Understanding the Tax Regime Governing the Indian Oil Industry

Author: Sheetal Saraswat*

The global oil and gas industry is redefining itself amid uncertain energy policies and a changing environment. India, being among them is trying to calibrate the overall industry scenario. In order to standardize the Indian oil and gas policy framework with the international level, over the years there have been myriad policy changes. This article in order to augment the awareness of the taxing system also discusses about the policy and regulatory framework.

It is very essential to understand that the policies and policy framework, the regulations and their regulators are collectively responsible for policy being a boon or bane to economy. This article aims to explore the wide subject of Taxation Regime in Indian Petroleum Sector.

The tax revenue is the most important source of public revenue. A tax is a compulsory payment levied by the government on individuals or companies to meet the expenditure which is required for public welfare.Adam Smith, the father of modem political economy in his famous book “The Wealth of Nations” gave four canons of taxation. Canons of Taxation are the main basic principles (i.e. rules) set to build a ‘Good Tax System’.

Adam Smith’s celebrated cannons of taxation are [1]:

  • Canon of equality or ability: “Tax payments should be proportional to income.”
  • Canon of certainty: “Tax liabilities should be clear and certain”
  • Cannon of Convenience: “Taxes should be collected at a time and in a manner convenient for taxpayer.”
  • Cannon of Economy: “Taxes should not be expensive to collect and should not discourage business.”

Thus, a good tax system is one which is designed on the basis of an appropriate set of principles (rules). The tax system should strike a balance between the interest of the taxpayer and that of tax authorities No tax system that does not satisfy these basic conditions can be termed a good one.

For better understanding of tax governance issues we need to track down to the fundamental source for levying tax.
According to the Constitution of India, the government has the right to levy taxes on individuals and organizations. However, the constitution states that no one has the right to levy or charge taxes except the authority of law. Whatever tax is being charged has to be backed by the law passed by the legislature or the parliament[2].

India has a federal level tax structure; upstream sector is mainly governed by the provisions of Income Tax Act, 1961. It has a broad network of tax treaties with over 90 countries across the globe including even those to avoid double taxation of income. In wake of economic reforms, the taxation system has undergone tremendous changes in the past ten years. The tax rates have been rationalized and compared favorably with many other countries. Further, over the period of time, the tax laws have also been simplified to ensure better compliance[3].

India also provides a customized tax regime for the upstream sector and non-resident service providers in relation to Exploration & Production operations.

The Oil and Gas sector is a vast sector. Before embarking upon the “Tax Framework in Oil Industry”, we need know that the entire chain of Oil and Gas sector is divided into three major components:

Upstream

The upstream oil sector or exploration and production (E&P) sector commonly used to refer to the searching for and the recovery and production of crude oil and natural gas.

Midstream

The midstream industry processes, stores, markets and transports commodities such as crude oil, natural gas, natural gas liquids. Generally midstream operations are included with downstream industry. The midstream provides the vital link between the far-flung petroleum producing areas and the population centers where most consumers are located.

Downstream

The downstream sector includes oil refineries, petrochemical plants, petroleum product distribution, retail outlets and natural gas distribution companies. The downstream industry touches every province and territory-wherever consumers are located-and provides consumers with thousands of products.

Likewise the functions, policies and taxation system are also different in every segment of Oil Industry.

TAX FRAMEWORK

The petroleum sector is a strategic industry for the economy and has traditionally been closely regulated, with the exploration and production activities being primarily concentrated in public sector companies. In order to attract private investment in the oil and gas sector, in 1999, the Government of India (“GoI”) formulated the New Exploration Licensing Policy (“NELP” or the “Policy”). The Policy sought a paradigm shift from the pre-NELP regime under which ONGC and OIL were granted a “Petroleum Exploration Lease” on a nomination basis.

The Policy framework seeks to provide a level playing field to the domestic public sector companies, private companies, and foreign companies, by offering similar regulatory and contractual terms for exploration and production of oil and gas. Also included is a seven year tax holiday from the date of commencement of commercial production.

In 2008, one of the announcements made in the Union Budget generated immense debate relating to the tax holiday for the upstream and refining sectors. The Finance Minister proposed to amend the existing provision of section 80IB (9) of the Income tax Act, 1961 (“IT Act”) to insert a sunset clause of a tax holiday for refining of mineral oil. As per the amendment, the tax holiday would not be available for an undertaking which begins the refining of mineral oil at any time on or after April 1, 2009. In the finalized law, the tax holiday was extended till March 31, 2012, for notified public sector refineries; however, the maximum collateral damages that emerged affected upstream oil and gas producers.

UPSTREAM TAXATION SYSTEM:

We are aware that to provide financial encouragement to the upstream companies in India, the Government has provided certain tax incentives in the Production Sharing Contract. Accordingly, the Government has gradually revised the rates on royalty and various taxes and duties.

India has a hybrid system of Production Sharing Contracts’ (PSC) containing elements of royalty, as well as sharing of production with the Government. Companies enter into a PSC with the Government of India to undertake exploration and production (E&P) activities[4].

Taxation of the E&P sector was traditionally driven with the objective of attracting investments and expertise to secure India’s energy resources. An attempt has been made to keep this objective in mind in the new legislation, i.e. the Direct Taxes Code (DTC), proposed to be enacted from 1 April 2012 but again been deferred in Budget 2012 , as well. Taxation of such companies is not only governed by the Income Tax law but also by the Production Sharing Contract (PSC) entered into between the Government and E&P players. In light of a judicial ruling by the Supreme Court of India, in the event of a conflict between the provisions of the law and the PSC, the provisions of PSC is to be applied[5].

Royalty Regime

Central Government is entitled to get Royalty on Oil and Gas produced from the offshore fields whereas in case of onshore fields it is payable to concerned State Government. The power of regulation and responsibility for the development of oil fields are exclusively within the domain of the Central Government. Oil Fields (Regulation and Development) Act, 1948 and the Petroleum and Natural Gas Rules, 1959 deal with it.

The Royalty on production from fields awarded under PSCs is governed by the provisions of the respective PSCs and the receipts in this regard depend upon the actual production from the various fields. The PSC provides protection in case changes in Indian law result in a material change to the economic benefits accruing to the parties after the date of execution of the contract.

  • Land areas — payable at the rate of 12.5% for crude oil and 10% for natural gas
  • Shallow water offshore areas — payable at the rate of 10% for crude oil and natural gas.
  • Deep-water offshore areas (beyond 400m isobaths) — payable at the rate of 5% for the first seven years of commercial production and thereafter at a rate of 10% for crude oil and natural gas.

The wellhead value is calculated by reducing the marketing and transportation costs from the sale price of crude oil and natural gas.
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 allowability 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

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.
Article 17 of the Model PSC5 provides for the following specific allowances in computing the taxable income of the E&P companies:

  • 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 (“the Act”)
  • 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.

DOMESTIC TAX LAWS

The contractor under NELP is required to pay taxed under Indian Income tax Act, 1961. The broad provisions under domestic tax laws are highlighted as below:

Corporate tax rates

Domestic companies are subject to tax at a rate of 30% and foreign companies at a rate of 40%. In addition, a surcharge (7.5% on tax for a domestic company and 2.5% on tax for a foreign company) must be paid if income is in excess of INR10 million. An education levy of 3% also applies. The effective corporate tax rates are as follows:

Minimum Alternate Tax

Minimum alternate tax (MAT) applies to a company if the tax payable on its total income as computed under the tax laws is less than 18 % of its book profit (accounting profits subject to certain adjustments). If MAT applies, the tax on total income is deemed to equal 18 % of the company’s book profit. Credit for MAT paid by a company can be carried forward for 10 years and it may be offset against income tax payable under domestic tax provisions. Due to the MAT regime, a company may be required to pay some tax, even during the tax holiday period.

Key changes under Budget 2012:

It has been proposed to expand the scope of MAT on non-corporate taxpayers if they are claiming tax holiday. Consequential amendment for availability of credit of MAT has also been provided[6].

Ring-Fencing

No ring-fencing applies from a tax perspective; therefore, it is possible to offset the exploration costs of one block against the income arising from another block.

Treatment of Exploration and Development Costs

All exploration and drilling costs are 100% tax deductible. Such costs are aggregated till the year of commencement of commercial production. They can be either fully claimed in the year of commercial production or they can be amortized equality over a period of 10 years from the date of first commercial production. Development costs (other than drilling expenditure) are allowable under the normal provisions under the domestic tax law.

PRODUCTION SHARING CONTRACT REGIME

India has a hybrid system of PSCs containing elements of royalty as well as sharing of production with the Government. E&P companies (contractors) that are awarded the exploration blocks enter into a PSC with the Government for undertaking the E&P of mineral oil. The PSC sets forth the rights and duties of the contractor. The PSC regime is based on production value.

Cost Petroleum or Cost Oil

Cost petroleum is the portion of the total value of crude oil and natural gas produced (and saved) that is allocated toward recovery of costs. The costs that are eligible for cost recovery are:

  • Exploration costs incurred before and after the commencement of commercial production
  • Development costs incurred before and after the commencement of commercial production.
  • Production costs
  • Royalties

The unrecovered portion of the costs can be carried forward to subsequent years until full cost recovery is achieved.

Profit Petroleum or Profit Oil

Profit petroleum means the total value of crude oil and natural gas produced and saved, as reduced by cost petroleum. The profit petroleum share of the Government is biddable by the contractor. The blocks are auctioned by the Government. The bids from companies are evaluated based on various parameters including the share of profit percentage offered by the companies.

The law has no caps on expenditure recovery. The percentage of recovery of expense incurred in any year is as per the bids submitted by the companies. Further, no uplift is available on recovered costs.

The costs that are not eligible for cost recovery[7] are as follows:

  • Costs incurred before the effective date[8] including costs of preparation, signature or ratification of the PSC.
  • Expenses in relation to any financial transaction to negotiate obtain or secure funds for petroleum operation. For example, interest, commission, brokerage, fees and exchange losses.
  • Marketing or transportation costs.
  • Expenditure incurred in obtaining, furnishing and maintaining guarantees under the contract.
  • Attorney’s fees and other costs of arbitration proceedings.
  • Fines, interests and penalties imposed by courts.
  • Donations and contributions.
  • Expenditure on creating partnership or joint venture arrangement.
  • Amounts paid for non-fulfillment of contractual obligations.
  • Costs incurred as a result of misconduct or negligence of the contractor
  • Costs for financing and disposal of inventory.

The PSC provides protection in case changes in Indian law result in a material change to the economic benefits accruing to the parties after the date of execution of the contract.

CAPITAL ALLOWANCES

Accelerated depreciation:

Depreciation is calculated using the declining-balance method and is allowed on a class of assets. For field operations carried out by mineral oil concerns, the depreciation rate is 60% for specified assets[9] while the generic rate of depreciation on the written-down basis is 15% (majority of the assets fall within the generic rate). Further, additional depreciation of 20% is available on the actual cost of new machinery or plant[10] in the first year.

INCENTIVES
Tax holiday

A seven-year tax holiday equal to 100% of taxable profits is available for an undertaking engaged in the business of commercial production of mineral oil or natural gas or refining of mineral oil.

Carry forward losses

Business losses can be carried forward and set off against business income for eight consecutive years, provided the income tax return for the year of loss is filed on time. For closely held corporations, a 51% continuity of ownership test must also be satisfied.
Unabsorbed depreciation can be carried forward indefinitely.
Research &Development

Expenditures on scientific research incurred for the purposes of the business are tax deductible.

Deduction for site restoration expenses

A special deduction is available for provisions made for site restoration expenses if the amount is deposited in a designated bank account. The deduction is the lower of the following amounts:

  • The amount deposited in a separate bank account or “site restoration account”
  • Twenty percent of the profits of the business of the relevant financial year.

WITHHOLDING TAXES

The following withholding tax rates apply to payments made to domestic and foreign companies in India:

Table: 1

NATURE OF INCOME

RATE (%)

Domestic Company

Foreign Company*

DIVIDENDS** 0% 0%
INTEREST 20% 20%***
FEES FOR PROFESSIONAL OR TECHNICAL FEES 10% 10%
NON- RESIDENT CONTRACTOR Maximum

40%****BRANCH REMITTANCE TAX0%0%

 

For countries with which India has entered into a tax treaty, the withholding tax rate is the lower of the treaty rate and the rate under the domestic tax laws on outbound payments.

* The rates are to be further enhanced by the surcharge and education levy (cess).

** Dividends paid by domestic companies are exempt from tax in the hands of the recipient. Domestic companies are required to pay Dividend distribution tax (DDT) at 16.61% on dividends paid by them.

*** This rate applies to interest from foreign currency loans. Other interest is subject to tax at the rate of 40% (plus applicable surcharge and education cess).

**** Subject to treaty benefits. If a permanent establishment is constituted in India, the lower withholding tax rate depends on profitability.

FINANCING CONSIDERATIONS

Thin capitalization limits

There are no thin capitalization rules under the Indian tax regulations. Under the exchange control regulations, commercial loans obtained by an Indian company from outside India are referred to as external commercial borrowings (ECBs). ECBs are permitted for capital expansion purposes. ECBs can be raised from internationally recognized sources such as international banks, international capital markets and multilateral finance institutions, export credit agencies, suppliers of equipment, foreign collaborators and foreign equity holders (subject to certain prescribed conditions including debt-to-equity ratio).

Interest quarantining

Interest quarantining is possible, subject to the exact fact pattern.

TRANSACTIONS

Asset disposals

A capital gain arising on transfer of capital assets (other than securities) situated in India is taxable in India (sale proceeds less cost of acquisition). Capital gains can either be long term (capital assets held for more than three years except for securities where it is required to be held for more than one year) or short term. The rate of CGT is as follows:

PARTICULARS

RATE (%)[11]

Short-term capital gains

Long-term capital gains*[12]

Resident Companies 30% 20%
Non-residents 40% 20%

* The rates are to be further enhanced by the surcharge and education levy.

A short-term capital gain on transfer of depreciable assets is computed by deducting the declining-balance value of the classes of assets (including additions) from the sale proceeds.

FARM IN AND FARM OUT

No specific provision applies for the tax treatment of farm in consideration, and its treatment is determined on the basis of general taxation principles and provisions of the PSC. However, special provisions do determine the taxability of farm out transactions in the certain situations.

SELLING SHARES IN A COMPANY (CONSEQUENCES FOR RESIDENT AND NON-RESIDENT SHAREHOLDERS)

Listed securities on a stock exchange

The transfer of listed securities is exempt from long-term CGT provided that securities transaction tax is paid. Short-term capital gains are taxable at a reduced rate of 15%.

Transfer of listed securities outside a stock exchange

Long-term capital gains derived from the transfer of listed securities are taxed at the rate of 10% (without allowing for indexation adjustments) or at the rate of 20% with indexation benefits. Short-term capital gains are taxable at the rate of 30% and 40% for resident companies and non-resident companies, respectively.

Unlisted securities

The CGT rate applicable to transfers of unlisted securities is as follows:

PARTICULARS

RATE (%)[13]

Short-term capital gains

Long-term capital gains*[14]

Resident Companies 30% 20%
Non-residents 40% 20%

* The rates are to be further enhanced by the surcharge and education levy.

TRANSFER PRICING

The Income Tax Act includes detailed transfer pricing regulations. Under these regulations, income and expenses, including interest payments, with respect to international transactions between two or more associated enterprises (including permanent establishments) must be determined using arm’s length prices. The transfer pricing regulations also apply to cost-sharing arrangements.

The Act specifies methods for determining the arm’s length price:

  • Comparable uncontrolled price method
  • Resale price method
  • Cost plus method
  • Profit split method
  • Transactional net margin method
  • Any other method prescribed by the Central Board of Direct Taxes (CBDT)

The CBDT has issued the regulations for applying these methods to determine the arm’s length price. The transfer pricing regulations require each person entering into an international transaction to maintain prescribed documents and information regarding a transaction. Each person entering into an international transaction must arrange for an accountant to prepare a report and furnish it to the tax officer by the due date for filing the corporate tax return, which is 30 September.

A tax officer may make an adjustment with respect to an international transaction, if the officer determines that certain conditions exist, including any of the following:

  • The price is not at arm’s length
  • The prescribed documents and information have not been maintained
  • The information or data on the basis of which the price was determined is not reliable
  • Information or documents requested by the tax officer have not been furnished Stringent penalties (up to 2% of transaction value) are imposed for noncompliance with the procedural requirements and for understatement of profits.

Other

There is a special tax regime for foreign companies that are engaged in the business of providing services or facilities or supplying plant or machinery or hire used in connection with prospecting, extraction or production of mineral oils.

Important Note:

The Indian Finance Ministry has proposed to release a new direct tax code (DTC). The New Direct Tax Code (DTC) is said to replace the existing Income Tax Act of 1961 in India. During the budget 2010 presentation, the finance minister Mr. Pranab Mukherjee reiterated his commitment to bringing into fore the new direct tax code (DTC) into force from 1st of April, 2011, but same could not be fulfilled.
Again, as per budget presented on 16th March, 2012, Implementation of Direct tax code has again been deferred and won’t be applicable from 1st April, 2012[15].

DOWN STREAM SECTOR: TAXATION SYSTEM

Indirect Taxes

Indirect taxes are applicable to activities that span from manufacturing to final consumption, and include within their scope distribution, trading and imports, as well as services. Therefore, indirect taxes impact almost all transactions. In India, indirect taxes are multiple, multi-rate and multi-tier (i.e., levied at the central, state and local levels). The principal indirect taxes are central excise, customs duty, service tax, central sales tax and value-added tax. Additionally, other indirect taxes such as entry tax and octroi are also levied by state Governments and municipalities.

Customs Duty

Customs duty is levied on the import of goods into India and is payable by the importer. The customs duty on imports comprises the following:

  • Basic customs duty (BCD)
  • Additional duty of customs (ADC), levied in lieu of excise on goods manufactured in India
  • Special additional duty of customs (SAD), levied in lieu of VAT on the sale of similar goods in India
  • Education cess

The rate of customs duty is based on the classification of imported goods. The classification is aligned to the Harmonized System of Nomenclature (HSN). The rates of BCD vary across goods and range from 0% to 10%, except for certain specified items which attract higher rates. ADC is levied in lieu of excise duty that applies to similar goods manufactured in India. It is generally 10.3% (including education cess). SAD is levied in lieu of central sales tax or VAT payable on the sale of similar goods at 4%. In addition, education cess at 3% is charged on the aggregate customs duty.

Thus, the general effective customs duty rate for most imported goods is 26.85%. Further, certain exemptions or concessions are provided on the basis of classification, location or usage of the imported products. In addition, the Government of India has entered into several free or preferential trade agreements with trade partners such as Thailand, Sri Lanka, the South Asian Association for Regional Cooperation (SAARC) countries, Singapore, ASEAN and MERCOSUR countries. To promote trade-in terms, preferential tariff rates have been extended for certain identified goods traded with these countries. Similar trade agreements with the European Union countries and others are also being negotiated currently. Subject to conditions, an importer using imported goods in the manufacture of goods may obtain a credit for ADC and SAD, whereas a service provider using imported goods may obtain a credit exclusively for ADC.

Notable Issues for the Oil and Gas Sector

Several concessions or exemptions have been provided for import of goods for specified contracts for exploration, development and production of petroleum goods. Further, concessions or exemptions have been provided for the import of crude and other petroleum products. Further, import of certain petroleum products also attracts other customs duties, in addition to the duties discussed above, such as additional duty on import of motor spirit and high-speed diesel, and national calamity contingent duty on import of crude oil.

Key Changes introduced in Budget 2012:

  • Standard customs duty rates remain unchanged.
  • Education cess and Secondary & Higher Education cess is exempt on the additional customs duty on import of goods.
  • Import of dredgers is exempt from basic customs duty and special additional duty of customs.
  • Natural gas/ Liquefied Natural Gas imported for power generation by power generation plants is exempt from basic customs duty.

Exemption is not available to imports by captive generation plant. Basic customs duty on survey instruments, 3D modelling software for ore body simulation cum mine planning and exploration (geophysics and geochemistry) equipment required for surveying and prospecting of minerals reduced to 2.5% subject to specified conditions.

  • Import of foreign going vessels is exempt from additional customs duty subject to payment of duty at the time of its conversion to coastal run and fulfillment of prescribed conditions

Excise Duty

Excise duty applies to the manufacture of goods in India. Most products attract a uniform rate of excise duty of 12% and education cessat a rate of 3%. Accordingly, the effective excise duty rate on most products is 12.3%. Excise duty is mostly levied as a percentage of the value of goods sold. However, for certain goods, the excise duty is on the basis of the maximum retail price, reduced by a prescribed abatement. The CENVAT credit rules of 2004 allow a manufacturer to obtain and use the credit of excise duty, ADC, SAD and service tax paid on procurement of goods and services toward payment of excise duty on manufactured goods.

Notable issues for the oil and gas sector

No excise duty is levied on domestic production of crude oil but the same attracts national calamity contingent duty as well as oil cess. On certain petroleum products, excise duty is levied both on the basis of value and quantity. Certain petroleum products also attract other excise duties such as additional duty (on motor spirit and high-speed diesel), special additional excise duty (on motor spirit).

CENVAT credit is not available in respect of excise duty paid on motor spirit, light diesel oil and high-speed diesel oil used in the manufacture of goods.

Key Changes from Budget 2012:

  • The standard rate of excise duty on non-petroleum products increased from 10% to 12%
  • Excise duty on Coal remains unchanged to 1%
  • Cess levied under the Oil Industries Development Act, 1974 on production of crude oil has been increased from Rs. 2500/- per metric tonne to Rs. 4500/- per metric tonne. This is effective from 17 March 2012.
  • Rate of excise duty on avgas has been increased from 5% to 6%

Service Tax

Service tax is levied on certain identified taxable services provided in India at the rate of 12%[16] (inclusive of a 3% education cess). The liability to pay the service tax is on the service provider, except in the case of a goods transport agency service or a sponsorship service, where the liability to pay the service tax rests with the service recipient. Service tax is applied on the basis of the destination principle.

Thus, export of services is not subject to tax. On the other hand, import of services is taxable in India and the liability to pay the tax is on the recipient of the service (under the reverse-charge mechanism). Specific rules have been promulgated to determine the conditions under which a specific service would qualify as an export or an import.

Similar to the manufacture of goods, the CENVAT credit rules allow a service provider to obtain a credit of the ADC and excise duty paid on the procurement of inputs or capital goods. Further, service tax paid on the input services used in rendering output services is also available as credit toward payment of the output service tax liability. However, credit of SAD is not available to a service provider.

Notable Issues for the Oil and Gas Sector

Service tax is levied on services provided in relation to the mining of minerals, oil and gas and also on the survey and exploration of minerals, oil and gas. Previously, the application of service tax extended to the Indian landmass, territorial waters (up to 12 nautical miles) and designated coordinates in the Continental Shelf (CS) and Exclusive Economic Zone (EEZ). Further, there was an amendment in the law (with effect from 7 July 2009) whereby the application of service tax was extended to installations, structures and vessels in the CS and EEZ of India. Subsequently, a new notification (with effect from 27 February 2010) was issued, superseding an earlier notification, which stipulates that the service tax provisions would extend to:

  • Any service provided in the CS and EEZ of India for all activities pertaining to construction of installations, structures and vessels for the purposes of prospecting or extraction or production of mineral oil and natural gas and supply thereof.
  • Any service provided, or to be provided, by or to installations, structures and vessels (and supply of goods connected with the said activity) within the CS and EEZ of India that have been constructed for the purpose of prospecting or extraction or production of mineral oil and natural gas and supply thereof.

VAT or Central Sales Tax (CST)

VAT or CST is levied on the sale of goods. VAT is levied on sale of goods within a state and CST is levied on a sale occasioning movement of goods from one state to another. VAT is levied at two prime rates of 4% and 12.5% (many states have now increased the VAT rates). However, certain essential items are exempt from VAT. CST is levied either at the rate of 2% (subject to the provision of declaration forms prescribed under the CST Act) or at a rate equivalent to the local VAT rate in the dispatching state. A VAT or CST registered dealer is eligible for credit for the VAT paid on the procurement of goods from within the state and to utilize it toward payment of the VAT and CST liability on sale of goods made the dealer, CST paid on procurement of goods from outside the state is not available as a credit.

Notable Issues for the Oil and Gas Sector

Petroleum products — petrol, diesel, naphtha, aviation turbine fuel, natural gas etc., — are subject to VAT at higher rates, which range from 4% to 33%, depending on the nature of product and the state where they are sold. VAT credit on petroleum products is generally not allowed as a credit against output VAT or CST liability, except in the case of the resale of such products. Since crude oil has been declared under the CST Act as being goods of “special importance” in the inter-state trade or commerce, it cannot be sold at a VAT/ CST rate higher than 4%.

Goods and Services Tax (GST)

The current scheme of indirect taxes is sought to be replaced by GST. GST was expected to be introduced with effect from April 2012. GST is expected to replace excise duty, service tax on the Centre’s front, VAT at states end, besides cesses, surcharges and local levies[17].

In his Union Budget 2012-13 speech finance minister Pranab Mukherjee said that the Goods and Services tax (GST) will be operational by August 2012[18].

GST would be a dual GST, consisting of a central GST and a state GST. The tax would be levied concurrently by the center as well as the states, i.e., both goods and services would be subject to concurrent taxation by the center and the States. An assessee can claim credit of central GST on inputs and input services and offset it against output central GST. Similarly, credit of state GST can be set off against output state GST. However, specific details regarding the implementation of GST are still awaited. Some goods, namely crude petroleum, diesel, petrol, aviation turbine fuel, natural gas and alcohol are not to come under the purview of the GST. Thus currently, the inclusion of the petroleum sector under the GST is not certain since there are varied views within the Government on the same.

CONCLUSION

In global oil industry, fiscal terms accepted by a country reflect its negotiating strength and experience of the country, geological prospects, and the track record of previous projects. These factors directly influence the size of the government’s revenue take.

With broad range of fiscal instruments available in the sector we can say that Indian policymakers have designed a fiscal regime for oil sector that attracts investments as well as secure reasonable revenue for the government. Despite these qualifications, there is dire need to outline some desirable features to target in the fiscal regime for the Indian petroleum sector from the perspective of the multinational oil companies.

One of the factors that had promoted investments in this sector was a 7 year tax holiday, which currently had a sunset clause of 31 March 2012. The industry was hoping that the tax holiday provisions will be extended to help realize the dream of making ‘India as a refinery hub’, but no such extension has been done.

During the past 30 years, numerous prospective reserves for oil and natural gas have been discovered in India. A growing economy with its inherent increase in energy demand is likely to welcome huge investment opportunities in the oil and gas industry. It is expected that India’s energy sector will provide investment avenues worth US$ 110 billion-US$ 160 billion over the next few years. With large areas of India’s sedimentary basins remaining unexplored, the Indian oil scenario is believed to comfortably cross expectations. It is high time since heed be paid towards solving various issues faced by the industry and also substantially simplify tax laws in this regard.

Sheetal Saraswat* is a Graduate [B.A, LL.B (Hons.)] from University of Petroleum & Energy Studies, Dehradun. She specialises in Energy Laws, especially in  Laws relating to Oil & Gas and Policies thereto.

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  1. Professor Stephen Smith, “Introduction to key concepts in the economics of taxation”, UCL Department of Economics. Retrieved from: http://www.ucl.ac.uk/~uctpa15/Econ7008_slides1.pdf .Web. November 3, 2011.
  2. “Tax system in India at”, Retrieved from: www.businessmapsofindia.com , Web. Nov. 5, 2011
  3. “Oil and Gas Sector : Overview in India 2009” KPMG, India
  4. Global Oil and Gas Tax Guide: 2011, Ernst & Young, pg. 173.
  5. Nidhi Agarwal, Neetu Vinayak, ”Taxation for the Exploration & Production Sector, Offshore World, print Dec’11-Jan’11.
  6. “Budget PLUS 2012- Key features of India’s Union Budget”, Impact on- Oil & Gas Sector, Ernst & Young, March 19, 2012.
  7. Without prejudice to their allowability under domestic tax laws.
  8. Effective date means the date when the contract is executed by the parties or the date from which the license is made effective, whichever is later.
  9. Mineral oil concerns: (a) Plant used in field operations (above ground) distribution — returnable packages (b) Plant used in field operations (below ground), not including curbside pumps but including underground tanks and fittings used in field operations (distribution) by mineral oil concerns
  10. Additional depreciation is permitted for all persons engaged in the business of manufacturing or producing any article or thing for new plant and machinery acquired after 31 March 2005.
  11. The rates are further enhanced by the applicable surcharge and levy.
  12. The cost of capital assets is adjusted for inflation (indexation) to arrive at the indexed cost (the benefit of indexation is not available to non-residents), which is allowed as a deduction while computing the long-term capital gains
  13. The rates are further enhanced by the applicable surcharge and levy.
  14. The cost of capital assets is adjusted for inflation (indexation) to arrive at the indexed cost (the benefit of indexation is not available to non-residents), which is allowed as a deduction while computing the long-term capital gains
  15. “Direct Tax Code (DTC): Highlights and Impact”, Retrieved from: http://www.pankajbatra.com/india/new-direct-tax-code-dtc-highlights/
  16. The peak rate of service tax has been increased to 12% from 10% from 1 April 2012.
  17. “Amendment bill on GST unlikely this session” Retrieved from: http://www[DOT]gst[DOT]co[DOT]in/ Web. March 11, 2012
  18. “Union Budget 2012-13: GST to be operational by August 2012” The Times of India , Mar 16, 2012, Retrieved from: http://articles.timesofindia.indiatimes.com/2012-03-16/union-budget/31200453_1_gst-council-gst-dispute-settlement-authority-115th-amendment , Web. April 1, 2012

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