Section 10AA Of Income Tax Act: Eligibility, Limit, Example and Calculation for deduction under Section 10AA

To promote exports and attract foreign investment, the Government of India introduced Section 10AA under Foreign Policy Act. However, it became fully functional in 2006 after which tax concessions were offered to specific businesses. On fulfilling certain conditions, Section 10AA of the Income Tax Act allows new businesses or units offering services in Special Economic Zones (SEZs) to enjoy income tax exemption and holidays. This zone is generally a part of the nation’s diverse business and trade legislation and is located within a nation’s borders. 

Here's more about Section 10AA of the Income Tax Act.

Eligibility for Section 10AA Deduction

Entrepreneurs, firms, companies, individuals and other categories of assessees can claim a deduction under Section 10AA. However, to claim a deduction under this section, SEZs units need to meet the following conditions or criteria:

• The entrepreneur should enrol within the provisions of Section 2(j) of the Special Economic Zone Act, 2005.
• The company should not have been established by relocating previously used plants or machinery. However, in certain cases, SEZ units can use second-hand machinery.
• The SEZ unit must commence its production on or after April 1, 2006.
• The SEZ unit should not be incorporated by reconstructing or splitting an existing business.
• In case SEZ businesses have already reaped the deduction benefit under Section 10AA for 10 years, it becomes ineligible to claim this deduction. 

10AA Exemption Limit

The amount of deduction available under this existing section is as follows:

• 100% of the profit coming from export is entitled to tax deduction for the first 5 consecutive years.
• 50% of the export profit is entitled to deduction for the next 5 years.
• Not more than 50% of the profit is entitled to tax deduction for the next consecutive 5 years.

Section 10AA Limit

Take a look at the following conditions that apply to the exemption amount under this section:

• Business owners of units in SEZs need to create a reserve account (Special Economic Zone Reinvestment Reserve Account) and businesses can utilise the amount only for buying new machinery and plants.
• Owners need to use the newly purchased plant or machinery for 3 years from the date of creating their reserve account.
• Owners need to provide the necessary particulars of the purchase of machinery in Form No.56FF for taxable income calculation.  

Calculation for Section 10AA Deduction Under Income Tax

In order to compute the deduction under Section 10AA, you can use the formula below:

Profit from export = Profit of the unit’s business X Unit’s Export Turnover) / Total Turnover of the Business.

Here, export turnover refers to the amount that a business receives for its exports. This turnover does not include insurance expenses, telecommunication charges, etc.

Section 10AA Amendment

The existing provision of Section 10AA of the Income Tax provides 15 years of tax benefit to newly established businesses or units located in SEZs. However, the claiming of deduction under this section is time-bound. For instance, it is only available if the SEZ unit has begun operation on or after 1 April, 2005 but before 1 April, 2021.

Moreover, with the recent amendment, no deduction will be allowed to an assessee who does not file a return of his income on or before the due date as mentioned under section 139(1).

Also, this section did not provide any time limit for timely remittance of the export proceeds from sales of goods or provision of services under Section 10AA. So, it has been amended and a new sub-section (4A) has been introduced to provide tax deduction on the proceeds from sales of goods that are brought into India in convertible foreign exchange within a time of 6 months from the end of the previous year.

Section 10 (10AA) Leave Encashment

The Finance Act 2023 has inserted a new clause (10 AA) in Section 10 which offers tax benefits to SEZ units. 

As per terms of employment under Section 10 (10AA), an employee gets certain leaves annually. Such leave(s) can include medical leaves, privileged leaves, or earned leaves. Employees can also accumulate medical or earned leaves and apply for them as per requirement. 

However, in some cases, employees can even encash the accumulated leaves and get monetary compensation in exchange. The leave encashed is taxable but the conditions differ between employees and sectors.

Now if you are wondering about the taxation of leave encashment, take a look below:

If you are a government employee (Central or State), then the leave encashment amount is not subject to taxation on resignation/retirement.

If you are a private sector employee, the Government will consider your earning or income from leave encashment after retirement or resignation as "Income From Salary” and therefore, will be taxable. Nonetheless, you can avail tax exemption under Section 10 (10AA) of the Income Tax Act as per the applicable limits. 

Final Word

SEZS are eligible to enjoy an income tax advantage and other associated provisions under Section 10AA of the Income Tax Act. However, it should be kept in mind that these provisions are only applicable to companies that operated from April 1, 2006, to April 1, 2021.