Tax attack may take bite out of Nelp

Nelp-IX blocks may not be eligible for profit-linked tax holiday as the government seems intent on doing away with profit-linked tax holiday.

Along with sustained economic growth and stability, energy security has been an important agenda for the Indian government.

Globally, oil and gas have been the most important source of energy and with 45% share in the country’s energy basket, its importance in the Indian context cannot be overemphasised.
    
Currently, the country relies on imports for about 70% of its crude oil requirement.

But there has been frenetic activity in the gas business with the rising usage of clean sources of energy.
    
To keep pace with the rising demand, the country has been looking at enhanced private participation and investment into its hydrocarbon space.

The last eight rounds of auction under the New Exploration Licensing Policy (Nelp) have helped to further the initiative of the government.
    
The discoveries in Rajasthan as well as Krishna-Godavari basin have also led to renewed interest in the Indian terrain.
    
To take forward the momentum in the exploration and production sector, the ninth round of Nelp (Nelp-IX) is scheduled to be launched on October 15. Under this round, about 34 blocks are likely to be offered for bidding.
    
However, as the exploration business has a long gestation period with a high risk quotient, prospective bidders would need to understand the impact of the tax regime on the business and factor that into their financial models.
    
This aspect attains significance in view of the proposed Direct Taxes Code (DTC) that is already in Parliament and is slated to come into force from April 1, 2012.
    
Under the existing tax regime, production of ‘mineral oil’ is eligible for a profit-linked tax holiday for seven years.

Further, natural gas produced from blocks licensed during Nelp-VIII and coal bed methane (CBM)-IV are also eligible for profit-linked tax holiday.

This tax holiday is available over and above the deduction of capital cost incurred for exploration and production activities.
    
In other words, investors are eligible for deduction of their capital cost and profit-linked tax holiday for a period of seven years on any profit they make after adjusting the capital cost.
    
The proposed DTC provides for investmentlinked tax incentive rather than a profit-linked tax holiday.

In simple terms, exploration and production-related capital expenditure incurred will be treated as tax-deductible expenditure in the year in which it is incurred.

However, producers would not be entitled to profit-linked incentive, as profitlinked tax holiday does not find place in the DTC.
    
In view of the paradigm shift in the tax regime as proposed by the DTC, there have been discussions on the eligibility of profit-linked tax holiday for exploration blocks to be allotted under Nelp-IX.
    
This aspect of profit-linked tax holiday could play an important role in the finalisation of investment decisions and payback period for the investors, even though the DTC is still a Bill and yet to be approved.

Typically, the fiscal regime at the time of bidding of the exploration blocks is relevant and, hence, this aspect has acquired significance.
    
Based on the analysis of the relevant provisions, one possible view is that the Nelp-IX blocks may not be eligible for profit-linked tax holiday as the government seems intent on doing away with the profit-linked tax holiday in the proposed DTC.
    
In other words, the exploration companies shall be allowed accelerated amortisation of the capital cost incurred on exploration and production but would not be entitled to any benefit linked to the profits earned by the company. This interpretation is based on the spirit of the DTC provisions.
    
Another possible view that emerges is that the DTC is a policy reform and, like any other reform, its impact should be prospective — only once the DTC Bill becomes an Act.

The provisions and intent of draft DTC cannot be read into the existing regime, not until the same becomes an enforceable law.
    
As the tax regime applicable at the time of bidding for the exploration blocks and signing of the production-sharing contracts would be relevant — which is likely to happen before the DTC becomes effective — the profit-linked tax holiday should continue for Nelp-IX blocks as well.
    
This view is also supported by the fact that the DTC contains a grandfathering provision that enables exploration companies eligible for tax holiday to continue claiming the benefit after the DTC becomes effective.
    
Both the above conclusions can be supported by arguments although the interpretations are likely to yield divergent results with respect to the payback period and viability of the investments.

Since the matter is yet to attain finality, it is likely to be a subject matter of interpretation and evaluation by the prospective bidders for Nelp-IX.