Courting foreign investment: SEZs, incentives and flexible labour

Detail

1. From protection to courting investment: the background

• 1950s–1991, protection: after Independence, India put up trade barriers and restricted foreign investment.
• A trade barrier is a rule that makes imports harder or costlier, such as a tax on imports or a limit on quantity.

• The aim was to shield young Indian producers from foreign competition.

• 1991, opening: the LPG reforms (Liberalisation, Privatisation, Globalisation) removed many of these barriers.

• Liberalisation means removing government controls on trade and investment.

• After 1991, competition for investment:

• An MNC (multinational corporation) is a company that owns or controls production in more than one country.
• MNCs choose where to produce by comparing costs, markets, facilities and rules.
• So governments now compete to attract MNCs. They offer three main things:
  • Special zones with good infrastructure (SEZs)
  • Tax incentives (tax breaks)
  • Flexible labour rules

2. Special Economic Zones (SEZs): what they are

• Special Economic Zone (SEZ): an industrial area set up by the central and state governments to attract foreign companies.
• Inside it, businesses get better facilities and lighter rules than in the rest of the country.

• The rest of India is called the Domestic Tariff Area (DTA). It is the normal customs territory, where ordinary import duties apply.

• World-class facilities promised (NCERT):

• Electricity, water, roads, transport and storage

• Recreational and educational facilities

• Legal base: the SEZ Act 2005 and the SEZ Rules 2006 [2].

• Size and performance (latest data):
• 368 notified SEZs (28 February 2025) [2]. "Notified" means formally approved and declared by the government.
• Exports: over ₹11.70 lakh crore in 2025-26 (up to December 2025). This is 32.02% higher than the same period of 2024-25 [2].
• Employment: over 31.73 lakh people (December 2025) [2].
• Total investment: ₹7.86 lakh crore (December 2025) [2].

3. Tax incentives for SEZ units

• Tax holiday: a period in which a firm pays no income tax, or less tax, on its profits.
• NCERT (Class 10): units pay no taxes for an initial five years. This is outdated. The current position is below.
• SEZ Act 2005 / Section 10AA of the Income Tax Act, 15-year graded holiday:
• Years 1–5: 100% of export profits are tax-free.
• Years 6–10: 50% of export profits are tax-free.
• Years 11–15: 50% is tax-free, but only on profits ploughed back (reinvested) into the business.

• "Graded" means the benefit shrinks step by step over time.

• Sunset clause: units that started on or after 1 April 2020 get no such holiday.

• A sunset clause is a date after which a benefit stops.

Worked example (Section 10AA)

• Suppose an SEZ unit earns ₹100 crore export profit every year.
• Years 1–5: ₹100 crore is tax-free. Taxable profit = ₹0.
• Years 6–10: ₹50 crore is tax-free. Taxable profit = ₹50 crore.
• Years 11–15: suppose the unit reinvests ₹60 crore. It gets 50% of that, so ₹30 crore is tax-free. Taxable profit = ₹70 crore.
• Lesson: the government gives up a lot of revenue in the early years. This is the revenue loss that critics point to.

4. Recent reforms (post-2025)

• Semiconductor and electronics SEZs:
• The SEZ Rules 2006 were amended in June 2025 to allow SEZs only for making semiconductors and electronic components [2].
• Changes made [2]:
  • A lower minimum land requirement for such SEZs.
  • Relaxed encumbrance norms. Land already mortgaged or leased to a government entity can now be used for an SEZ.
  • DTA supply of semiconductor products is now allowed.
  • Goods received free of cost now count in the Net Foreign Exchange (NFE) calculation. NFE is the rule that an SEZ unit must earn more foreign exchange than it spends.

• Two such SEZs were notified in June 2025: Sanand (Gujarat) for semiconductors and Dharwad (Karnataka) for electronic components [2].

• Union Budget 2026-27, one-time DTA sales relief:

• Why: global trade disruptions hurt SEZ exporters [3].
• What:
  • Eligible SEZ manufacturing units may sell part of their output inside India (DTA) at concessional customs duty, instead of the full duty [3].
  • The cap is 30% of the highest annual FOB export value in any of the three preceding financial years [3]. FOB (Free on Board) value is the price of goods at the port, before freight and insurance.

• Example: a unit's best export year out of the last three was ₹200 crore. It can sell up to ₹60 crore in India at the lower duty.

• DESH (Development of Enterprise and Service Hubs):

• Announced in Budget 2022-23 to recast SEZs as broader "enterprise and service hubs".
• It is still pending. No enactment was found in official sources (verify current).

5. Why people oppose SEZs (Class 10 exercise)

• Land acquisition and displacement:
• Farmland is taken, so farmers and farm workers lose their livelihoods.

• Examples: Singur and Nandigram (West Bengal), 2006-07.

• Revenue loss:

• Tax breaks reduce government income.

• Class 11: tax incentives to foreign investors cut the revenue available for welfare spending (health, education, poverty programmes).

• Land diverted to real estate: land meant for industry is used for housing or commercial property.

• Enclave growth: the SEZ grows like an island.
• It has weak links to local suppliers, local workers and nearby industry.
• So the benefits do not spread much into the local economy.

6. Flexible labour laws

• Labour laws: rules that protect workers, such as minimum wages, working hours, job security and social security.
• NCERT (Class 10):
• Firms in the organised sector must follow these rules. The organised sector means registered firms with regular jobs and legal protections.
• The government has allowed companies to ignore many of these rules.
• Firms hire workers "flexibly", for short periods when work pressure is high.
  • Result: labour costs fall.

• Foreign companies still demand more flexibility.

• Now, the four Labour Codes:

• 29 central labour laws were merged into four Codes, effective 21 November 2025 [4]:
  1. Code on Wages, 2019
  2. Industrial Relations Code, 2020
  3. Code on Social Security, 2020
  4. Occupational Safety, Health and Working Conditions Code, 2020

7. Key changes under the Codes

• Fixed-term employment (FTE):
• FTE means hiring a worker for a set period, for example one year, directly and not through a contractor.
• FTE workers get benefits equal to permanent employees, on a pro rata basis (in proportion to the time worked) [4].
• They become eligible for gratuity after one year of continuous service. Earlier the requirement was 5 years [4].

• Gratuity is a lump-sum payment made when a job ends.

• Layoff, retrenchment and closure threshold, raised from 100 to 300 workers:

• Definitions:
  • Layoff: the worker is temporarily not given work.
  • Retrenchment: the worker is permanently removed for reasons other than punishment.
  • Closure: the unit is shut down.
• Establishments with 300 or more workers need prior government permission before any of these [5]. The old limit was 100.
• A Parliamentary Standing Committee had recommended this increase [5].
• The application must be made 15 days before a layoff, 60 days before retrenchment and 90 days before closure [5].

• Cause and effect:

  • Firms with 100–299 workers no longer need permission.
  • So they can shrink their workforce more easily.
  • This is more flexibility for firms and less job security for workers.

• Standing orders:

• Standing orders are written service rules on hiring, discipline and leave.

• Certified standing orders now apply only to establishments with 300 or more workers (earlier 100) [6].

• Gig and platform workers:

• Gig worker: earns from work outside a traditional employer–employee relationship [7].
• Platform worker: does work through an online platform, such as delivery or ride-hailing apps [7].
• Aggregators (platform companies) contribute 1–2% of annual turnover to a social security fund. This is capped at 5% of the amount paid to these workers [7].
• Each worker gets a unique Aadhaar-linked ID through e-Shram registration [7].
  • Because of this ID, benefits continue when the worker switches platforms [7].

8. Race to the bottom

• Race to the bottom: countries keep lowering taxes, labour standards or environmental standards to attract investment and trade.
• Cause and effect:
• Country A cuts its corporate tax, so Country B cuts too, and then A cuts again.
• In the end, public revenue and worker protection shrink everywhere.

• Yet the MNC's location choice barely changes, because every country offers the same deal.

• Numerical illustration:

• Two countries each tax an MNC's ₹1,000 crore profit at 30%. Each collects ₹300 crore.
• Both cut the rate to 15% to attract the MNC. Each now collects only ₹150 crore.

• The MNC still invests in the same place. Both countries have lost ₹150 crore that could have gone to welfare.

• Counter-moves:

• OECD/G20 global minimum corporate tax of 15% (Pillar Two). This is covered in the taxation topic.
  • If an MNC's profit in a low-tax country is taxed at only 5%, another country can collect a top-up tax of 10%.
  • This takes away the gain from cutting taxes too low.
• ILO core labour standards (fundamental principles and rights at work):
  • Freedom of association
  • No forced labour
  • No child labour
  • No discrimination
  • Safe and healthy working conditions, added in 2022

Prelims Hooks

• SEZs are set up by both central and state governments. The legal base is the SEZ Act 2005 plus the SEZ Rules 2006.
• Section 10AA (Income Tax Act) holiday pattern: 100% for 5 years → 50% for 5 years → 50% of reinvested profit for 5 years. That is 15 years in total.
• No holiday for units starting on or after 1 April 2020.

• Trap: NCERT's "5 years, no tax" is outdated.

• 368 notified SEZs (28 February 2025) [2].

• June 2025: SEZ Rules amended for semiconductor/electronics-only SEZs. The first two are Sanand (Gujarat) and Dharwad (Karnataka) [2].
• Budget 2026-27 one-time DTA sales at concessional duty: capped at 30% of the highest FOB export value of the preceding 3 years [3].
• DESH was announced in Budget 2022-23 to replace or recast the SEZ framework. It is not yet enacted.
• Four Labour Codes replace 29 laws and have been effective since 21 November 2025 [4].

• Trap: the Code on Wages is of 2019. The other three are of 2020.

• The IR Code threshold for prior permission for layoff, retrenchment or closure is 300 workers (earlier 100) [5].

• Fixed-term employees get gratuity after 1 year of service [4].

• Platform aggregators contribute 1–2% of turnover, capped at 5% of payouts to workers [7].

• Race to the bottom: competitive cutting of taxes and standards.

• Counters: OECD Pillar Two (15% global minimum tax) and the ILO core labour standards (safety and health added 2022).

Mains Points

• SEZs: export engines or enclaves?
• For:
  • Exports of ₹11.70 lakh crore in 2025-26 (till December 2025), up 32.02% [2]
  • 31.73 lakh jobs (December 2025) [2]
• Against:
  • Farmland lost and people displaced (Singur, Nandigram)
  • Tax revenue given up
  • Weak links to the local economy

• The June 2025 semiconductor rules and the 2026-27 DTA-sales relief show SEZs moving from pure export enclaves towards being part of domestic value chains [2][3]. DESH is the pending legal step.

• Tax incentives, a trade-off:

• Holidays like Section 10AA attract investment but reduce revenue for welfare (Class 11 point).

• The 2020 sunset and Pillar Two show a global shift away from tax competition towards infrastructure and ease of doing business.

• Labour Codes: flexibility vs security:

• Raising the threshold to 300 and allowing fixed-term employment gives firms flexibility, which foreign investors demand [5].
• Pro rata benefits, one-year gratuity and gig-worker social security try to balance this with security [4][7].
• This is the "flexicurity" balance: flexibility for firms plus security for workers.

• Risks:

  • Weaker job security
  • Growth of short-term, informal-like work (NCERT's "flexible" hiring)

• Race to the bottom and cooperative solutions:

• One country acting alone cannot resist this race.
• Multilateral floors (OECD 15% minimum tax, ILO core standards) protect revenue and labour rights while still allowing competition on productivity.