Applicability Of GST On Supplies Made To Special Economic Zones

Introduction - SEZs as an Extension of India's Export Policy

Special Economic Zones were conceived as instruments of national economic policy to promote exports, attract foreign investment, and generate employment. The Special Economic Zones Act, 2005, accords SEZs a unique legal status by treating them as territories deemed to be outside the customs territory of India FOR AUTHORISED OPERATIONS. This deeming fiction is not ornamental; it forms the foundation of the indirect tax treatment accorded to SEZs.

When the Goods and Services Tax was introduced as a comprehensive destination-based tax, Parliament consciously preserved this export-oriented philosophy. Supplies made to SEZ Developers and SEZ Units were not absorbed into the domestic tax chain. Instead, the GST law retained its special position so that domestic taxes do not burden export-linked activities. Courts have consistently recognised that provisions relating to SEZs must be interpreted in the light of this overarching export-promotion objective.

The foundational policy rationale underpinning Special Economic Zones (SEZs) is also manifest in India's broader constitutional and trade commitments. Article 286 of the Constitution limits the taxation of exports, acknowledging that taxes should not hinder international commerce. The SEZ framework, when considered in conjunction with the Goods and Services Tax (GST), should therefore be viewed as an extension of this constitutional philosophy. Judicial authorities have consistently maintained that tax statutes pertaining to exports must be interpreted with purposiveness, bearing in mind that exports serve as engines of economic development rather than primary revenue sources. It is within this constitutional, financial, and trade policy context that the exemption of supplies to SEZs from the domestic GST chain is substantively justified.

At a deeper level, the GST treatment of supplies to Special Economic Zones reflects a simple economic wisdom-that exports should carry the strength of Indian enterprise, not the weight of domestic taxes.

कर का बोझ जब निर्यात पर नहीं डाला जाता, तभी व्यापार विश्व में अपनी पहचान बनाता।

[When the burden of tax is not placed on exports,trade truly finds its identity and acceptance in the global market.

Zero-Rated Supply under Section 16(1) of the IGST Act, 2017

Section 16(1) of the Integrated Goods and Services Tax Act, 2017 defines "zero-rated supply" to mean export of goods or services or both, and supply of goods or services or both to a SEZ Developer or a SEZ Unit. This provision is the cornerstone of GST treatment for SEZ transactions.

By placing supplies to SEZs on the same footing as physical exports outside India, the law recognises that such supplies, though made within India, are economically indistinguishable from exports. GST is therefore neutralised at the source, ensuring that Indian goods and services meant for global markets remain competitive. Judicial forums have repeatedly emphasised that zero rating is not a concession but a structural feature of export taxation intended to achieve complete tax neutrality.

The Supreme Court, while addressing export-related tax provisions in multiple contexts, has consistently underscored that zero rating is not a fiscal concession subject to executive discretion but a structural necessity to prevent the export of domestic taxes. In Gujarat Ambuja Exports Ltd. v. Union of India [2023 (3) TMI 487 - Supreme Court; judgment dated 27 February 2023], the Court observed that the essence of zero rating lies in achieving complete tax neutrality, and not merely exemption at the output stage. The Court emphasised that exports must be freed from the burden of indirect taxes at every stage of the supply chain. Applying this principle to GST, supplies to SEZ Developers and SEZ Units must be treated on par with physical exports; otherwise, the competitiveness of Indian goods and services in global markets would stand eroded, defeating the very rationale of zero-rated supplies under Section 16(1) of the IGST Act, 2017.

Zero-Rated Supply Is Not an Exempt Supply - Section 16(2) in Its True Context

A recurring area of confusion under GST is the distinction between zero-rated supplies and exempt supplies. Section 16(2) of the IGST Act clarifies that input tax credit is available for making zero-rated supplies, notwithstanding the fact that such supplies may otherwise appear to be non-taxable.

This clarification is fundamental. Exempt supplies break the ITC chain and ordinarily trigger reversals under Section 17. Zero-rated supplies, on the other hand, preserve the credit chain as a whole. Courts have consistently reaffirmed that treating zero-rated supplies as exempt supplies would defeat the very architecture of GST. The Department itself has acknowledged this distinction through Circular No. 48/22/2018-GST, dated 14.06.2018, thereby removing any lingering ambiguity for suppliers dealing with SEZs.

The practical significance of Section 16(2) becomes evident when contrasted with exempt supplies. For instance, where a domestic supplier provides services to an SEZ Unit under zero rating, the entire input tax credit chain remains intact. No reversal under Section 17 is attracted. Conversely, if the same supply were treated as exempt, the supplier would be required to reverse common credits, thereby converting GST into a cost. Such an outcome would directly contradict the GST's foundational objective as a value-added tax. It is for this precise reason that the legislature consciously carved out zero-rated supplies as a distinct category.

Authorised Operations - From Implicit Understanding to Explicit Statutory Mandate

The zero-rated status of supplies made to a SEZ Developer or a SEZ Unit is not unconditional. The supply must be made for authorised operations of the SEZ entity. Authorised operations are activities approved explicitly under the SEZ framework and intrinsically linked to the SEZ's functioning and export objectives.

The words "for authorised operations" were inserted in Section 16(1)(b) of the IGST Act by the Finance Act, 2021. However, this amendment was brought into force only with effect from 1 October 2023. From this date onwards, the requirement has acquired explicit statutory force. Even before the statutory insertion, effective from 01.10.2023, disputes frequently arose when the Department attempted to deny benefits by questioning the end use of supplies. Judicial forums generally adopted a pragmatic approach, holding that once the Specified Officer of the SEZ had approved an activity as an authorised operation, tax authorities could not sit in appeal over such approval. The amendment brought into force in 2023 must therefore be viewed not as a substantive restriction, but as a legislative affirmation of an already evolved legal position.

Even before this insertion, courts and tax authorities consistently examined whether supplies bore a reasonable nexus with authorised operations. Judicial reasoning in several SEZ-related matters reflected a balanced approach: benefits were not to be denied mechanically, but neither were they meant to extend to activities falling outside the approved operational framework. The amendment, effective from 01.10.2023, does not disturb this jurisprudence; rather, it codifies it and removes interpretational ambiguity.

Transitional Perspective - Supplies Before and After 01.10.2023

For supplies made before 01.10.2023, the zero-rated character of supplies to SEZ Developers or SEZ Units continues to be governed by the unamended statutory language. During this period, denial of the zero-rated benefit solely based on a later insertion would not be legally sustainable, provided the supplies were otherwise made to SEZ entities in accordance with law.

For supplies made on or after 01.10.2023, however, the position is unequivocal. The authorised-operations condition must be demonstrably satisfied, and refund eligibility must be tested against this explicit statutory requirement.

Examples of SEZs in Practice

India's SEZ ecosystem demonstrates why the GST law adopts this policy-driven approach. Zones such as Noida Special Economic Zone, Mundra Port SEZ, and Sri City SEZ operate as export-oriented clusters rather than ordinary industrial estates. Supplies to such zones are integral to global supply chains, reinforcing the rationale for treating them as exports in substance. Further, in such zones, even routine supplies like maintenance services, professional consultancy, or infrastructure support form an inseparable part of export-linked operations.

Modes of Making Zero-Rated Supply - Section 16(3) of the IGST Act

Section 16(3) provides a registered person with two alternative routes for making zero-rated supplies to SEZ Developers or SEZ Units. Supplies may be made without payment of IGST under a Bond or Letter of Undertaking, followed by a refund of unutilised input tax credit. The refund shall be governed by the provisions of Section 54 of the CGST Act, 2017. Alternatively, supplies may be made on payment of IGST with a subsequent claim for refund of the tax paid.

From a commercial standpoint, the choice between supplying under LUT without payment of IGST and supplying on payment of IGST followed by a refund is influenced by cash-flow considerations. Large suppliers with substantial ITC accumulation often prefer the LUT route to avoid working capital blockage. Conversely, entities with limited ITC may opt to pay IGST and seek a cash refund. The law deliberately preserves this flexibility, recognising that zero rating should not be defeated by procedural rigidity.

Refund of Taxes - Section 16(3) Read with Section 54 in the Post-01.10.2023 Regime

Refunds arising from zero-rated supplies are governed by Section 54 of the CGST Act. While Section 16(3) creates the substantive right to a refund, Section 54 read with Rule 89 sets out timelines, documentation, and processing requirements.

With effect from 01.10.2023, the insertion of "for authorised operations" has significantly influenced refund scrutiny for SEZ supplies. Endorsement by the Specified Officer of the SEZ, earlier viewed largely as procedural, has now acquired decisive statutory significance. Refund authorities are legally empowered to examine whether the goods or services supplied have a clear and demonstrable nexus with approved authorised operations.

Departmental circulars that streamline SEZ refund procedures must now be read in harmony with the amended Section 16(1)(b). Experience shows that refund disputes rarely arise on taxability; they arise on proof. Post-amendment, documentation and alignment with SEZ approvals have become determinative.

It is important to note that the proviso to Section 16(3), which mandates repayment of the refund if export proceeds are not realised within the time prescribed under FEMA, applies only to physical exports involving an obligation to realise foreign convertible foreign exchange. Supplies made to SEZ Developers or SEZ Units, though treated as zero-rated under GST, do not constitute exports under FEMA and do not carry any statutory requirement of foreign exchange realisation. Consequently, the said proviso does not apply to supplies made to SEZ entities. Any contrary interpretation would amount to importing FEMA conditions into domestic SEZ transactions, a result not contemplated by the legislature.

Physical Exports and SEZ Supplies - Two Routes, One Export Philosophy

A comparative understanding of physical exports and SEZ supplies reveals that the difference lies not in tax philosophy but in regulatory mechanics. Physical exports involve geographical movement of goods outside India and customs clearance. In contrast, SEZ supplies rely on a legal fiction that treats SEZs as territories outside the customs frontier for authorised operations.

In conceptual terms, physical exports may be described as exports by geography, while SEZ supplies represent exports by legal design. Both converge on the same destination: zero rating, ITC availability, and refund, reinforcing the export-neutrality principle under GST.

Regulating Zero-Rated Refunds: The Evolving Framework under Sections 16(4) and 16(5)

With effect from 01.10.2023, Section 16(4) of the IGST Act marks a significant shift in the framework governing zero-rated supplies made on payment of integrated tax. The provision now empowers the Government to specify both the class of persons and the class of goods or services in respect of which zero-rated supplies may be made on payment of IGST, followed by a refund claim under Section 54 of the CGST Act and the Rules made thereunder. Export on payment of IGST is thus no longer an unconditional statutory right but a notified entitlement, exercisable only in accordance with Government-prescribed parameters.

In exercise of this power, Notification No. 01/2023-Integrated Tax dated 31.07.2023 (as amended) permits export of all goods and services on payment of IGST except those specifically listed in the notification, predominantly comprising tobacco, pan masala, and certain essential oils. Notably, suppliers making supplies to SEZ Developers or SEZ Units for authorised operations have been expressly recognised as a permitted class of persons, subject to the same goods-based restrictions. This ensures that the zero-rating mechanism remains available for genuine export-oriented and SEZ-linked transactions, while curbing its misuse in sensitive commodity segments.

Further, with effect from 01.11.2024, Section 16(5) introduces an overriding restriction by providing that where exported goods are subject to export duty, no refund of input tax credit or integrated tax paid shall be allowed, notwithstanding anything contained in Sections 16(3) or 16(4). This provision reflects a conscious policy choice to deny GST refunds in cases where exports are already subjected to export duty, thereby preventing unintended revenue outflows and maintaining fiscal equilibrium.

Together, Sections 16(4) and 16(5) represent a calibrated legislative response-preserving the export-neutrality principle of GST, while enabling the Government to regulate refund entitlements in line with broader economic and revenue considerations.

Concluding Remarks

The GST framework governing supplies to SEZ Developers and SEZ Units reflects a carefully calibrated balance between export promotion and fiscal discipline. Judicial precedents, departmental circulars, and legislative amendments collectively convey a consistent message: zero-rated benefits are meant for genuine, authorised, export-oriented activities.

The amendment effective from 01.10.2023 marks a decisive evolution by converting implicit expectations into explicit statutory conditions. Far from weakening the SEZ regime, it strengthens its credibility by aligning tax benefits more closely with economic substance.

In this sense, physical exports and SEZ supplies are not competing concepts but complementary routes within India's export architecture-two paths guided by one policy objective: ensuring that Indian goods and services reach global markets free from the burden of domestic taxation.

Seen in its entirety, the GST framework governing supplies to Special Economic Zones demonstrates how tax law, when aligned with economic purpose, can quietly enable trade rather than constrain it.

नीति जब व्यापार का साथ निभाती है, तभी अर्थव्यवस्था नई ऊँचाइयाँ पाती है।

[When policy stands beside trade, the economy rises to new heights.]