The exemptions finally ended in 2020, coinciding with the outbreak of the Covid19 pandemic -- a double whammy for the SEZs that saw a mass exodus of tenants as the economic lockdown caused many export firms to either shut shop or downsize.

“As lease contracts expired, a sharp increase in occupier exits led to a surge in vacancy levels from 9.7 per cent in December 2020 to 19.4 per cent in September 2023," said Samantak Das, Chief Economist at real estate management and consulting firm JLL.

"In contrast, the vacancy rate in high-quality IT/ITeS office assets across India’s top seven markets of India stands at 13.7 per cent, which provides a clear indication of the leasing potential once the SEZ spaces are clear after denotification,” Das added.

Saina Kathawala, Associate Director at rating agency Crisil, agrees thatIndia’s office space leasing will likely benefit from the amendment.“The amendment permits demarcation of part of the SEZ area into the non-SEZ area after repayment of tax benefits availed till date. Such demarcated areas are expected to have better occupancy, in line with the existing non-SEZ spaces. Hence, benefits from better leasing and higher income of demarcated areas will outweigh associated costs,” Kathawala said.

Taking Stock Of REITs

Real Estate Investment Trusts (REIT), which continue to build a growing share in SEZs, are expected to benefit from the amendment. There are currently three REITs that are listed -- Brookfield India Real Estate, Embassy Office Parks REIT and Mindspace Business Parks REIT. The level of occupancy in these three RE is around 84 per cent. The SEZ space accounts for 64 per cent of their operational portfolio.

The occupancy for REIT portfolio has been going down for the last three years due to high vacancies in SEZs after the removal of tax benefits. The new rules are relevant for operational IT and IT-enabled services.Since new space has been allowed to be leased out, the balance sheets of the listed REIT may improve in the next 12-18 months.

Embassy Office Parks shares have gained nearly 20 per cent in the past three months since the amendment was made, while that of Brookfield and Mindspace have increased about 5 per cent.

The easing of rules in SEZS is going to benefit leasing companies and companies that have been looking at leasing huge spaces in these areas. It will open opportunities for international players, including MNCs, who needed space but had put plans on hold because of complications in the earlier laws.