SEZ Compliance for Manufacturing Units: The Obligations Behind the Incentives

Introduction : Special Economic Zones are set up in India to attract export-led manufacturing. To facilitate the exports, the Special Economic Zones Act 2005 was enacted. Units inside the zone receive duty-free imports, duty-free domestic procurement and zero-rated GST supplies. The income-tax holiday under section 10AA of the Income-tax Act 1961 is not open to new units. For new manufacturers, the main benefits are therefore customs and GST concessions, and these depend on continued compliance. This article sets out the governing provisions and examines how they apply over the life of a unit, from approval to expansion and exit. It also reviews the judgments that define the limits of the regime and offers suggestions for reform.

Legal Provisions

The Special Economic Zones Act 2005

The Special Economic Zones Act 2005 exempts goods imported into an SEZ for its authorised operations from customs duty. Also, Section 26 exempts goods procured from Domestic Tariff Area (DTA) from customs duty.  Section 30 of the act provides that when goods move from an SEZ into the Domestic Tariff Area (DTA), the Act charges duty as if they were imported.  Under Section 16 the Approval Committee can cancel a Letter of Approval for persistent breach of its conditions by the entrepreneur, after giving the unit a hearing.

The entrepreneur must first be given a reasonable opportunity of being heard. Once approval is cancelled, the unit loses its exemptions and must remit the benefits availed on capital goods, finished goods and unused raw materials. The entrepreneur may appeal to the Board of Approval. In addition, Section 49 provides for the Central Government to modify the application of other laws to zones. Its proviso excludes matters relating to trade unions, industrial and labour disputes, and labour welfare.

The Special Economic Zones Rules 2006

Approval and commencement. The Letter of Approval records the items of manufacture, the projected exports and Net Foreign Exchange (NFE) for the first 5 years. It is valid for one year for starting production. The Development Commissioner may extend it by up to 2 years, and by one further year if two-thirds of the setup is complete. Otherwise, the approval lapses.

Bond and records.    Each unit must execute a Bond-cum-Legal Undertaking in Form H. the unit must keep the accounts of goods received, used and disposed of must be kept for seven years and an Annual Performance Report in Form I must be filed. In addition, Rule 25 requires that a unit to refund the benefits on any goods it does not use for authorised operations or cannot account for.

Net Foreign Exchange. Rule 53 requires that a positive NFE, calculated cumulatively over 5 years from commencement, must be maintained. Under rule 54, the Approval Committee monitors the performance.  A shortfall exposes the unit to penalties under the Foreign Trade (Development and Regulation) Act 1992.

Exit. Rule 74 allows a unit to leave on payments with the approval of the Development Commissioner on payment of duty on its capital goods and stock. It also mandates executing a legal undertaking in Form L. Rule 74A allows a unit to be sold once it has held its approval and lease for 5 years and has operated for 2 years. The sale needs Approval Committee approval, and the buyer takes on the seller’s duties and export obligations.

Other Applicable Law

Outside the SEZ statute, several other laws apply such as tax, labour and environment. Under section 16 of the IGST Act 2017 supplies to a unit are zero-rated. A Letter of Undertaking furnished under rule 96A of the CGST Rules 2017 is valid for one financial year. A unit still within an existing deduction period now claims it under section 144 of the Income-tax Act 2025. Regarding the labor law, the four Labour Codes were brought into force on 21 November 2025 and apply to SEZ.  The Industrial Relations Code 2020 repealed the Industrial Disputes Act 1947. Item 7(c) of the Environment Impact Assessment Notification 2006 covers industrial estates, including SEZs. Thus, Environmental clearance for the zone falls under item 7(c) of the EIA Notification 2006. Each unit still needs consent to establish and consent to operate from the State Pollution Control Board.

Two recent measures are relevant to manufacturers. The SEZ (Amendment) Rules 2025 reduced the minimum land area for zones dedicated to semiconductors or electronic components to ten hectares. They also included free-of-cost goods in the NFE calculation for units providing manufacturing services in the semiconductor sector. Notification No 11/2026-Customs permits concessional DTA sales from 1 April 2026 to 31 March 2027. It is limited to units that commenced production by 31 March 2025 and goods with at least 20 per cent value addition, and sales are capped at 30 per cent of the highest annual export value in the three preceding years.

Legal Analysis

Even though the units are located in India and subject to Indian domestic law, the regime treats the zone as foreign territory for customs purposes. This creates three tensions. The first concerns the domestic market. Section 30 treats a DTA clearance as an import. Therefore, a zone manufacturer selling in India can bear a higher duty than a competitor importing the same finished product at a preferential rate under a trade agreement. The 2026 notification has acknowledged the problem. Notification No. 11/2026-Customs allows concessional DTA sales from 1 April 2026 to 31 March 2027, capped at 30 per cent of the highest annual exports in the preceding three years. One view holds that a temporary measure gives investors too little certainty to plan capacity while the opposing view is that the cap is needed to stop zones from becoming a duty-concessional route into the domestic market and to protect revenue and DTA producers.

The second is concerned with the strength of the export obligation. Positive NFE requires only that foreign-exchange earnings exceed foreign-exchange outflows over 5 years. Supporters consider this to be a flexible test that lets units compete on cost. However, critics argue that it does not ensure meaningful domestic value addition, because a unit that assembles imported inputs can satisfy it with modest margins. The 2025 amendment for semiconductor units makes the calculation more accurate for one sector but leaves the general test unchanged.

The third concerns labour. Rule 5(5) asks each State to try to delegate its powers under the Industrial Disputes Act 1947 to the Development Commissioner and to declare zones public utility services under that Act. The rule has not been amended even though that Act has since been repealed. It is therefore uncertain whether delegations and declarations made under the repealed Act continue in force, and units should confirm the position with the State concerned. The proviso to section 49 confirms that Parliament did not intend zones to be exempt from labour law. The primary question is of enforcement, not of applicability.

Case Laws

Commissioner of Customs (Import), Mumbai v Dilip Kumar & Co (Constitution Bench, 30 July 2018). 

The Supreme Court held that an exemption notification must be interpreted strictly. Also, that the person claiming the exemption must prove eligibility. Where there is ambiguity, the benefit goes to the revenue, not to the assessee. The Court overruled Sun Export Corporation v Collector of Customs on this point. SEZ concessions operate as exemptions, so a unit that relies on them must show that it clearly meets every condition.

Adani Power Ltd v Union of India (2026). The Supreme Court held that customs duty could not be levied on electricity generated in an SEZ and supplied to the DTA. As electricity produced in India is not an imported good, there was no taxable event, and exemption notifications cannot create a tax that the statute does not impose. The Court set aside a 2019 Gujarat High Court judgment. It directed refunds, without interest. This ruling confirms that section 30 cannot be extended by delegated legislation beyond its text.

Practical Implications

Compliance follows the life of the unit.

Approval : The projections in the Letter of Approval later serve as the benchmark for monitoring. Thus, they should be realistic.

Setting up : Since the approval lapses automatically, the commencement deadline needs close tracking.

Operations : Monthly stock reconciliation and quarterly reviews of the bond value and NFE prevent most lapses.

Expansion : New products or added capacity need prior approval, and the bond usually needs to be increased.

Exit : A duty computation and an NFE review should be obtained before applying, because penalties must be cleared or secured first.

Each obligation should be assigned to a named function, such as finance, customs, human resources or environment and safety. Two further developments affect planning. Units should build the end of the concessional DTA window on 31 March 2027 into their pricing, and should track State rules under the Labour Codes as they are finalised.

Conclusion

For new manufacturers, now SEZ benefits consist of indirect tax concessions. These concessions depend on continuing compliance. Three changes would make the regime more

coherent: firstly, replace the annual DTA relief with a permanent rule linked to value addition; secondly, amend rule 5(5) of the SEZ Rules so that it refers to the Labour Codes instead of the repealed Industrial Disputes Act; and finally publish a standard compliance calendar on the SEZ Online portal so that obligations under the Act, the Rules and the Letter approval can be tracked in one place.

Author: Apurva Damle in case of any queries please contact/write back to us via email to content@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney

References

1. Oxford University Standard for Citation of Legal Authorities