AN INCENTIVE PACKAGE FOR EPZS
Improving the performance of Export Processing Zones Authority
From YOUSAF RAFIQ
Special Correspondent, Islamabad
August 23 - 29, 1999
Export Processing Zone Authority (EPZA) was established in 1980 with the objectives to provide a show-window for display of the enterprising ability of country's work force in order to attract foreign investment in the country. It was also aimed at providing a growing market for country's raw materials, semi-manufactured products and sub-contracting and service industries, to increase foreign exchange earnings of the country through export of value added items; attracting foreign capital, technology and modern management skill for export oriented industry; providing new employment opportunities and upgrading their managerial and technical skills. Due to inconsistent government policies so far practiced viz-a-viz EPZA and the negative credibility so aroused, investment in the zones has turned shy. There is also a demand in all the four provinces to establish more EPZs, which is an internationally practiced scheme that attracts much needed foreign exchange. Besides the Karachi Export Processing Zone, there are three notified zones (nine under progress and five in the offing). The notified zones are Sialkot EPZ, Rawalpindi EPZ and Risalpur EPZ. The zones under process are Lahore EPZ, Multan EPZ, Faisalabad EPZ, Quetta EPZ, Gaddani EPZ, Sukkur EPZ, Nooriabad EPZ, Sialkot-Sector II EPZ, and Gwadar EPZ. The zones in the offing are Nawabshah EPZ, Kotri EPZ, Swat EPZ, Abbotabad EPZ and Mirpur EPZ. There is, therefore, a strong need to improve the investment climate by taking such measures which not only enhance the present performance of KEPZ but makes the new zones an attractive proposition for the potential and prospective investors. The Ministry of Industries and Production is presently working on a new incentive package for Export Processing Zones. The Ministry has recommended that the incentives and facilities presently available in the EPZs of the country need further improvement so as to at least make it competitive with the EPZs of the regional countries. PAGE in this Exclusive story gives details of the steps being taken for improving the performance of Export Processing Zones Authority and package of incentives, prepared for Export Processing Zones Authority.
Corporate tax exemption
Recommendation: 100 per cent Corporate Tax Exemption be allowed to a unit for a period of 15 years from the date it starts operation in an EPZ subject to the condition that: (i) minimum capital investment is US $1 million and (ii) the value addition is not less than 30 per cent; in case of Hi-Tech industry not less than 20 per cent; 50 per cent Corporate Tax Exemption to unit not filling in Category (A) but having at least 20 per cent value addition; 100 per cent Corporate Tax Exemption to unit transferring 20 per cent of the export earnings to DTA of Pakistan. The recommendations for Corporate Tax Exemption have been balanced to the mutual benefit of the country and the investor by making the incentives conditional.
The Fiscal incentive of 5 years exemption from corporate tax and tax rate of 25 per cent in perpetuity after expiry of tax period, was included in the original scheme of KEPZ approved by ECC in 1979. The tax exemptions were provided for under the Finance Ordinance 1981 second schedule of Finance Ordinance in 1981. However, very few investors established industries in the zone in the earlier period due to slow pace of development of the zone infrastructure which could only be fully developed during 1988-89. In the late 80's when new EPZs came into being all over the world as a popular option for industrial growth, tax exemptions provided by EPZs of the region were found more liberal and competitive than that given by Pakistan. Taking cognizance of the genuine complaints of KEPZ entrepreneurs and potential foreign investors, the government, in 1988, allowed the tax exemption period upto the year 2000 though the recommendation of EPZA was for a period of 12 years exemption from the date of start of production.
In the Finance Act 1996, amendments have been carried out in clause 126, 126A, 127 and clause 2 of part-II, as a consequence of which the availability of exemptions have been further curtailed upto June 30, 1997. This sudden withdrawal of fiscal package of incentive altogether badly affected the credibility of EPZA with current and potential investors; more so because, the government had earlier provided statutory assurance to investors through notification NO SRO 165(KE)/89 dated 18-9-1998 which stated "change in incentive package, under which an investment, sanctioned in a Zone, shall not be made except where such change is more advantageous to the investor and is also accepted by him."
Corporate tax exemption is considered one of the main features of an EPZ. Dubai (Jebel Ali) EPZ offers 15 years of exemption from the date of production, Sri Lanka EPZs offer 5-15 years exemption (extendable to another 15 years), Bangladesh EPZs offer 10 years tax holiday, while India, Malaysia, Philippines and Taiwan EPZs offer 5 years exemption from the date of production. As a consequence, EPZs in Pakistan have, therefore, been placed at a great disadvantage as a potential investor would prefer to invest in a regional zone rather than in Pakistan. Thus the government and EPZA efforts would receive a serious setback towards attracting foreign investment.
The Central Board of Revenue is of the view that incentives considered necessary for industrial investment were thoroughly examined while formulating the investment policy, 1997. According to them, one of the major policy directives was that instead of area specific concessions, the incentives should be industry-related. Moreover, it was also reflected in the said policy that no Tax Exemption is possible in the present circumstances. Furthermore, following incentives have also been provided which have the same effect as a tax exemption and are thus a substitute for various exemptions in the past for encouraging and attracting investment: (a) First Year Allowance at the rate of 50 per cent, 75 per cent or 90 per cent, depending upon the category of industry. (b) Re-Investment Allowance at the rate of 50 per cent. (c) Industrial Building Allowance at the rate of 30 per cent. (d) Reduction of withholding tax rate on royalties from 30 per cent to 15 per cent. The CBR, therefore, has not supported the said suggestion as according to them it would result in substantial revenue loss.
According to the Ministry of Industries and Production, as a matter of policy, there is no justification to treat the industrial units proposed to be established in EPZA with the industrial units established outside such zones. Moreover, EPZs, unlike ordinary industrial estates is an international concept with common characteristics worldwide associated with package of monitoring and fiscal incentives. In Sri Lanka's EPZA, the Tax Exemption is available from 5-15 years and in Bangladesh this facility is available for 10 years. Even in India, Philippines, Malaysia and Taiwan the tax exemption is available for 5 years. The Ministry of Industries and Production is therefore of the view that at least 10 years tax holiday may be allowed so as to put the investors at advantageous position viz-a-viz similar zones established in other countries.
INCOME TAX EXEMPTION
Recommendation: The Ministry considers that such foreign investors and employees be encouraged to provide their services to Pakistan in EPZs and as such the government may give them this reasonable incentive of tax exemption for 5 years from the time of their employment by a unit in the Zone.
The government provided an income tax relief for 5 years to foreign nationals employed in Zone through the fiscal incentives originally notified in 1983 Clause 127 of the Income Tax Ordinance which stated: "Any income chargeable under the head "Salary" received by or due to any person (who is neither a citizen of Pakistan nor was resident in Pakistan in any of the four years immediately preceding the year in which he arrived in Pakistan) from an industrial undertaking set up in an area declared by the Federal Government to be a Zone within the meaning of Export Processing Zones Authority Ordinance 1980 (IV of 1980) for a period of five years from the date of his arrival in Pakistan and for such period as may be allowed by the Federal Government."
However, in the Finance Act 1996 amendment has been carried out as a result of which the concession is only available to those foreign nationals who are working in a Zone prior to June 30th, 1996. Thus, the incentive which is being enjoyed by those foreigners who are employed prior to 3oth June 1996 is not available to those coming Pakistan/EPZA after the deadline.
Withdrawal of this incentive has not only eroded the credibility of the Authority in the eyes of foreign investors as it is not in conformity with the EPZA rule 24-A but has also prevented employment of foreigners, having international experience, managerial skills, technical expertise from imparting their know-how to the local Pakistanis.
The Central Board of Revenue has not agreed to the proposal on the ground that it would result in substantial revenue losses. According to the Ministry of Industries and Production, Pakistan has entered into bilateral agreements with countries for avoidance of double taxation of income. By virtue of these agreements employees from these countries would automatically stand exempted from payment of income tax if they pay the tax in their own country. Hence only those employees will get the benefits from this proposed incentive which come from a country with which Pakistan does not have such agreements. Hence there would be no substantial loss to the government. This concession would in fact encourage flow of managerial skills from developed countries.
EXPORT OF TRADING GOODS TO TARIFF AREA
Recommendation: Export of 'Goods' to tariff area from Trading/Warehousing units be allowed.
Warehousing and trading is a normal and important activity of all the EPZs in the region and in fact most of the successful EPZs started with trading and then moved on to manufacturing such as Jebel Ali and Malaysia FTZs. Likewise the scheme of KEPZ clearly envisaged the trading/warehousing role for units in the Zone apart from units engaged in industrial activity. Relevant Rule 5(4) of EPZA Rule 1981 says: " Consignment and distribution service for receiving and storing goods meant for export to foreign markets and to the tariff area subject to the provision of national import policy shall be permitted."
However, the Customs authorities allowed KEPZ trading units to export their goods to foreign markets only and not to tariff area. It may be mentioned that an Industrial Commission set up by government in 1987 to review the functioning of KEPZ had recommended that KEPZ could not achieve the desired results because certain facilities which were available to similar other zones in the region were not extended to KEPZ and as such KEPZ be allowed to undertake export of trading/warehousing goods to tariff area subject to provisions as contained in the import policy order and on payment of customs duties etc. ECC of the Cabinet in its meeting held in December 1988 approved the recommendation that CBR should amend the SRO to bring it in line with the EPZA rules on the subject. ECC decision has not yet been implemented.
Ministry of Industry feels that there is no justification to stop or curtail this facility which if allowed can encourage and attract more investment. The import policy of the country is prepared by Ministry of Commerce after taking necessary safeguards to indigenous industry. The domestic market is open to imports from the entire world subject to the provisions and restrictions of the import policy and payment of duties etc. The present restriction tantamount to mean that a commodity can be imported from any outside zone but not from KEPZ. There is thus justification for allowing warehousing and trading units to export-re-export their goods to tariff area subject to import policy and payment of normal duties etc.
The CBR is of the view that very purpose of setting up of EPZs would be defeated if goods are allowed to be exported to tariff area from trading/warehousing units. Moreover, according to them this concession would also be against the very spirit of EPZs which have been set up for value addition by processing and manufacturing goods in the zones for exports instead of simply trading of goods in the same estate.
EXPORT OF WASTE AND DEFECTIVE PRODUCTS
Recommendation: Upto 5 per cent export of waste and defective products/items be allowed to tariff area without payment of duties and taxes provided the unit gives the evidence to EPZA that 95 per cent of the product has been exported abroad.
Rule 6 of Customs EPZ Rules, 1981 states as: "Removal of goods produced by investors in a Zone to Tariff Area for home consumption may be allowed subject to the import restrictions and formalities applicable to imports from abroad, customs duties and other taxes levied on imports into Tariff Area from the Zone shall be the same as duties and taxes levied on similar imports from abroad. This rule applies to any export to tariff area without any exception.
However, in any industrial activity, it is not possible to achieve production of 100 percent quality goods. An allowance has, therefore, to be given for defective items. These items do not get any buyer with reasonable prices in the world market and hence cannot be exported. If such defective items are exported to Domestic Tariff Area, the importer has to pay duties and taxes in accordance with normal rules, hence it again is not viable for local importers to import such defective items from Zone. The stock piles of such defective items are, therefore, increasing. In addition any industrial activity also produces a quantity of waste which is presently being burnt under Customs orders and supervision.
The CBR is of the view that defective inferior products are termed as secondary and are being destroyed under SRO 249(I)/81. Since the destruction solves no purpose, therefore, the same may be allowed after payment of duty and taxes leviable thereon. Further, the export of defective or inferior goods from EPZA to the tariff area should be treated at par with general imports and respective clauses of the Import Policy Order will also apply to such exports. The Ministry of Commerce have agreed to the suggestion for export of waste and defective products to tariff area without payment of duties and taxes. Presently Custom EPZ Rules envisaged destruction of industrial wastes through burning in the zone. This causes environmental pollution on the one hand and loss of income to the investors as well as to the government on the other hand.
PERMISSION FOR EXPORTING OLD/USED MACHINERY TO TARIFF
AREA Recommendation: Plant and machinery used in EPZ for over 10 years may be allowed to tariff area without payment of customs duties and taxes provided the unit gives the evidence to EPZA that 95 percent of the products has been exported abroad.
Investors of the Zone are allowed to import machinery/equipment for setting-up their industrial units without Custom's duties and taxes from abroad. This capital investment is allowed to be repatriated but is not allowed to be sold in the Domestic Tariff Area as this activity tantamount to 'trading' and beyond the scope of 'industrial activity' allowed under the Customs rules.
However, every machinery has its life and utility. Presently the investors are facing difficulties in replacing their machinery due to non provision of disposing of their existing imported machinery and equipment. Thus, they are unable to undertake modernization of their equipment/machinery through replacement.
The CBR has agreed to allow to the EPZA units to send such machinery to tariff area after the payment of duty and taxes and as per the Import Policy Order. Ministry of Industries and Production feel that the restriction of 10 years for sale of machinery in the tariff area many not be desirable. There could be units which want to dispose off the old machinery earlier for undertaking BMR.
EXEMPTION FROM DUTIES ON VALUE ADDED
Recommendation: EPZ units may be allowed exemption of duties on value addition while exporting to tariff area, provided 80 per cent of the products are exported abroad.
The Customs EPZA Rules provided that "the amount of duties and taxes chargeable on goods taken into home consumption was to be limited to the duties and taxes applicable to the foreign goods utilized." Thus value added in Zone was exempted from tax. Value addition involves use of local raw material, salaries of workers, bills of utilities like water, power, gas , telephone and telex and purchase of other local material. However, this incentive was withdrawn in 1984. Withdrawal of a given incentive is against EPZA rules and creates a credibility gap. The investors of the Zone have been agitating on this issue persistently.
Ministry of Industries considers that Pakistan should favour imports from EPZA units rather than imports from manufacturers abroad because EPZA units provide employment opportunities in the domestic labor market besides adding to the industrial growth of the country. Secondly, the foreign exchange invested in EPZA units is not a liability on the State Bank and also does not affect our borrowing limits and credit ceilings etc in comparison to Pakistani importers.
It may be mentioned that the facility of concessional duty for export to tariff area is available in a number of Zones in the region e.g. Taiwan, Malaysia and Philippines to name a few. It is, therefore, necessary to restore the exemption of duties on value added component, in order to accelerate the pace of investment in KEPZ and to restore credibility about the government policies.
The CBR is of the view that conceptually exports from EPZ to the tariff area should be subject to the same tariff and regulatory treatment as applicable to normal imports. They, therefore, do not support the suggestion for duty exemption in any case. According to the Ministry of Industries and Production, Export Processing Units (EPUs) which export at least 70 per cent of their production are allowed to import goods (inputs for export) without payment of customs duty, sales tax or withholding income tax. Hence there is every justification to allow duty free exports from EPZs to tariff area provided such units exports minimum 80 per cent of their products abroad.
REVISED LABOUR LAWS FOR EPZs
Recommendation: Revised Labour Laws for EPZs that are production oriented.
Vide Export Processing Zones (Control of Employment) Rules 1982, EPZs are at present exempted from the application of nine labor laws of the country including the Industrial Relations Ordinance 1969 (right to form union and collective bargaining). EPZA has received a decision taken by the cabinet that the nine exempted laws will be applicable in EPZs of Pakistan with effect from year 2000. In case the exemptions are unilaterally withdrawn, this will again be a contravention of Article 24A of EPZA Rules, 1981.
The prospective investor in an EPZ is attracted because of incentives it provides. One of which is control on employment of labor, with hiring and firing authority. The investor prefers a Zone where Labor Laws are production oriented and trade unionism is limited
CUSTOM OFFICIALS TO BE PLACED UNDER EPZA
Recommendation: Customs officials working in EPZs may be placed under EPZA in order to implement the concept of "One Window" service in true spirit.
EPZA Pakistan tries to capitalize on one window service. EPZA has infact been vested with powers of Controller of Imports and Exports. It issues permits in respect of material/goods entering and leaving KEPZ. The Authority is also empowered to sanction utilities such as electricity, gas, telephone, telex to industrial undertakings and has also put into practice the labor laws framed for EPZ. The only exemption to this system is the Customs which works in isolation from EPZA.
The prevailing situation is that KEPZ is being governed under multiple laws, acts, rules and un-notified practices by Customs Officials at gate. In case of a problem, the investor approaches EPZA which claims a One Window service to solve investor's problem. But all EPZA can do is to approach them and forward the complaints to the customs who in turn take a long time to solve the problem resulting in the investors frustration. The problem is of administrative nature.
FACILITY OF LAND ROUTE
Recommendation: The facility of transportation of goods through land route be allowed to all imports and exports to and from EPZs.
Land-route facility for exporting goods to neighboring countries was available to all including the investors of the Zone but this facility was withdrawn by the government in January 1989. This adversely effected the trading activity from the Karachi Zone. A number of warehousing and trading units were forced to close down their units in the Zone.
A hope was raised after the announcement of 1997-98 Trade Policy in which encouraged the investors who in turn approached EPZA for setting up new trading units in the Karachi zone and ultimately four units were sanctioned. Regretfully the facility has not yet been extended to KEPZ investors because the requisite SRO on the subject has not yet been issued.
Land route has always been recognized as one of the means to transport goods in conduct of business. The central location of Pakistan is an advantage over other countries of the region as it has a shortest road link to all large markets of Iran, China, India and Central Asian Republics and Afghanistan. EPZA considers that by depriving EPZs to use the land route for its exports the investors are being denied a large consumer market and the advantage EPZs in Pakistan have over the regional zones is lost.
Recommendation: Procedure for sale and disposal of duty free vehicles may be finalized by CBR which is pending with them for the last five years.
The investors of KEPZ are allowed to import one duty free car upto 1600 for their official use. Besides under the standing rules, they can also import one duty free pickup for transportation of goods and one vehicle for transportation of labor as per CGO No 1/83 dated 9-1-1983. The vehicles so imported by the investors can be utilized for unlimited period. Rules are, therefore, required to replace and dispose the imported vehicles, for which the draft rules are pending with CBR for approval for the last five years.
Karachi Export Processing Zone was the first project of EPZA launched in 1980 and was planned to be completed within three years time i.e. 1984. It was however, delayed due to paucity of funds provided under public sector development programs and was completed in June 1989. KEPZ, attracted foreign investment of more than US $250 million within two years. But almost all the investment faded away due to various reasons. Some of the reasons were: delay in full establishment of the Zone, unattractive incentive package, only 5 years tax exemption, neither any banking facility was available in the Zone nor investors were allowed to deal with tariff area banks or DFIs, labor laws of tariff area were effective in the Zone in spite of EPZA employment Rules 1982, 1 percent surcharge was leviable on both imported and exported goods and export to tariff area was not allowed.
INCETIVES PROVIDED AT THE TIME OF KEPZ INCEPTION
Foreign and Pakistani banks and insurance companies will be permitted by the State Bank of Pakistan to open branches in KEPZ. The branches of Pakistani banks and Insurance companies in the Zone would be subject to same regulations as are applicable to foreign branches of Pakistani banks and insurance companies. Banks and insurance companies will conduct all transactions in foreign convertible currency like any industrial undertaking of the Zone. The provision of Foreign Exchange Regulation Act 1947, State Bank of Pakistan Act 1956 and Banking Companies Ordinance 1962 will accordingly stand modified. All preliminary expenses for opening of branches will be met from external resources of the bank and Insurance Companies. The branches in the Zone will not be eligible for any financial assistance from the State Bank. Foreign exchange funds of the enterprises may be kept with the banks in any currency in the zone. Foreign currency notes and other foreign exchange instruments can be freely exported from KEPZ. Export/Import of Pakistani currency from/into KEPZ from abroad will, however, be subject to the normal currency regulations of Pakistan.
Exports from KEPZ will be completely free from exchange control which would mean exemption from form 'E' and from procedure enabling exporters to sell goods abroad in whatever manner they like without the obligation of repatriating the export proceeds to Pakistan. Supplies from KEPZ to tariff area of Pakistan would, however, be subject to the same controls and regulations as are applicable to imports into Pakistan. There will be no duty or tax on exports except a development surcharge of 1 percent on the FOB value to meet the administrative expenditure of the KEPZ.
Imports of machinery, component, spare parts and raw materials for the industrial undertakings of the Zone, and goods for re-export, would be
freely allowed and shall be exempted from all taxes and duties of both Federal and Provincial Government such as Customs, excise, Sales tax, provincial and municipal taxes. The restrictions of Import Trade Control Act would not be applicable on imports into the Zone. However, import of such specific items shall not be allowed into Export Processing Zones as may be notified by the government from time to time. Goods supplied from the tariff area to KEPZ would be eligible for all rebates of customs/excise/sales tax etc which are normally available to similar exports of Pakistan.
Investors in KEPZ were allowed the following package of income tax relief at the time of the inception of KEPZ. Total exemption from tax on profits and on income of foreign personnel attached to occupant enterprises for five years from the date of start of commercial production. Tax holiday period may be extended by the Federal Government on a case to case basis depending on the capital investment, development of technology, creation of employment and exports of value added of the enterprises concerned. After five years termination of the holiday period income tax will be charged at 25 percent. capital gains including gains arising on sales of shares will not be taxable. Trading losses to be allowed to be carried forward indefinitely. All reasonable expenses on overseas advertising, market research etc would qualify for deduction for income tax purposes. No tax would be levied on income arising abroad when remitted to KEPZ.
In order to ensure smooth and unhindered productivity the Industrial Relations Ordinance of 1969 will be modified, without taking away the basic right and bargaining power of labor working in the KEPZ. In the absence of any agreement to the contrary the employer in KEPZ would have the right to terminate the services of any employee on giving one moth's notice or on payment of one month's salary.
AMENDMENT AND ADDITION IN THE PACKAGE
Twenty per cent export to tariff area was allowed in December 1984 and then 100 per cent was allowed in 1988. Tax exemption was allowed upto the year 200 beginning June 1988. Banking facilities in the Zone were made available in June 1983. Exemption to certain laws were provided to curb union activities in 1992. One per cent surcharge on imported goods was omitted in 1989. Non resident Pakistanis were allowed to invest, in 1989. Joint venture with resident Pakistani was allowed in 1992. Trading facility was allowed in 1989. Export quota of textiles was allowed in 1992. Exemption of Central Excise Duty granted to such products of Tariff area which are imported into the Zone as a raw material or intermediary.