The Hindu Business Line : Oil companies under taxman’s scanner

The oil and gas sector plays a vital role in the economic growth of a country and more so in the case of oil importing countries like India, which imports about 70 per cent of its crude oil requirement. It is anticipated that oil and gas would meet about 45 per cent of the total energy needs of India by 2025 as per ‘India Hydrocarbons Vision 2025’.

The last seven years have seen significant discoveries of oil and gas, largely due to liberalised exploration regimes and participation by private players. The cumulative investment commitment made by companies stands close to $8 billion under the first six rounds of bidding conducted under New Exploration Licensing Policy (NELP).

Special tax regime

Oil Exploration and Production (E&P) industry, by its very nature, is highly capital intensive, has long-gestation period and, above all, is a highly risky business. To encourage companies to carry out oil exploration and production activities, most countries have provided for a special accounting and tax regime to address the special needs of this high priority industry.

Likewise, India has also provided for a special tax regime for E&P companies. Under this regime, even capital expenditure is allowed as a deduction in the year of incurrence itself as opposed to general tax principles, where such costs are usually amortised and depreciation is allowed on year-to-year basis.

However, tax disputes are being created in several matters even where the Supreme Court has pronounced decisions. One of them concerns supremacy of a production sharing contract (PSC), entered into by an oil exploring company with the Government of India, which includes clause on tax. In the case of Enron Oil and Gas Ltd, the Supreme Court upheld the supremacy of the PSC and the special tax regime for oil exploration companies.

Cairn Energy case

The supremacy of the PSC has been challenged recently in the case of Cairn Energy. The brief facts are that Cairn Energy India Pty Ltd , an Australian company engaged in prospecting for and production of mineral oil in India, entered into a PSC with the Government of India along with other joint venture partners to carry out E&P activities in various contract areas awarded by the Government.

The parent company of Cairn Energy incurred certain expenses in connection with the E&P activities carried on by the latter in India and recharged the same on cost-basis, that is, without any mark-up or profit as per the terms provided in the PSC. Cairn Energy reimbursed these expenses without withholding any tax from the payments. Before the tax authorities, the company pleaded that it was governed by the special tax provisions applicable to E&P companies and as such the allowability of an expense is not jeopardised by general provisions requiring withholding of tax from non-resident payments.

Further, the payments made by the company did not contain any element of profit so as to trigger the withholding tax provisions as applicable for non-resident payments.

The tax authorities, including the Commissioner (Appeals), disallowed the expenses by resorting to the general provisions holding that since tax was not withheld by the company from the payments made, the expenses are not allowed without giving due cognisance to the special provisions for E&P companies and other established withholding tax principles applicable to non-resident payments.

Tribunal’s ruling

The matter reached the tribunal, which weighed the contentions of the company and held that firstly the withholding tax provisions are attracted in cases where the ‘sum is chargeable under the provisions of the Act’ and, accordingly, tax is leviable on such payments.

If the payment represents only reimbursement of actual expenditure and did not contain any element of profit in it, withholding tax would not apply. The tribunal referred to various rulings put forth by both the company and the tax authorities on this matter and correctly interpreted the ruling of the Supreme Court in Transmission Corporation of AP Ltd case, which has been a landmark ruling on this principle; but often incorrectly interpreted by tax authorities to their advantage.

Secondly, the tribunal referred to the Supreme Court ruling in the Enron Oil and Gas India Ltd case wherein the apex court had occasion to examine the special provisions for E&P companies and the legal sanctity of PSC. The Supreme Court held that the special provision is an independent code by itself for computing the income from the business of prospecting for or extraction or production of mineral oils and, therefore, is to be applied.

The tribunal also observed that even though these are not non-obstante provisions (that is, not over-riding other general provisions), yet being special provisions must be given priority over the general provisions as per settled legal principles and as contained in Central Board of Direct Taxes (CBDT) Circular clarifying the superiority of the special provision.

The tribunal also observed that deduction would be allowed for such expenses as are provided in the PSC and so long as the deduction claimed is in accordance with the PSC and the special tax provisions, the same should be allowed without necessarily meeting the tests of other restrictive sections in the Act, which are general in nature. Accordingly, the tribunal rightly upheld the special provisions and allowed the deduction for the expenses.

While, this ruling provides relief to E&P companies, however, the tax authorities can approach the High Court and prolong litigation. The NELP VIIIth round of bidding has already been deferred due to concerns over availability of tax holiday to natural gas and the VIIth round got lukewarm response from private companies. Considering the economic meltdown, bringing in clarity to tax laws and reduction in tax disputes could provide more comfort to investors.

(The authors are with Deloitte Haskins & Sells, New Delhi.)