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
• 100% of profits
• For seven consecutive years including initial year

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...Tax Holiday – Some Issues

What is an ‘undertaking’?

Contract area /
Block

Oil field

Oil well

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...Tax Holiday – Some Issues

x
Whether an operator taking over an existing oil field(s)
a
eligible for benefit? T
ate
• Relinquishment by existing operator
er n
• Alt
Signing of new PSC with Government of India
• um
New/ separate petroleum exploration license and mining lease
nim
Typical life cycle ofM
i
an oil field Issues
of
li t y
• Initial development • Whether results in a new
b i
• Commencement of production undertaking
i ca
• lReaching peak production level • What would be the year of
p
Ap • Declining production level commencement of
commercial production
• Reaching a stage of
abandonment

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 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 100
(b) Exp. Remaining Unallowed 60
(c) Proceeds of Transfer 50
(d) Amount allowable as deduction (b-c) 10
Excess of proceeds of transfer over exp.
(e) NIL
Remaining unallowed (c-b)
Diff between the expenditure incurred and
(f) 40
exp remaining unallowed (a-b)
(g) Amount chargeable to tax as P&GBP [Lower of e & f] NIL

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Taxability of consideration…

Scenario B: Proceeds exceed expenditure remaining unallowed

Particulars Rs
(a) Exp. Incurred 100 100
(b) Exp. Remaining Unallowed 60 60
(c) Proceeds of Transfer 70 150
(d) Amount allowable as deduction (b-c) NIL NIL
Excess of proceeds of transfer over exp.
(e) 10 90
Remaining unallowed (c-b)
Diff between the expenditure incurred and
(f) 40 40
exp remaining unallowed (a-b)
(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 100
(b) Exp. Remaining Unallowed 60
(c) Proceeds of Transfer 60
(d) Amount allowable as deduction (b-c) NIL
Excess of proceeds of transfer over exp.
(e) NIL
Remaining unallowed (c-b)
Diff between the expenditure incurred and
(f) 40
exp remaining unallowed (a-b)
(g) Amount chargeable to tax as P&GBP [Lower of e & f] NIL

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A simplistic approach

Section 42(2) provides for terminal allowance

Scenario A B C D
Expenditure Incurred 100 100 100 100
Exp. Remaining Unallowed 60 60 60 60
Proceeds of Transfer 50 70 150 60
Terminal Allowance 10 0 0 0

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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
Excess of sales consideration (A) 0 10 90 0
Expenditure allowed (B) 40 40 40 40
Balancing charge (lower of A & B) 0 10 40 0

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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
60 60 60 60
equivalent to unallowed expenditure

(-) Terminal allowance 10 0 0 0

(+) Balancing allowance 0 10 40 0
Effective cost of acquisition/ 50 70 100 60
improvement
Capital Gains 0 0 50 0

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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!

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