Tax holiday to Oil and gas sector undertakings
Current Situation: Under the existing provisions of the Income-tax Act, 1961 (the Act), profit based deduction is available for a period of seven years to an Oil and Gas undertaking (being all blocks licensed under a single production sharing contract) - which begins commercial production of ‘mineral oil’ on or after April 1, 1997 is engaged in commercial production of ‘natural gas’ on or after 1 April 2009 from the blocks licensed under NELP-VIII and CBM-IV.
DTC Proposals: DTC has proposed to bring a paradigm shift in granting tax incentives to undertakings engaged in business of mineral oil or natural gas. The new scheme has proposed to substitute the profit-linked incentives prevalent under the existing provisions of the Act with expenditure / investment based deductions. Further, it has provided for grandfathering of tax holiday available to oil and gas undertakings.
Undertakings eligible for profit based deduction in Assessment Year 2012-13
- Undertakings producing ‘mineral oil’ eligible for profit linked incentives under the Act as on assessment year beginning April 1, 2012 would be grandfathered under DTC for the unexpired period
- Undertakings producing ‘natural gas’ from blocks licensed under NELP VIII and CBM IV rounds eligible for profit linked incentives under the Act as on assessment year beginning April 1, 2012, would be grandfathered under DTC for the unexpired period
- While computing deduction, capital expenditure as well as expenditure incurred prior to commencement of business shall not be allowed.
Undertaking set up in the DTC regime
- Undertakings producing ‘natural gas’ from blocks licensed under NELP VIII and CBM IV rounds are eligible for profit-linked incentives under the DTC
- profits shall be gross earning as reduced by business expenditure in accordance with Schedule XI of DTC
- capital expenditure and expenditure incurred prior to commencement of business shall be allowable as business expenditure, except expenditure incurred on acquisition of any land including long term lease, goodwill or financial instrument.
- Under the DTC, the terms ‘mineral oil’ and ‘natural gas’ have been defined separately, where as under the Act (except under section 80-IB), the term ‘mineral oil’ has been defined to include ‘natural gas’.
- The DTC grandfathers undertakings producing of ‘mineral oil’ eligible to claim tax holiday under Act as on Assessment year 2012- 13. Thus, undertakings producing ‘natural gas’, other than NELP VIII and CBM IV undertakings, and claiming tax holiday under the Act may not be eligible to claim benefit of the grandfathering provisions under the DTC.
- It has been provided that the profit linked deduction under DTC shall be computed as per the provisions of the DTC, but no capital expenditure would be allowed. Accordingly, there is an ambiguity as to whether depreciation on the WDV carried forward from the Act would be allowable under DTC and thus need to be adequately addressed.
- The proposal to allow oil and gas companies to offset losses against profits of other infrastructure projects or corporate income would be a welcome measure.
- As such, continuation of these tax incentives to new oil and gas undertakings under the DTC, though under a restrictive grandfathering clause, is a positive step.
Definition of ‘mineral oil’ and ‘natural gas’
Current Situation: Under the existing Act, mineral oil has been defined to include petroleum and natural gas (except under section 80-IB).
DTC Proposals: Under the DTC, the terms ‘mineral oil’ and ‘natural gas’ have been given different meanings.
‘Mineral oil’ means crude oil, being petroleum in its natural state before it is refined or otherwise treated but for which water and foreign substances have been extracted.
Natural gas means any subsoil combustible gaseous fossil fuel.
Our Comments: Existing debate on applicability of specific provisions to oil and gas business has been put to rest by defining both ‘mineral oil’ and ‘natural gas’ separately.
Deposits to Site Restoration Fund
Current Situation: The Act allows deduction of amounts deposited (subject to certain conditions) to a Site Restoration Fund Account by an assessee engaged in the exploration and production of petroleum or natural gas in the year in which amount is deposited.
Where the amount is withdrawn and utilized for the purpose of meeting expenditure towards removal of all equipments and installations, pursuant to an abandonment plan or towards site restoration, such expenditure is not allowed as deduction.
DTC Proposals: Under the Direct Tax Bill 2009, no deduction was allowable with respect to the amounts deposited or kept aside for site restoration. The revised DTC has reinstated the deduction in respect of amounts deposited to Site Restoration Account maintained with State Bank of India in accordance with the Scheme as may be prescribed.
Our Comments: Restoration of the deduction for Site Restoration is a welcome step as this deduction is significant for companies nearing depletion of reserves which may not have any income when the actual expense on site restoration is incurred, unless they have other income generating contract areas.
Allowability of capital expenditure
Current Situation: The Act allows deduction of the following capital expenditure:
- infructuous or abortive exploration expenses for any area which is surrendered prior to beginning of commercial production
- drilling or exploration expenditure incurred before or after commencement of commercial production after the commencement of such production
- Expenditure incurred on depletion of mineral oil in the mining area.
DTC Proposals: Under the DTC, deduction will be allowed with respect to the following expenditure:
- operating expenditure
- finance charges
- expenditure on any license charges, rental fees or other charges, if actually paid
- capital expenditure incurred by the assessee (except expenditure for acquisition of any land including long-term lease, goodwill or financial instrument)
- expenditure on infructuous or abortive exploration of any area
- expenditure referred to above incurred before commencement of the business and
- payment to Site Restoration Account maintained with the State Bank of India.
- Under the DTC, apart from operating costs and finance charges, capital expenditure is allowed as deduction in the year in which it is incurred irrespective of whether commercial production has commenced. Unsuccessful exploration costs are also allowable in the year of expense even if the contract area is not surrendered by the assessee
- DTC allows deduction of the above expenditures even when they are incurred before commencement of the business, as against cumulative allowance in the year in which commercial production commences under the existing provisions.
- The allowance in the year of incurrence may however be significant only for companies with more than one contract area which may be able to offset expenses incurred prior to commercial production from one area against profits from other area. Companies with a single contract area would naturally need to await commercial production to claim benefit of the deduction.
Taxability in case of transfer of business or interest thereof
Current Situation: Under the Act if the business or interest in the business is transferred, either wholly or partly, and if the proceeds of transfer:
- are less than the expenditure incurred remaining unallowed, then a deduction for the expenditure which is remaining unallowed, will be allowed in the previous year in which the business is transferred
- exceeds the amount of expenditure incurred remaining unallowed, excess of the amount over expenditure remaining unallowed will be taxable as profits and gains in the previous year in which the business is transferred
- are not less than the amount of expenditure incurred remaining unallowed, no deduction for such expenditure will be allowed in the previous year in which the business is transferred or in respect of any subsequent year or years.
- If the business is transferred pursuant to an amalgamation or a demerger, the above provisions will apply to the amalgamated or the resulting company.
Gross income from the business of mineral oil and natural gas includes the accruals or receipts from the leasing or transfer, either wholly or partly, or of any interest in any mineral oil or natural gas right and asset used in the business.
The successor in a reorganization of the business will be allowed deduction in respect of the unabsorbed current loss determined in case of the predecessor subject to certain conditions.
Under the DTC all receipts from transfer of business or part there of are taxable as business income irrespective of the amount of expenditure incurred or claimed.
Taxability as Association of Persons
Current Situation: In exercise of the powers, given to the Central Government under section 293A of the Act, the Government had issued Notification No. GSR 117(E), dated 8-3-1996 providing that persons with whom contracts for association or participation in exploration or production of mineral oils has been entered by the Government —
- shall not be assessed on the income as association of persons or body of individuals consisting of such persons but each of the persons referred to above be assessed in respect of his or its share of income, as the case may be, in the same status in which that person has entered into the agreement with the Central Government.
DTC Proposals: Such a consortium may be regarded as an AOP (which has not been defined) and be taxed at a flat rate of 30 percent on combined profits, irrespective of the residential status of each of the partners. The Central Board of Direct Taxes is empowered to issue orders, instructions, directions or circulars for the proper and efficient management of the Direct Tax Code, if it considers it necessary or expedient to do so.
Our Comments: There is no provision in the DTC similar to the existing provisions of the Act. In the absence of the said section and the notification issued there under, joint venture partners engaged in exploration and production under a single contract may be regarded as an Association of Person (which has not been defined in the DTC) and shall be taxable at the rate of 30 percent as applicable to an unincorporated body as against the rate applicable to each of the JV partners in their individual capacity.
Business of laying and operating a cross country distribution network
- Income from business of laying and operating cross country pipeline (including storage facilities being an integral part) for distribution of natural gas, crude or petroleum oil is taxable as business income under the head ‘Profits and gains of business and profession’
- All revenue expenditure incurred for the purpose of the business are allowable in computing profits from the business
- The Act provides for allowance of capital expenditure (excluding expenditure on acquisition of any land or goodwill or financial instrument) incurred in the business, subject to certain conditions.
- Taxation of profits (gross income reduced by business expenditure) from business of laying and operating a cross country natural gas or crude or petroleum oil pipeline network for distribution, including storage facilities being an integral part of the network has been consolidated in the Schedule XIII of the DTC
- Allowable business expenditure includes capital expenditure (except expenditure for acquisition of any land, goodwill or financial instrument) incurred by the assessee, including allowable expenditure incurred before commencement of business
- The successor in a reorganization of the business will be allowed deduction in respect of the unabsorbed current loss determined in case of the predecessor subject to certain conditions.
Our Comments: Prior to the introduction of section 35AD by Finance (No. 2) Act 2009, undertakings engaged in laying and operating cross country pipeline were eligible for 100 percent deduction of profits. With the introduction of section 35AD, the investment – based incentive was introduced and profit – linked incentive withdrawn. Therefore, proposal under the DTC is principally similar to the provisions of the Act.
Tax Holiday for undertakings engaged in refining of mineral oil
- 100 percent profits of an undertaking engaged in refining of mineral oil are allowed as deduction for a period of seven consecutive assessment years from the year in which refining of mineral oil begins
- Where the undertaking is transferred in an amalgamation or a demerger, the provisions of the section will apply to the amalgamated or resulting company.
DTC Proposals: No tax incentive available for refining of refining of mineral oil. However, undertakings eligible to tax holiday under the Act as on assessment year beginning April 1, 2012 would be grandfathered under the DTC for the unexpired period.
Our Comments : DTC has done away with all profit– linked incentives. Further, no tax incentive is available to refining of mineral oil. Grandfathering of tax incentive available to undertakings under the Act is a welcome step.
Non-resident service providers to the Oil and Gas sector
- Non-resident assessee engaged in the business of providing services or facilities in connection with, or supplying plant and machinery on hire used, or to be used in the business of exploration or production of mineral oils are taxable on presumptive basis
- Ten percent of receipts, whether in or out of India, from such services are deemed as profits chargeable to tax. Hence effective tax rate, including surcharge and education cess, applicable to such non-residents is 4.23 percent (tax rate 40 percent + surcharge 1 .5 percent + education cess 3 percent)
- Assessee has an option to claim lower profits on maintenance of books of account and other documents and on furnishing audited accounts
- The term ‘plant’ has been defined to include ships, aircraft, vehicles, drilling units, scientific apparatus and equipment, used for the purposes of the said business.
- Under the DTC also such a non-resident assessee is taxable on presumptive basis
- Fourteen percent of receipts of such assessee, whether in or out of India, or directly or indirectly, from such services are deemed as profits chargeable to tax. Hence effective tax rate applicable to such non-residents shall be 4.2 percent (at tax rate 30 percent)
- Further, if the non-resident has a permanent establishment in India, as defined under the DTC, an additional tax of 15 percent in the nature of Branch Profit tax is leviable. In such cases, the effective tax rate amounts to 5.67 percent
- The presumptive income is further required to be increased by the excess of the amount of income, if any, actually earned by the assessee
- Receipts in the nature of fees for technical services and royalty are not eligible for taxation on presumptive basis
- Assessee has an option to claim lower profits on maintenance of books of account and other documents and on furnishing audited accounts
- The term ‘plant’ has been defined to include ships, aircrafts, vehicles, books, scientific apparatus and surgical equipment but does not include tea bushes, livestock, buildings and furniture and fittings.
- Intent of the Government, as per the discussion paper to Direct Taxes Code Bill 2009 was to continue the presumptive basis of taxation for non-resident oil and gas service providers. However, with insertion of the provision to increase the amount of income of such assessees by the excess of the amount actually earned, the said intent has been defeated as assesses will end up paying tax on actual income rather than presumptive income
- Although the effective rate of tax remains the same in case the service provider does not constitute a permanent establishment (PE) in India, for foreign companies with PE (defined under the DTC), the tax incidence has been increased to 5.67 percent on account of branch profit tax from the existing 4.23 percent.
- Further, although definition of the term ‘plant’ under the DTC is an inclusive one, it does not specifically include drilling units like the existing provisions.
Concluding Remarks- It is interesting to note the path of the Direct Taxes Code from the 2009 Bill to the 2010 one. Undoubtedly, the Code in its revised form is more simplified and aligned towards expectations of the oil and gas industry, for instance, grandfathering of tax incentives to awardees of NELP VIII and CBM IV rounds of bidding and reinstating of MAT based on Book Profits.