• The Government of India ("GoI") is empowered under the constitution1 to make laws with respect to regulation and development of oilfields and mineral oil re sources, and petroleum and petroleum products. In exercise of these powers, GoI has drawn up a comprehensive set of petroleum legislation that regulates and covers various facets of the industry. The Ministry of Petroleum and Natural Gas ('MoPNG') is responsible for the administration of the petroleum legislation. The Oilfields (Regulation and Development) Act, 1948 • This Act provides for regulation of oilfields and for development of mineral oil resources in the upstream sector. Under this Act, GoI is empowered to grant mining rights for the exploration and production of mineral oil and natural gas in India and levy royalty on the production of crude oil and natural gas • all mining leases should be granted in accordance with this Act (mining lease includes exploration); • any mining lease contrary to this Act shall be void and of no effect; • GoI has the power to make rules in respect of conservation and development of mineral oil; and • the holder of a mining lease has to pay royalty in respect of any mineral oil mines, quarry, excavated or collected by him from the leased area as per the Petroleum and Natural Gas Rules, 1959
• These Rules are made by GoI in exercise of the
powers conferred by section 5 and section 6 of The Oilfields (Regulation and Development) Act, 1948, regulating the grant of exploration licenses and mining leases in respect of petroleum and natural gas which belong to Union of India, for its development and conservation. • These Rules provide for two types of rights, the Petroleum Exploration Licence and the Mining Lease, both for onshore and offshore blocks. Petroleum and Natural Gas Rules, 1959 • A license or lease in respect of land where ownership vests with the State Government is granted by the State Government with the prior approval of GoI. The licence or lease is granted for a specified period against pre- scribed payment, in accordance with the terms and conditions detailed in the Act and the Rules. • In the event of a petroleum discovery, the Petroleum Exploration Licence is converted into a Mining Lease. - Petroleum and Natural Gas Rules, 1959 • The Mining Lease grants exclusive rights to exploit hydrocarbons, subject to limitations on the mining area, terms and conditions specified, and payments, as provided for in these Rules. • GoI is empowered to grant a license or a lease in respect of any land or mineral under the ocean within the Territorial Waters or the Continental Shelf. The Rules relating to award of mining rights through lease are on the same basis as for onshore areas. The Territorial Waters, Continental Shelf, Exclusive Economic Zone and Other Maritime Zones Act, 1976 • This Act defines the sovereign right of India over territorial waters upto 12 nautical miles measured from the appropriate baseline, to the seabed and subsoil underlying, and the airspace over such waters. • Union of India also has sovereign rights for the purpose of exploration, exploitation, conservation and management of natural resources in the Exclusive Economic Zone, which includes the Continental Shelf and extends upto 200 nautical miles. It also exercises exclusive jurisdiction in respect of authorizing all such operations as are necessary for the exploration and exploitation of the resources of the Zone. • The Union of India is further empowered to extend the jurisdiction of any of the existing laws of India to the Exclusive Economic Zone. In pursuance of these powers, the Government of India has extended the applicability of the Income Tax Act, 1961 to operations carried out within the Continental Shelf, and the applicability of the Customs Act, 1965 to specific coordinates within the Zone. The Oil Industry (Development) Act, 1974 • This Act provides for the development of board for the development of oil industry and for the levy of a duty of excise on the production of crude oil and natural gas. • Amongst its other functions, the Oil Industry Development Board (OIDB) established under the aegis of this Act has the powers to extend financial and other assistance for the development of the oil industry. • Such assistance includes making grants, advancing loans, pro- viding guarantees, underwriting shares and subscribing to the stock of any oil industrial concern. Royalty regime • Royalty, under NELP, is pegged to the market value of production at well head as under: For Crude Oil it is fixed at 12.5% for on land and 10%for off shore For Natural Gas, it is fixed at the rate of 10% for on land and off shore Special incentive for deepwater (i.e. beyond 400 m isobaths) - 50% of the above offshore royalty rates for the first 7 years. Income tax regime • Each PSC PI holder liable for assessment on the same status as is as per contract entered with GOI for value received and gains as per PIs • Full deduction for all expenditure incurred on EDRILL and DEVDRILLING. • For expenditure incurred on other than drilling operations and development expenditure and production expenditure it is same as Per IT ACT. • However all such expenditure is subject to • where any expenditure is not solely incurred on Petroleum Operations or is incurred as part of or in conjunction with any other business, only that portion of the total expenditure which is proved to the satisfaction of the Assessing Officer to be attributable to the Petroleum Operations, having regard to all the relevant facts and circumstances, shall be allowed to be deducted Income tax regime • is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business • More than Rs 20000 payment other than thro cheque, gratuity • Limitation on HO expenditure5 % of the adjusted total income, or so much of the expenditure in the nature of head office expenditure incurred by him as is attributable to the business carried on in India • For any or all accumulated expenditures incurred in respect of Exploration Operations and drilling operations prior to the date of commercial production, PSC Participants shall have option to amortize such expenditures over a period of ten (10) years from the date of first commercial production Income tax regime • to deduct all its unsuccessful exploration costs in contract areas covered by other contracts from the aggregate value of Petroleum allocable to the PSC participant from any Field (s) in the Contract Area in the manner as follows: • unsuccessful exploration costs incurred in contract areas other than the Contract Area where a commercial discovery has been made up to the date of commencement (and after) of Commercial Production shall be aggregated and the PSC participant shall be entitled to deduct such costs at the rate of one hundred per cent (100%) per annum; Income tax regime • A PSC Participant shall be entitled to deduct, while computing his profits and gains of business from Petroleum Operations, for the purpose of income tax, any amount deposited by him in the Site Restoration Fund, in accordance with and for the purposes specified in, the Site Restoration Fund Scheme, 1999 notified by the Ministry of Petroleum and Natural Gas, Government of India, in the year in which such amount is deposited, up to a maximum of 20% of such profits. Interest reinvested the same up to the limits • Deprecation as Per WDV except for those where 100 percent deduction applicable. Income tax regime • The Indian Income Tax Act ('Act') provides special provision for taxability of upstream companies. Section 42 of the Act lists downs the allow ability of certain categories of expenditure as are specified in the PSC Expenditure by way of Infructuous or abortive exploration • Expenditure incurred for exploration or drilling activities or services or assets used for these activities • Depletion of mineral oil in the mining area post commercial production Income tax regime • It further provides that such allowances shall be computed and made in the manner as specified in the PSC,and the other provisions of the Act being deemed for this purpose to have been modified to the extent necessary to give effect to the terms of the PSC. • Accordingly,for such kind of expenditure, one has to examine the relevant provisions of the PSC. Income tax regime • Exploration and drilling expenditure, both capital and revenue in nature, is 100% tax deductible. Expenditure incurred on development and production activities (other than drilling expenditure) is allowed as per the provisions of the Income tax Act Income tax regime • All exploration and drilling expenditure is allowed to be aggregated till year of commencement of commercial production. Alternately such expenditure may be amortized equally over a 10-year period from start of commercial production Income tax regime All unsuccessful exploration costs from other PSCs are permitted to be setoff (and thus not ring fenced) from income arising under the present PSC. • The Act allows the companies to claim deduction in relation to the depletion of mineral oil in the mining area in year in which commercial production begins and for subsequent year as may be specified in the agreement.However, the PSC does not make any reference to this allowance. Thus, there is a need of harmonization between the provision of the Act and the PSC to enable companies to get depletion allowance benefit. Minimum Alternate Tax • The Act provides for payment of minimum alternate tax ("MAT"). MAT is payable at the rate of to 11.22 percent in case of domestic company and 10.46 per cent in case of foreign company. Now MAT applicable, if tax payable is less than 10 per cent of book profits as against 7.5 per cent earlier.. • Enterprises engaged in the exploration and production of mineral oils, which otherwise enjoy a tax holiday, continue to be subject to levy of MAT even during the tax holiday period. • The credit for taxes paid under MAT has been reintroduced and the same will be available for carry forward and set off for 7 subsequent years. Fringe Benefit Tax • The Finance Act, 2005, has introduced a new tax, the fringe benefit tax ("FBT") on all categories of employers. • The rational for introducing this tax has been found in the inherent difficulties in isolating the 'personal element' attributable to an individual employee where expenditure incurred by the employer is ostensibly for the purposes of business or collective enjoyment of all employees. • This tax is payable notwithstanding the fact whether any income tax is payable by the employer in the normal course. • The specified percentage (20%, 50% and 100%) of the expenditure incurred on prescribed items is deemed to be value of fringe benefits provided to employees and liable to tax at 30% plus applicable surcharge and cess. Corporate tax rates The domestic companies will be liable to tax at33.66% (including surcharge of 10% and cess of 2%)while foreign companies will be liable to tax at on their business income at 41.82% (including surcharge of 2.5% and cess of 2%). Subsequent, dividend flowing from the Indian company to its foreign parent is also subject to a Dividend Distribution Tax in India of rate of 14.025%.(including surcharge of 10% and cess of 2%) Tax Holiday • The Act provides for a 7 year income tax holiday to an undertaking engaged in E&P activities from the date of commencement of commercial production. • Though the above appears to be a reasonable, practically, it is however, observed that the actual benefit of tax holiday does not flow to E&P companies given the large exploration expenditure which is to be set off during the same period. It thus calls for a further flexibility in availing the tax holiday period by the E&P companies. Site restoration fund scheme, 1999 • With a view to cater to the need for proper abandonment of oil wells after their economic life, Government has introduced the Site Restoration Fund Scheme ("Scheme"). Under this Scheme, E&P companies are allowed a deduction in respect of the amount deposited in a separate bank account. • The amount transferred to the reserve account can be utilized only for site restoration after cessation of commercial production of oil from a particular well. If any withdrawals are made from such reserve account and utilized for any purpose other than site restoration as certified by the prescribed authority, the withdrawals are taxable as business profits in the year of withdrawal. Site restoration fund scheme, 1999 • Deductibility of transfers to site restoration reserves continues to require deposits with the State Bank of India in local currency. Exchange risks associated with fluctuations in the Indian Rupee and international competition for scarce exploration capital had hindered oil companies in availing benefits of the incentive, as planned by the Government of India. The upstream sector has sought relaxation of these conditions by permitting maintenance of reserve monies in foreign currency (even if book provisions made for abandonment are not deductible). Farm-in transactions • The Farm-in transactions are alternate mechanism of entering into the E&P operations. World over, these transactions have become routine in the E&P arena and the way the farm out transactions are typically structured, the consideration make take the form of free carry, production bonus, reimbursement of past costs with premium, etc. • In view of the expanding exploration activities in India and with the increased participation of foreign companies, the above models of farm-out are being replicated in India. Given the same, the tax provisions, which currently visualizes simplistic form of consideration arising in terms of such transactions needs modification to deal with the complex farm-out transactions and to avoid any ambiguity and alternate interpretations. Customs Duty • Import of goods into India attracts levy of customs duty, the incidence of the levy being on the importer. • Typically, the effective general rate of customs duty on import of plant and machinery is 34.448%, which comprises the basic customs duty (15 percent) and additional customs duty (16.32 per- cent) and 2 percent education cess on the entire cus- toms duty component. • The specific rate of levy would depend on the nature of goods being import- ed and available concessions, if any. Customs Duty • Specific conditional incentives / exemptions are available for imports required for E&P operations in India. • In case of imported goods that are re-exported after completion of work within specific periods of time, it is possible to claim a drawback (ie refund) of the customs duty earlier paid on the import of such goods, subject to satisfaction of certain conditions. Customs Duty • Import of machinery, plant, equipment, materials and supplies by the PSC Participant or any of its subcontractor shall be exempt from customs duty, provided - • they fall within the list given • the goods are imported in connection with Petroleum Operations to be undertaken under a Production • Sharing Contract • where the importer is a contractor, he produces to the Assistant Commissioner of Customs, at the time of importation, the following, namely - • a certificate from a duly authorized officer of the Directorate General of Hydrocarbons in the Ministry of Petroleum and Natural Gas, Government of India to the effect that the imported goods are required for such Petroleum Operations and have been imported under a contract signed under the New Exploration Licensing Policy; and other documentations Excise duty/ Cess • Excise duty is exempted on production of petroleum oils, oils obtained from bituminous minerals and crude oil and natural gas. On crude oil production a cess at the rate of Rs. 2500 per tonne is imposed under Oil Industry (Development) Cess Act, 1974. • However, crude produced in the exploration block to be offered under NELP competitive international bidding has been exempted from levy of such cess. • These attractive fiscal terms have consistently lowered the Governments take in the income from exploration and production activities and in effect a major portion of this income has been made biddable. Accordingly, companies can bid for acreages depending on their prospectively, ie bid aggressively for acreages with attractive prospectively. Service Tax • In recent time service tax is emerging as a significant element to be considered, especially with the recent inclusion of survey and exploration activities by the Finance Act 2004 within the ambit of service tax and rate of service tax been increased to 10% plus education cess, making the effective rate of 10.2% on specified services • The specified services relevant to the E&P segment interalia include: • Services to a client by a "consulting engineer in relation to advice, consultancy or technical assistance in any manner in one or more disciplines of engineering". Service Tax • Prospecting (geological, geophysical or other kind), surface or sub surface surveying or map making services by any person to a customer, in relation to location / exploration of deposits of minerals, oil or gas. It has been clarified that the service tax would be limited to the services rendered in relation to survey and exploration only and not on the activity of actual extraction after the survey and exploration is complete. Service Tax • Commissioning or installation services; Technical inspection and certification services; Technical testing and analysis services; Maintenance or repair services; and Site preparation and clearance services Service tax is presently applicable on services that are provided in India. However, where service provider is from outside India and service recipient is in India, such service will be taxable in India. This change is going to be effective from the date to be notified. Service tax credit mechanism • The Government had introduced a credit mechanism via the Service Tax Credit Rules, 2002 ('Credit Rules') where-in, service tax paid on input services could be utilized to off-set service tax payable on output services, subject to certain conditions. The Government has recently extended this credit mechanism to provide credit of duties paid on goods (specified inputs and specified cap-ital goods) used for rendering services. • Apart from the specific levies and taxes covered above,there are certain other levies and taxes such as works contract tax, sales tax/VAT, lease tax, entry tax, octroi,Research & Development Cess, etc. The incidence of these levies and taxes varies from case-to-case, and typically their impact is not as significant as taxes and levies discussed above. SALES Tax/vat • Exploration and production sector no relevance from a sales tax/VAT perspective, the following points are relevant to note: Local sales tax, a-state levy, is applicable on intra-state sale of goods. Inter-state sale of goods attracts a central levy viz. central sales tax. • With effect from April 1, 2005, some of the states have implemented VAT law in lieu of local sales tax law to levy tax on its intra-state sale transactions. Inter-state sales will still be governed by central sales tax law. SALES Tax/vat
The sales tax laws only extend upto 12 nautical
miles from the Indian land mass, while the territorial limit extends upto 200 nautical miles. While this is applicable to sale of all goods, it is particularly relevant for oil and gas, as there are several offshore oil and gas fields located outside 12 nautical miles. As per NELP, the sales tax incidence has to be borne/ reimbursed by the buyer of oil and gas. This effectively means that the sales tax, if levied, would not have any bearing on the contractor (seller). SALES Tax/vat • Crude oil has been notified as 'declared goods' i.e. goods of special importance under Central Sales Tax Act, 1956. This means that rate of sales tax on sale of crude oil (either on a local sale or in case of inter- state sales) cannot exceed 3 percent. • Under some state sales tax laws (e.g. Gujarat), inter oil companies sale of petroleum products are specifically exempt from sales tax. Deposits, License Fee, Dead Rent and Surface Rent • Before the license is granted, the applicant for a license shall deposit with the Central Government or where the license is to be or has been granted by the State Government, the State Government as security for due observance of the terms, covenants and conditions of the license, a sum of Rs. 1,00,000 (Rupees One Lac only). • The licensee shall pay yearly in advance by way of license fee in respect of his license a sum calculated for each square kilometer or part thereof covered by the license at the following rates - a. Rs. 50 (Rupees Fifty only) for the first year of the license b. Rs. 100 (Rupees One Hundred only) for the second year of the license c. Rs. 500 (Rupees Five Hundred only) for the third year of the license d. Rs. 700 (Rupees Seven Hundred only) for the fourth year of the license e Rs. 1,000 (Rupees One Thousand only) for the first and second years of the renewal Deposits, License Fee, Dead Rent and Surface Rent • The applicant for a lease shall, before the lease is granted to him - a. deposit with the Central or the State Government, as the case may be, as security, a sum of Rs. 2,00,000 (Rupees Two Lacs only), for due observance of the terms and conditions of the lease, b. also deposit with the Central or the State Government, as the case may be, for meeting the preliminary expenses, such sum not exceeding Rs. 30,000 (Rupees Thirty thousand only), as the Central Government or the State Government with the approval of the Central Government, may determine. • On the grant of a lease, the lessee - • a. shall pay to the Central or the State Government, as the case may be, for every year a fixed yearly dead rent at the following rates - Rs. 25 (Rupees Twenty Five only) per hectare or part thereof for the first 100 square kilometres and Rs. 50 (Rupees Fifty only) per hectare or part thereof for area exceeding the first 100 square kilometres provided that the lessee shall be liable to pay only the dead rent or the royalty, whichever is higher in amount but not both. • b. shall also pay to the State Government, for the surface area of the land actually used by him for the purpose of the operations conducted under the lease, surface rent at such rate, not exceeding the land revenue and cesses assessed or assessable on the land, as may be specified by the State Government with the approval of the Central Government. • (5) The deposits, license fee, dead rent and surface rents are subject to change in accordance with the relevant • laws and rules by the Government or State Government, as the case may be, from time to time. Taxation issues • E&P companies to be allowed to choose period of seven years of tax holiday . • Deduction for Infructuous or abortive exploration expenses u/s 42 . • Introduction of specific provisions in the Income Tax Act regarding ‘Farm-in costs’ • Allowance of deduction to E&P companies for Site Restoration Expenses • Infrastructure Status to E&P under Section 80IA • Grant of infrastructure status to cross country pipelines for crude/ gas / petroleum products and LNG re-gasification terminals Taxation issues • Extending depreciation benefits available to pollution control equipment to capital investments made by refineries for producing fuels with stringent emission norms • Depreciation on LPG Cylinders • Recognize discounts given by PSU upstream companies i.e. ONGC, OIL and GAIL to PSU downstream refiners/marketing companies as their contribution under burden sharing mechanism instituted by the Government, under income tax and should be allowed as deduction. Taxation issues • Concessional rates of customs duty on goods required for oil and gas projects. • Excise duty on crude oil and petroleum products to be made specific or based on tariff values • Withdrawal of National Calamity Contingent Duty • Withdrawal of end-used based exemptions applicable to Industrial Units • Captive consumption benefit for LSHS/ Fuel Oil etc used as Fuel Oil • Exemption to services provided to Oil & Gas exploration sector mainly land leveling and site restoration issues Salient features of 2008-09 Budget • Section 80IB(9)
– Tax holiday no longer available for new
refineries/expansion plan
– Deduction not available if undertaking starts refining
post April 1, 2012 Salient features of 2008-09 Budget • Does the term Mineral oil also includes natural gas and petroleum. Memorandum explaining the Provisions of Finance Bill, 2008 “Sub-section (9) of section 80IB provides for a hundred percent deduction of profits and gains derived from commercial production or refining of mineral oil. Salient features of 2008-09 Budget 1. Duty on Project imports reduced from 7.5% to 5% 2. BCD on crude & unrefined sulphur reduced from 5% to 2% 3. Duty on unbranded MS & HSD now at specific rates • New services brought under tax net include: Services in relation to transfer of right to use tangible goods not chargeable to sales tax/VAT • Impact on equipment leasing with/without operator. • Impact on charter hire of vessels, oil rigs, tugs etc with operator • Impact on operating leases with/without operator