A Complete Guide To Taxation In Special Economic Zones

By Thibault Serlet, Co-Founder and Chief Researcher of The Adrianople Group

Introduction

Special Economic Zones (SEZs) are business parks or cities that offer various incentives to attract foreign investors. The most famous SEZs are the city of Shenzhen in China, the Dubai Internet City, and Freeport in the Bahamas. However, there are more than 7,500 SEZs in 100 countries.

SEZs most famously offer tax incentives to help attract businesses.

This article is a complete guide to the types of incentives that you might encounter in different SEZs around the world. It gives a surface overview of each tax, explains why SEZs offer the exemptions, and gives several illustrative examples.

Personal Income Tax

This is likely the type of taxation that everyone is most familiar with in their day-to-day life. The personal income tax is defined as “a tax levied on the wages, salaries, dividends, interest, and other income a person earns throughout the year.” It applies to individuals, not to businesses or organizations.

Very few SEZs offer any tax breaks for personal income taxes because SEZs often try to attract businesses, not individuals. SEZs are also wary about the perception that they are tax havens.  

Poland’s SEZs grant personal income tax exemptions in very limited circumstances. Poland does not tax corporations in SEZs directly; instead, it taxes them indirectly through the personal income taxes of employees and company officers. The owners of sole proprietorships and other small businesses enjoy a complete exemption from the personal income tax on income earned through their small businesses registered in the SEZs.

Other SEZs, such as Aqaba, Jordan cater to foreign workers. Non-Jordanian employees working in the zone are exempt from personal income taxes for 12 years.

A small handful of residential SEZs offer exemptions from the personal income tax to attract high net worth individuals. Residents in the Suez Canal Economic Zone, in Egypt, are subject to a flat 5% personal income tax regardless of income. Personal income taxes are reduced from 13% to 9% for residents of the Great Stone Industrial Park in Belarus. Foreign workers are also exempt from social security contributions.

Corporate Income Tax

The corporate income tax is similar to the personal income tax but is paid by businesses instead of individuals. It is usually measured as a tax on all of the revenue that a company earns (not just profit). Most countries allow businesses to write off certain expenses (IE rent), deducting that from their corporate income tax. In many cases, the tax rate is less important to businesses than what they can and cannot write off.

Corporate Income Tax (CIT) exemptions are the most common incentive that SEZs offer.

Because almost all SEZs offer CIT exemptions, the SEZs that don’t offer CIT exemptions fall behind, as it can be thought of as mandatory for the success of a zone. Ironically, because of how widespread CIT exemptions are, they have little impact on the outcome of any individual SEZ. In addition to exemptions, many SEZs modify what businesses can and cannot write off, leaving the actual rates intact.

In Zhuhai, China, the ​​CIT is reduced from 25% to 15% for foreign-invested companies. The Konza Technopolis, in Kenya, also offers CIT exemptions. Kenya normally has a 30% CIT.

Companies located in Konza pay 10% for their first 10 years, 15% for the next ten years, and then pay the normal rate. Tenants in Zona Franca Del Cauca, in Colombia, enjoy a reduction of rates from 31% to 20%.

Some SEZs, like the Sharjah Airport Free Zone in the UAE or the Cayman Enterprise City in the Cayman Islands have no CIT whatsoever.

Value Added Tax (VAT)

Value Added Taxes (VAT) are levied on each stage of production of a product where value is created. For example, imagine a pencil is being built. A tiny tax would be levied when the eraser is added, when the pencil is dyed yellow, and even when intangible services like marketing are performed.

The VAT is a hidden tax that makes all products purchased much more expensive. Rules for computing VAT can be very complicated. There is no VAT in the US, but there is in most other countries.

Many value added processes that occur in SEZs don’t count towards the VAT. For example, in the case of the pencil, if the pencil was dyed in a VAT exempted SEZ, the tax levied at that moment in production would be exempted.

VAT exemptions in SEZs are extremely common. Without SEZ VAT exemptions, modern manufacturing would be much more expensive. 

Sohar Port in Oman; the Maersk Integrated Logistics Park Saudi Arabia; Clark Freeport in Philippines; and the Moscow Technopolis Russia all offer 100% exemption from VAT. However, there are subtle but important differences between all four example SEZs.

The Sohar Port, in Oman, has the simplest exemption—it grants a complete exemption from the VAT for all processes occurring in the zone. By contrast, the Maersk Integrated Logistics Park, in Saudi Arabia, only grants the exemption for the first 50 years of a company’s operation in the zone.

The Clark Freeport, in the Philippines, grants a full exemption of all value added processes destined for export or foreign markets but not if the goods stay in the Philippines. In the Moscow Technopolis the opposite is the case: there is a full exception for processes using products that are imported, but full VAT applies to products being exported.

When looking for an SEZ for your business, make sure you understand the limitations of the VAT in your zone. Subtle differences can have a major impact on the effective amount of taxation.

Payroll Taxes

A payroll tax is a percentage withheld from an employee's pay by an employer who pays it. For example, imagine that there is a 10% payroll tax, and you are paid $1000 a month. $100 would be withheld by the employer in taxes, and you would only receive $900 a month.

Payroll taxes generally are used by governments to fund social security, healthcare, pension funds, and other government-sponsored work benefits. Some countries have progressive payroll tax rates while others have flat rates.

Many SEZs exempt foreign workers from payroll taxes. The rationale is simple: foreign workers would have to pay the taxes but would be ineligible to receive the benefits (IE social security). Some SEZs also, rarely, exempt domestic workers. Economists argue that reduced payroll tax rates contribute to higher employment.

For workers in the Sovetskaya Gavan Port Zone in Russia, contributions to the Pension Fund, the Social Insurance Fund and the Federal Compulsory Medical Insurance Fund are reduced from 30% to 7.6%. Companies in the Sughd Free Economic Zone, in Tajikistan, are completely exempted from all payroll taxes.

Other zones, like Shenzhen in China, have more exotic systems: Shenzhen has its own separate social security fund and unemployment insurance separate from the rest of China, which charges lower rates.

Finally, some zones have negative payroll taxes. Coega SEZ, in South Africa, participates in a national program that provides a subsidy for companies to hire unskilled youths (which could be interpreted as a negative payroll tax).

Land / Property Taxes

Property taxes (sometimes called land taxes) are based on the assessed value of land or property. Property taxes can either be flat or progressive. One variation, called the Land Value Tax, taxes the value of the land without regard to the buildings/man made objects located on top of it. Other variations base tax rates off of the profits made by the owner of the land, typically for commercial properties.

Land and property tax exemptions are very common within SEZs.The goal is generally to increase the amount of construction or development. They are especially common in SEZs in remote, rural, and isolated regions that want real estate developers to build new projects there.

In the Katowice SEZ, in Poland, companies may apply for exemption from property taxes which are negotiated with the government on a case by case basis. Zones like the Skolkovo Innovation Center, in Russia, or the Valencia SEZ, in the Philippines, completely exempts all tenants and developers from all property taxes. Properties in the Francistown SEZ, in Botswana, are exempt from taxes during ownership transfers.

Capital Gains Taxes

Capital gains taxes are taxes on the sale of an investment asset (like a stock). Usually, only assets that increase in value are taxed. For example, if there is a 5% capital gains tax, and the price of your stock went from $100 to $200, (a 100% increase), you would pay $5 in taxes. Capital gains may apply to the sale of stocks, bonds, precious metals, real estate, collectable items, art, commodities, and property.

Many SEZs hope to encourage foreign investment into their country, so make capital gains exemptions. Others want to establish themselves as financial centers to compete with New York, Hong Kong, or London. Some make exemptions if the investments are in poor/distressed regions.

The Dubai International Financial Center, UAE, is completely exempt from all capital gains taxes. The Cayman Enterprise City, in the Cayman Islands, grants a similar complete exemption but it only lasts for 30 years. The Belarus High Technologies Park grants capital gains tax exemptions for SEZs.

Although not strictly “real” SEZs, the US’ Opportunity Zones program also grants capital gains tax exemptions for investments held more than 10 years in economically distressed areas.