What is the debate? The two important changes in the recent budget announcement include: Sunset clause of March 31'09 for availing tax holidays on refineries commencing commercial production by that date,an explanatory memorandum (slipped into the budget document) clarifying that the term "mineral oil" does not include petroleum and natural gas for the purpose of seven year tax holiday . |
Whereas, the first change is understandable, the second change is being labelled as a 'dampener' and attributable to inadequate response by bidders to the recent New Exploration Licensing Policy (NELP) round of concessions. India attracts private participation in exploration and production of hydrocarbons via NELP for the past nine years and its fiscal terms are labelled as best among the world.
The question before the potential bidders is whether they should consider availability of the tax holiday on production of natural gas? Typically, concession agreements (a contract for a specified area for exploration of hydrocarbons) are valid for periods between 25 to 30 years and availability of seven year tax holiday on production can have significant impact in the overall project economics of bidders and lending agencies. To make matters worse, the said explanatory memorandum intents denying tax holiday has retrospective applicability, since it is issued as clarificatory in nature. Hence, domestic producers of natural gas, who bid for projects under the early round of concessions, will get impacted.
The natural oil companies who are producers of natural gas would face the ire of the taxman with respect to past tax affairs seems certain. Is this another instance to deny legitimate tax holiday claim or an after thought? OR is the debate on affordability of tax cost no longer an issue given the prevailing international price of crude oil and petroleum products. If this is the debate in policy makers mind, why discriminate between crude oil and natural gas, particularly if natural gas is a safer and green energy.
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Interpretation of Mineral Oil
The definition under the Income Tax Law is unambiguous and includes petroleum and natural gas. Further, interpretations given by the Mumbai High Court in the case of Caltex and Burma Shell leave no doubt that "mineral oil" includes crude oil, petroleum and other forms. Tax holiday was introduced in 1997 with an intent to exploit vast potential for "oil and gas" exploration in the country.
Though initially, the tax holiday applied to North-Eastern states, Finance Act 1998 extended tax holiday to cover the entire country. Coincidentally, the F M in the 2008 budget speech acknowledged gas as a benign fuel and authored the previous budgets introducing tax holidays.
Petroleum Laws and regulatory developments
The Oil Fields Act, 1948, have given wider definition for mineral oil resources to include natural gas. Further, the Petroleum Tax Guide of '99 published by Ministry of Petroleum and Natural Gas to aid bidders acknowledges availability of tax holiday to gas producers.
The term petroleum has been defined in the guide to mean crude oil and /or natural gas. Further, the Production Sharing Contract (PSC) for Cold Based Methane (CBM) defines CBM as natural gas. PSCs, govern the contractual relationship between the contracting parties, including the government.
Contractual obligation under PSC
The PSC governs the terms and duration of concession and overrides the provisions under the Income Tax Act with respect to deductibility and tax concessions.
The uncertainty around availability of tax holiday would cause anxiety in the minds of investors since they would like to believe that the terms of PSC would override the explanatory memorandum. The PSC is signed by none other than a representative of the President of India, besides being placed in both houses of parliament and hence its sanctity is wider than a simple contract.
Investors in the gas summit raised the question on 'Doctrine of Promissory Estoppel'. The position of Indian Courts has been that applying the Doctrine of legitimate expectations or promissory estoppel looses significance due to change in policy of government.
While the discretion to change the policy in exercise of the executive power is wide, what is imperative and implicit under the constitutional provision (article 14) is that it must be fair and not impress that it is arbitrary.
Changes warrant a relook
I sincerely believe that given the energy security challenges India is facing and the focus to attract investment in highly capital intensive industry, there is need to relook the explanatory memorandum.
The memorandum explaining the budget provisions are expected to explain the underlying changes and provide a reference point. Hence, the intent of '97 and '98 law would prevail, read along with the petroleum regulations, including the petroleum tax code. However, one cannot rule out the chances of taxman adopting a narrow interpretation thereby denying the benefit.
Given the stakes in a typical gas project, denial of tax holiday could be catastrophic. Since the bill is undergoing debate in the Parliament and the due date for bids under recent round of NELP has been extended, this would be the best opportunity to settle the dust.
The author is a partner with BMR Advisors and views are personal