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Nepal introduces a new legislation on special economic zone

12 February 2017

 

Government of Nepal (“GON”) first institutionalized the concept of Special Economic Zone (the "SEZ") through the establishment of Special Economic Zone Development Committee (“SEZDC”) on February 11, 2013 (19-10-2069 B.S.) through the Special Economic Zone Formation Order 2012 (2069 B.S.). The SEZDC was established under Ministry of Industry (“MOI”) to conduct pre-feasibility and feasibility studies for establishment of SEZ in different areas of the country and construct required infrastructure in the SEZ areas.

The Special Economic Zone Act, 2016 (2073 B.S.) (the "Act") was enacted by the Legislative Parliament and has come into effect from October 4, 2016 (08-18-2073 B.S.). The GON is yet to issue the Special Economic Zone Regulations (the "Regulations") to make the Act fully operational. The GON is expected to issue the Regulations in the near future.

As of January, 2017, GON has conducted pre-feasibility or feasibility study for establishment and operation of SEZ in 14 places inside the country. The list of such areas is set out in Annex-II.

The concept of the SEZ and enactment of the Act are in line with a number of other acts and policies. The Industrial Policy 2010 incorporated the features where export oriented industries and industries based in export promotion house and SEZ were entitled to facilities and assistance on customs duty, excise duty and value added tax (the "VAT"). The recently enacted Industrial Enterprises Act 2016 (“IEA”) has also recognized the establishment of SEZ for operation of industrial activities in an intensive manner.

This briefing sets out the regulations relating to determination of SEZ, establishment of industrial units inside the SEZ and associated compliance requirements.  It also discusses various incentives available to industries established inside SEZ.

 

1.         Special Economic Zone Authority.

            Special Economic Zone Authority (the “Authority”) serves as the primary regulator for the operation and management of SEZ and industries inside an SEZ. The Act has provided for constitution of the Authority, its functions, rights and responsibility. The Authority has dual roles: as the regulator of the industries established inside the SEZ and as an operator of the SEZ.


2.         Determination of the SEZ.

2.1       Pursuant to the Act, the SEZ may be developed and operated either by-(a) the GON exclusively, (b) joint investment of the GON and the private sector, or (c) by the private sector exclusively.

2.2       With respect to the SEZ to be developed by and operated by the GON exclusively, the Authority conducts necessary surveys including feasibility study for the determination of any area as SEZ and provides its recommendations to the GON. Upon the recommendation of the Authority, GON may declare any area inside the territory of Nepal as an SEZ. The GON publishes a notice to that effect in the Nepal Gazette.

2.3       The SEZ Act states that any area is determined as the SEZ on the basis of availability of infrastructures such as road, land, electricity grid connectivity, drinking water, among other necessities to set up industries in the SEZ.

2.4       The Regulations will set out provisions relating to development and operation of the SEZ by the joint investment of the GON and the private sector, or the private sector exclusively.  

 

3.         Criteria and Procedures for Setting up of Industries inside SEZ.

3.1       Eligibility Criteria for setting up of Industries inside the SEZ:

(a)        The Act follows a “positive-list” approach in permitting the businesses that are eligible to receive SEZ licenses. The Regulations will set out the list of industries that can be established and operated inside an SEZ. This approach is not consistent with the international best practice.  Usually the SEZ law is supposed to follow a “negative-list” approach, under which only prohibited activities are listed and applications for all activities not on the list are approved.  However, in addition to the industries included in the "positive list", the Act has authorized the Authority to provide approval for the establishment of industries of special nature inside the SEZ, even if such industry has not been included in such list.

(b)       The Act provides that any investor willing to establish industries that are environment friendly, has positive economic potential and export oriented may be given approval for establishment inside SEZ even if not included in the list. Such investor by making an investment of a specific amount may submit an application in a specified format to the Authority for approval. The SEZ Authority after conducting necessary investigations over the application may provide approval if it finds suitable.

3.2       License and Agreement to establish and operate the industries inside the SEZ:

(a)        The procedure for setting up of the industries inside the SEZ include primarily following two steps: (a) obtaining of a license to establish and operate industry, and (b) entering into a lease (operating) agreement between the industry and the Authority.

(b)       With respect to licensing, the Act follows "application based" licensing regime, meaning licenses are not subject to competitive bidding. The investors willing to establish industries inside the SEZ are required to submit an application to the Authority in the given format for license to establish and operate the industry inside the SEZ (the "License"). However, The SEZ Act states that in case more than one industries of same nature apply for the license and the Authority is unable to provide the license to all, the license is provided on the priority as specified in the Regulations.

(c)        The Authority grants the license to establish an industry inside SEZ after conducting necessary evaluation of the application. The investor also must furnish reports of environmental studies (Initial Environment Assessment (IEA)/Environmental Impact Assessment (EIA)) to the Authority along with the application. The industry is required to conduct IEA or EIA pursuant to Schedule 1 or 2 of Environment Protection Rules 1997 (“EPR”). The Act empowers the Authority to approve such environmental report. The Authority is required to finish its assessment and provide the license to the applicant industry within 30 (thirty) days of the evaluation of IEA/EIA Reports.

(d)       In case the Authority finds any application unsuitable to be approved, the decision of rejection should be given to the applicant along with the reason for such rejection within 7(seven) days of the decision. The applicant may file an appeal against such rejection before the Ministry of Industry (the "MOI"), within 35(thirty-five) days. The Ministry must decide on the matter within 30(thirty) days of the appeal submitted.

(e)        After obtaining license from the Authority, an agreement has to be entered into between the industry and the Authority. The agreement should include, among other things, (i) the amount of rent or lease for using building, land and other services (electricity, water, sewage, waste management, etc.) (ii) the date of incorporation and operation of industry(iii) the amount of products or services to be exported, (iv) issue of technology transfer in case of the foreign investors, (v) other things as prescribed under the Regulations.

(f)        The Act is not clear as to whether a local entity is required to be created for obtaining the license and entering into the agreement with the Authority in advance. It seems logical that the local entity is created only after obtaining the license and prior to entering into the contract. The requisite entity and tax registration will need to be completed at the designated authorities (unless the Authority is delegated relevant power to do so) pursuant to applicable legislations. However, the process needs to be channelized through the one window service.

3.3       Relocation of Industries inside a SEZ:

            The Act has restricted relocation of any industries already established and operating at the time of the commencement of the SEZ inside the SEZ. Also, tools or equipment used previously in other industries is also prohibited to be used and transferred in industries inside SEZ. An exception to such restriction is that some industry of special nature as published in the Nepal Gazette can be relocated in an SEZ despite its prior establishment and operation. The GON has not published any Gazette notification in this regard till date.

3.4       License Period and Renewal:

(a)        The duration of license is of maximum 30 years depending upon the nature of the industry. This means that the Authority can set out different periods for licenses on the basis of the nature of industry.

(b)       The license can be renewed after expiry of the initial license period. An application is to be submitted to the SEZ Authority for renewal of the license. In case of an industry that is operating by utilizing in more than 30(thirty) percent of the total capacity (compared to the registered capacity) the term of the License may be renewed for further 10 (ten) years at a time after fulfilling the necessary procedures.

 

4.         Mandatory Export Requirement.

4.1       Key objective of establishment of SEZ is the promotion of export. Therefore, the industries established inside the SEZ are required to mandatorily export all of their products or services outside of Nepal. However, the Act permits to sell 25(twenty-five) percent of the total production or service in the domestic market on the prescribed basis. The Regulations will set out the relevant basis for allowing the domestic sales. The Act is not clear as to whether the industry selling up to 25% of its production or service is still entitled to tax incentives or benefits for such domestic sale.

4.2       The domestic sale is not subject to approval of the Authority. However, the industry is required to inform and provide necessary details to the Authority in advance if it wishes to sell its goods and services in Nepal.

4.3       If an industry exceeds the permitted domestic sales percentage, the industry is exposed to following legal consequences: (a) fine equal to the amount of local sales, and (b) non-availability of the tax incentives and benefits for the relevant fiscal year. In addition, the Authority may also cancel the license or close the industry.

 

5.         Facilities and Incentives to Industries established inside SEZ.

            The tax incentives, benefits and facilities provided to the industries established and operated inside the SEZ are briefly outlined below.  

5.1       One window service:

            The Act has provides a one-window service for industries that are established inside SEZ. Services related to tax concessions and other benefits, company and industry registration, renewal, administrative formalities in relation to company, industry and visa required to operate the industry will be provided through one-window service.

5.2       Tax incentive and benefits:

            Tax incentives and benefits provided to the industries inside SEZ are briefly set out in Annex-I.  In addition to the SEZ Act, Industrial Enterprises Act 2016 (“IEA”) as well as Income Tax Act 2002 (“ITA”) have also set out benefits/incentives for industries inside SEZ.

            The Act has guaranteed the stability of the tax incentives, benefits and other concessions provided under the Act and other laws. The Act provides that if any provision is made in the Act or other laws adversely impacting on the benefits, concessions and facilities provided to the industries, such provisions shall not apply to the industries.

            Generally, the relevant tax laws and industrial enterprise law accord tax incentives and benefits and they are subject to review and change through the Finance Act, which is published each Fiscal Year. As the Act has guaranteed the stability of the tax incentives and benefits provided under the Act and other laws, such incentives and benefits cannot be taken away by the Finance Act.  As the initial period of the license can be 30 years and such license can be renewed further period, it appears that the benefits and incentives as available under the laws can last perpetually.

5.3       Repatriation:

            The foreign investors of the industries established in SEZ can repatriate the following amount in convertible foreign currencies: (a) sale proceeds of the equity, (b) dividend amountand (c) principal and interest of the loan.

            The currency for the repatriation would be as per the agreement made between the license holder and the Authority. The Act allows the foreign investors with recommendation of the Authority to open bank accounts in any commercial banks in a foreign currency. The Act permits the license holder to carry out transactions in foreign currency.

           
These are the general benefits which are also available under the foreign investment laws.


6.         Employment.

6.1       Contract employment:

(a)        The Act provides that the facilities that workers and employees receive, security measures, duty hour, the works to be done, obligations to be fulfilled, leaves, facility of medicine and treatment, bonus, insurance and other welfare provision shall be “as per the contract” between the employer and employee. This is a marked departure given that the existing employment laws are stringent and allow the employees to hire employee on the contract only for irregular work and for specified period.

(b)       The Act also states that the “facilities and welfare benefits” must not be “less than” those guaranteed by existing laws. Though this provision does not appear to be sufficiently clear, this implies that facilities and welfare benefits as covered under the existing Labour Act and Labour Rules will be applicable to the industries established inside the SEZ. The existing Labour Act and Labour Rules cover welfare fund, compensation, gratuity, provident fund, housing fund, etc.; within the welfare provisions.

6.2       Minimum wage:

            The Authority can establish a separate minimum wage applicable in the SEZ. However, such minimum wages must not be lower than the national minimum wage.

6.3       Work permit for foreign expatriates:

(a)        The Act does not provide any flexible rule for the appointment of foreign expatriates. As under the current regulations, foreign expatriates can be hired only if-(a) there is no skill set available locally, (b) for “technical” and “highly technical” positions and (c) for a defined period with an obligation to train the local manpower and substitute the foreign expatriates over the specified period.

(b)       The non-availability of the skill set will need to be established through an advertisement for the job locally and hiring of such foreign expatriate is subject to work permit from the Authority. The Act has not given the recognition of the "inter-corporate transferee" in line with the WTO commitments of Nepal.

(c)        The Authority generally grants work permit for a maximum period of 5 years for technical positions and 7 years for highly technical positions. However, the Authority can grant work period for longer period.

(d)       The Act permits the foreign expatriates to repatriate up to 60% of the net repatriation. This provision is more stringent given that the IEA has permitted repatriation of 75% of the salary and allowance.

6.4       Strikes:

(a)        The Act states that the workers and employees of the industries established inside the SEZ are not permitted to commit any acts and actions that harm and damage the industry by launching strikes, closure, or movement so as to affect the industry and its products. This provision seems to impose restriction on the strikes. However, it may be challenging to implement this provision.

(b)       The Act provides for a formation of complaint management committee in each SEZ as a grievance handling mechanism. The committee must consist of one representative of the SEZ Office, one representative from the investors and one representative from the worker unions.

6.5       Visa

            Non-Tourist Visa for 6 (six) months is provided to the foreign nationals visiting Nepal for the purpose of conducting study or research with the objective of investing in industries. Business Visa is granted to foreign investors and their families, representative officers and their families until the existence of their investment in the industries in SEZ. Residential visa is provided to the investors as well as their family who have an investment of over 10(ten) million USD or an amount equaling the same in other foreign currencies.

 

7.         Transfers of Shares.

            An approval from the Authority is required to transfer 50 (fifty) per cent or more shares of the industry.


8.         Reporting Compliance.

            The industries are required to submit reports to the Authority within 3(three) months of the end of every fiscal year. The Report should include among other things, volume of exports and income/expenditure details.


9.         Dispute Settlement.

9.1       The Act states that any disputes between the investor or the concerned industry or the Authority should be settled amicably with mutual consultations in the presence of the Ministry.

9.2       In case the dispute cannot be settled by mutual consultations, such dispute is required to be settled through arbitration pursuant to the prevailing Arbitration Rules of the United Nations Commission on International Trade Law (UNCITRAL). The arbitration has to be conducted in Kathmandu and the laws of Nepal apply in the arbitration.

9.3       The Act provides flexibility for settlement of disputes in case of industries having foreign investment. If the dispute is related to foreign investment in the industry, it is settled according to the provisions contained in the foreign investment agreement. However, such flexibility will be available only to such industries which have specified amount of the investment and amount will be specified by the Regulations.

9.4       As the Authority is also a regulator, it has statutory power to impose sanctions for breach of the licensing conditions and provisions of the agreements by the industries. In view of this, it may be a problem to reconcile the statutory power of the Authority with the mandatory dispute resolution process discussed above. 

 

Annex-I

FISCAL CONCESSIONS FOR INDUSTRIES INSIDE SEZ
 

A.             Concession in the rent of the land and building inside SEZ  
Industries having rented Land or Building inside SEZ are entitled to concessions in the rent or lease amount.

First year: 50(fifty) percent

Second year: 40(forty) percent

Third year: 25(twenty-five) percent

 

B.             Income Tax Concessions under SEZ Act  
Industries

Exemptions

All Industries

100% Income Tax exemption for first 5 years from commencement of commercial transaction of the products.

50% Income Tax exemption for the following 5 years

50% exemption for the following 10 years if the industry utilizes a minimum of 60% domestic raw materials.

Industries inside SEZ of Himalayan Region and Government specified Hilly regions

 

100% income tax exemption for first 10 years from the date of commencement of commercial transaction of the products.

 

50% percent exemption for the following 10 years.

 

C.             Dividend                                         
Industries inside SEZ

100% exemption in dividend distributed by such industries for the first 5 years from the date of commencement of commercial transaction

  50% exemption in the following 3 years

Note:

The industries relocated in SEZ are not entitled to income tax exemptions listed above.
 

D.             VAT Exemption
0% VAT on goods and services exported by industries.
0% VAT on raw materials and finished goods imported by industries.

 

E.              Custom Duty Exemption

Industries inside SEZ are entitled to Custom Duty exemption under Bank Guarantee and other facilities in the following goods:

a.  raw materials, auxiliary raw materials, packaging and other materials used for producing export products;

b.  plants, machineries, equipment, tools and spare parts and maximum 3(three) vehicles depending upon the nature and size of industry.

 
Custom Duty paid on any Goods imported by any importer is refunded if such goods are sold to industries inside SEZ under prescribed conditions.
 

Products of the industries established in SEZ, if sold to other industries established in SEZ will be treated as export and customs concession will be provided.

ANNEX - II

Areas identified by GoN for establishing SEZs

1.              Bhairahawa SEZ (Coming into operation soon)

2.              Simara SEZ

3.              Panchkhal SEZ

4.              Biratnagar SEZ

5.              Kapilvastu SEZ

6.              Jumla SEZ

7.              Dhangadi SEZ

8.              Nuwakot SEZ

9.              Nepalgunj SEZ

10.           Jhapa SEZ

11.           Dhanusha SEZ

12.           Rautahat SEZ

13.           Siraha SEZ

14.           Gorkha SEZ

Disclaimer: This Pioneer Law Briefing may not necessarily deal with every important aspect of the subject matter. This Briefing is intended for general information only and not to be construed as legal or other advice.
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