Allowability of depreciation on participatory right in the nature of license

This article summarizes a recent ruling of the Delhi Income Tax Appellate Tribunal (ITAT) in the case of M/s ONGC Videsh Ltd. (Taxpayer) [2009-TIOL-758-ITAT-DEL] on the issue of allow ability of depreciation on participatory right to carry out the hydrocarbon operations, acquired by the Taxpayer, pursuant to a Production Sharing Arrangement (PSA).

The ITAT held that the participatory right acquired by the Taxpayer was in the nature of asset, in the form of ‘license’ i.e. license to have an access and to carry out exploration, development and production of hydrocarbon operations. Considering this, it was held that the participatory right is eligible for depreciation under the provisions of the Indian Tax Law (ITL).

 Facts of the case

• The Taxpayer is engaged in the business of exploration, development and production of hydrocarbons in overseas jurisdictions. This is meant to augment India’s oil security, mainly by way of acquiring a participating interest in a PSA.

• During the relevant tax year, the Taxpayer acquired a 20% participating interest (participating interest) in Sakhalin Block, located in Russia, from the existing consortium members. The existing consortium members had entered into a PSA with the Russian Government (Government). Consequent to the acquisition of the participating interest, the Taxpayer became a member of the consortium. It acquired a proportionate share in the business rights and exploration and production licenses (participatory right) granted by the Government for the Sakhalin Block.

• The expenditure incurred by the Taxpayer on the acquisition of the participatory right was treated as an intangible asset, eligible for depreciation under the ITL. The Tax Authority disallowed the Taxpayer’s claim for depreciation.

• The first appellate authority held that the expenditure incurred on the acquisition of the participatory right was in the nature of deferred revenue expenditure and allowed 1/19^th of the expenditure as a deduction under the ITL.

• Aggrieved by the order of the first appellate authority, both the Taxpayer and the Tax Authority preferred an appeal before the ITAT. The Taxpayer appealed for a claim of depreciation under the ITL on the expenditure incurred on the acquisition of the participatory right. The Tax Authority appealed against the allowance of 1/19^th of the expenditure under the ITL.

Contentions of the Taxpayer:-The Taxpayer had acquired a business right in the form of a license which qualifies as an intangible asset under the ITL and is eligible for depreciation.

 Contentions of the Tax Authority

• The intangible assets, eligible for depreciation under the ITL, are in the nature of intellectual property rights (IPRs). The participatory right acquired by the Taxpayer is not in the nature of IPRs.

• The Taxpayer did not acquire any business rights, as the right acquired only gives the Taxpayer an access to the area to carry out hydrocarbon operations. Therefore, it was just a participatory right and not a right in the nature of business or commercial rights.

• The concept of business or commercial rights would be broadened if the participatory right is treated to be in the nature of a business or commercial right. In such a situation, any partnership or joint venture agreement between various entities would fall within the purview of business rights. Hence, depreciation would be claimed on any amount of a capital nature, including the amount in the nature of investment.

• The expenditure incurred by the Taxpayer was a capital expenditure and cannot be permitted to be amortized as deferred revenue expenditure, as held by the first appellate authority.

Ruling of the ITAT

• The hydrocarbons, being embedded in a particular territory, the jurisdiction over such a territory lies only with the Government. The hydrocarbon operations can be carried out only by entering into a PSA. By virtue of a PSA, the Government granted rights to the Taxpayer along with license to carry out hydrocarbon operations. The business rights in the license are owned by the Taxpayer and such rights and license can be assigned and transferred to others, subject to the terms and conditions of the PSA and the Government’s approval.

• All the business or commercial rights are not by themselves assets, eligible for depreciation. Only those rights which are similar in nature to know-how, patents, copyrights, trademarks, licenses etc. are eligible for claim of depreciation. The participatory right acquired by the Taxpayer was a business or a commercial right similar in nature to one of the category of intangible assets i.e. license. The Tax Authority had referred to the PSA as the license granted by the Government to explore and produce hydrocarbons in the specified area. Hence, the participatory right acquired by incurring the expenditure was eligible for depreciation under the ITL.

• The expenditure incurred by the Taxpayer was capital in nature and can qualify for depreciation in terms of the provisions of the ITL. There is no concept of deferred revenue expenditure under the ITL.

Comments :-Taxpayers in the business of exploration of mineral oil generally enter into production sharing agreements/contracts, which provide them the right to carry out the activities of exploration of mineral oil etc. for a certain period of time. This ruling provides a guidance that payment made for the acquisition of such rights from the existing consortium member is in the nature of license, which is eligible for depreciation under the ITL.