Upstream Taxation India

GLOBAL TAX ADVISORY SERVICES

PSC & Related Direct Taxation Issues Discovery to Delivery: Resource Mobilisation for India’s Upstream Sector Ravi Mahajan

Overview

î Association of Persons î Section 42(I) read with Article 17 of Model PSC î Site Restoration î Tax Holiday î Farm – Out: Taxation Principles

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Association of Persons

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Association of Persons (‘AOP’) Concept of Association of Persons (AOP) • A consortium of members engaging in common scope of work, with joint and several liability to earn income may be regarded as AOP • In case an AOP is classified as a resident (if any part of control and management is in India), worldwide income of the AOP may become taxable in India; issues arise in relation to claim of depreciation • In case of consortium undertaking E&P activities, if an Indian entity (like ONGC) is also a member, it is likely to attract a higher rate of tax; this may cause concern to members

Relief from AOP taxation • Under Section 293A, government has powers to provide incentives for participation in the oil and gas business • Government has issued notification GSR 117(E) which provides that persons who have entered into agreements with the Government for the extraction etc of mineral oils will not be assessed to tax as AOP

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Section 42(I) read with Article 17 of Model PSC

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Section 42(I) Enabling provisions under domestic tax law Eligibility • Business consisting of prospecting for or extraction or production of mineral oils (includes petroleum and natural gas) • Has entered into a Production Sharing Contract (PSC) with the Government

Specific provisions • Specific allowances [in addition or in lieu of allowances under the Income tax Act, 1961 (Act)] as specified in the PSC are permitted • The specific allowances could relate to: – 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

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Article 17 of Model PSC Allowability of expenditure • 100% of exploration and drilling expenditure is allowed (both capital and revenue) • Expenditure incurred on development and production activities (other than drilling expenditure) is allowed as per the Act

No ring fencing of expenditure • All unsuccessful exploration costs in other contract areas can be set off against income in the contract area in which commercial production has commenced

Manner of deduction • Allowable expenditure is aggregated • Does not lapse after 8 years like tax losses • Accumulated expenditure is deducted against income post-commencement of commercial production

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Section 42 read with Article 17 • Concept of “unsuccessful exploration costs” – Determination on year to year basis vis-à-vis aggregation upto year of commencement of commercial production

• Whether “unsuccessful exploration cost” adjustable against other income (other than income from producing PSC’s) • Treatment of expenditure incurred post declaration of commercial discovery – Whether required to be aggregated/can be termed as “unsuccessful”

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Site Restoration

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Site Restoration Section 33ABA Eligibility • Business of prospecting for, or extraction or production of petroleum or natural gas or both • Has entered into a PSC with the Government

Deduction being lesser of • Sum deposited either in a special account or “Site Restoration Account” or • 20% of the profits for relevant financial year calculated as per the provisions of the Act

Some issues • Whether Section 33ABA over rides or is in addition to Section 37(1) relating to deductibility of business expenses? • Level playing field – option to maintain deposit in dollar terms in case of foreign companies

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Tax Tax Holiday Holiday

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Tax Holiday – Section 80 IB... Eligibility • Establishment of undertaking • The business to involve commercial production or refining of mineral oils • Commercial production of mineral oil on or after April 1, 1997 – Exception: Undertaking in North-Eastern region even prior to April 1, 1997

• Refining of mineral oil on or after October 1, 1998

Deduction available

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•

100% of profits

•

For seven consecutive years including initial year

...Tax Holiday – Some Issues What is an ‘undertaking’?

Contract area / Block

Oil field

Oil well

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...Tax Holiday – Some Issues Whether an operator taking over an existing oil field(s) x a eligible for benefit? T •

Relinquishment by existing operator

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Signing of new PSC with Government of India

•

New/ separate petroleum exploration license and mining lease

m u m

ni i Typical life cycle ofM an oil field f o • Initial development y t i l i • Commencement of production b a c i • lReaching peak production level p Ap • Declining production level • Reaching a stage of abandonment

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te a er n

Alt

Issues • Whether results in a new undertaking • What would be the year of commencement of commercial production

Farm-Out: Taxation Principles

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Farm -Out – Taxation Principles Farm-Out Section 42(2) • Determines the taxability of proceeds from assignment of interest (whole or in part) in PSC • Broadly based on the difference between the capital proceeds of transfer and the ‘expenditure remaining unallowed’ • Taxability envisaged under three scenarios: – Proceeds are less than the expenditure incurred remaining unallowed – Proceeds exceed the amount of expenditure incurred remaining unallowed – Proceeds are equal to expenditure incurred remaining unallowed

CBDT circular gives the numerical depiction under the above mentioned three scenarios as discussed in following slides

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Taxability of consideration… Scenario A: Proceeds less than expenditure remaining unallowed Particulars

Rs

(a)

Exp. Incurred

(b)

Exp. Remaining Unallowed

60

(c)

Proceeds of Transfer

50

(d)

Amount allowable as deduction (b-c)

10

(e)

Excess of proceeds of transfer over exp. Remaining unallowed (c-b)

(f)

Diff between the expenditure incurred and exp remaining unallowed (a-b)

(g)

Amount chargeable to tax as P&GBP [Lower of e & f]

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100

NIL 40 NIL

Taxability of consideration… Scenario B: Proceeds exceed expenditure remaining unallowed Particulars (a)

Exp. Incurred

(b)

Rs 100

100

Exp. Remaining Unallowed

60

60

(c)

Proceeds of Transfer

70

150

(d)

Amount allowable as deduction (b-c)

NIL

NIL

(e)

Excess of proceeds of transfer over exp. Remaining unallowed (c-b)

10

90

(f)

Diff between the expenditure incurred and exp remaining unallowed (a-b)

40

40

(g)

Amount chargeable to tax as P&GBP [Lower of e & f]

10

40

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Taxability of consideration… Scenario C: Proceeds equal expenditure remaining unallowed Particulars

Rs

(a)

Exp. Incurred

(b)

Exp. Remaining Unallowed

60

(c)

Proceeds of Transfer

60

(d)

Amount allowable as deduction (b-c)

NIL

(e)

Excess of proceeds of transfer over exp. Remaining unallowed (c-b)

NIL

(f)

Diff between the expenditure incurred and exp remaining unallowed (a-b)

(g)

Amount chargeable to tax as P&GBP [Lower of e & f]

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100

40 NIL

A simplistic approach Section 42(2) provides for terminal allowance Scenario

A

B

C

D

100

100

100

100

Exp. Remaining Unallowed

60

60

60

60

Proceeds of Transfer

50

70

150

60

Terminal Allowance

10

0

0

0

Expenditure Incurred

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A simplistic approach Section 42(2) provides for balancing charge Scenario

A

B

C

D

Sales consideration

50

70

150

60

Less: unallowed expenditure

60

60

60

60

0

10

90

0

40

40

40

40

0

10

40

0

Excess of sales consideration (A) Expenditure allowed (B) Balancing charge (lower of A & B)

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A simplistic approach Capital gains provisions continue to apply Scenario

A

B

C

D

Sales consideration

50

70

150

60

Cost of acquisition/ improvement equivalent to unallowed expenditure

60

60

60

60

(-) Terminal allowance

10

0

0

0

0

10

40

0

50

70

100

60

0

0

50

0

(+) Balancing allowance Effective cost of acquisition/ improvement

Capital Gains

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Farm -Out – Tax Issues Farm-Out

• What constitutes ‘capital proceeds of transfer’?

• What is ‘expenditure incurred remaining unallowed’? • Taxability of sale consideration – over and above covered under section 42(2) • Taxation of cashless considerations, free carry and production bonuses

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Thank You! 24