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Corporate Indirect International M&A Transfer Pricing
New Exploration Licensing Policy – VFiscal aspects
Gokul ChaudhriMay 9, 2005
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NELP V1
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Euphoric finds…
The significant hydrocarbon finds in the previous few years has set the backdrop for this fifth round of NELP…
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Interest in NELP V
Roadshows for Nelp-V blocks begin
LONDON, JANUARY 20: Union Petroleum Minister Mani Shankar Aiyar on Thursday invited global firms to bid for oil and gas exploration blocks under the Fifth Round of the New Exploration Licensing Policy (NELP-V).
Surge in demand for NELP-V blocks
Petroleum minister Mani Shanker Aiyar on Monday said there was a “surge” in the response of global oil majors, particularly the “middle-level companies,” to the domestic oil blocks on offer for exploration. Speaking to media persons here after the roadshow in London for the fifth round of the New Exploration and Licensing Policy (NELP), the minister said he was “pleasantly startled” by the interest shown (in Indian oil blocks) by oil biggies like Shell, British Petroleum, British Gas who he had met in London.
20 blocks on offer — Net worth norm for NELP-V bidders cut
THE Government has cut the net worth criteria from $1 billion to $500 million for prospective bidders seeking to explore oil and gas in 20 blocks under the fifth round of New Exploration Licensing Policy (NELP-V).
Gail, Gazprom to bid jointly under NELP-V
Aiyar launches NELP V roadshow
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Fiscal aspects in NELP V
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Bid evaluation criteria
‘Government take’ is to be determined
‘Government take’ will include Royalty, profit petroleum and Income tax accruing to the Government
Government take is equal the ratio of Government NPV to project NPV
NPV is calculated by applying 10% discount rate
The bidder offering highest Government NPV will get maximum points and other bidders will get points proportionately
Fiscal package
Four major criteria for bid evaluation have been identified against which weights have
been assigned for bid evaluation:
Technical capability
Financial capability
Work programme
Fiscal package
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Purpose of presentation
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Purpose of presentation
‘Government take’
Royalty
Profit split
Income tax
Discuss the ‘income tax element’ of Government take
Fiscal terms in PSC negotiations
Selection of bidding vehicle
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Fiscal Scenario4
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Fiscal Scenario under NELP V in summary
Customs duty
Tax / Duty Provision under NELP V
Cess
Royalty
Tax holiday for seven years
Royalty on well-head value; varies from 5 – 12.5%
Sales Tax Incidence to be borne / reimbursed by buyer
Exemption for equipments etc imported for use in petroleum operations
Exemption from levy of cess of Rs 1,800 per tonne
Corporate Tax
Custom Duty
Cess
Royalty
Sales Tax
Exchange Control Full repatriation of profits abroad
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Income tax4.1
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General framework
Ownership of resources
On-land – State Government
Offshore – Central Government
Jurisdiction of Indian tax laws
200 nautical miles from appropriate base line for specified E&P activities
Income tax rates
Indian company
Corporate tax - 33.66%
DDT (on dividend distribution) – 14.025%
Effective tax rate – 41.82%
Foreign company
Corporate tax – 41.82%
All tax rates are as proposed by the Finance Act, 2005
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E&P taxation - framework
Section 293A of the Income tax Act, 1961 (Act)
Exemption / reduction in relation to participation in business of prospecting for, or
extraction of mineral oil
Section 42 of the Act
Special provisions for taxation of E&P companies – directs the asessee to PSC for
specific matters
Article 17 of the PSC
Specific aspects which are unique for taxation of E&P companies
Section 33ABA of the Act
Contribution to SRFS deductible at 100% per annum
Section 80IB of the Act
Provides for an income tax holiday for production of mineral oils
Framework of taxation:
Details
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Tax outcomes … issues
All exploration and drilling costs eligible for tax deduction
Deduction actually allowed only in year in which commercial production commences (bullet or over 10 years)
Exception in case assessee has both exploration and producing properties, then unsuccessful exploration costs allowed as a deduction against income from producing property
Exploration phase
Forced ‘ring-fencing’ of exploration costs even if assessee has other non-E&P income
No clear definition of what constitutes ‘unsuccessful exploration costs’
Some issues
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Tax outcomes … issues (cont.)
Production income eligible for a 7 year tax holiday
Tax holiday from year in which commercial production commences
Production phase
MAT payable during the period of tax holiday
In case of Indian incorporated entity, DDT payable even in case of tax holiday period
Tax holiday available for ‘undertaking engaged in production of mineral oils’, no clarity on definition of ‘undertaking’ ie whether a well, field or block will constitute undertaking
Some issues
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Tax outcomes … issues (cont.)
Proceeds are less than the expenditure incurred remaining unallowed, excess allowed as a business deduction in year of farm-out
Proceeds exceed the amount of expenditure incurred remaining unallowed, excess (to the extent of total expenditure incurred) is taxed as business income in year of farm-out
Proceeds are equal to expenditure incurred remaining unallowed, no significant tax outcome
Farm-outs
What constitutes ‘capital proceeds of transfer’?
What is ‘expenditure incurred remaining unallowed’?
Taxability of sale consideration – over and above the total expenditure incurred
What if there is no monetary flow / flow of any consideration from the farmer-in to the farmer-out in the year of farm-out?
Some issues
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Tax outcomes … issues (cont.)
Section 42(2) - Two conditions need to be fulfilled:
Transfer (wholly or partly) of business or any interest in business
Consideration (ie capital proceeds of transfer) to be measured against the costs incurred by the farmer-out (to determine taxability)
Do these conditions have to be fulfilled in the same year to claim the deduction?
Carry arrangements where there is no transfer of consideration
Treatment of production bonuses paid in subsequent years
Some issues (cont.)
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Tax outcomes … issues (cont.)
Tax levied on fringe benefits provided to employees
Rate of tax – 33.66%
Fringe benefits valued at specified percentages of defined expenses
FBT not a tax deductible expense
FBT
Whether FBT will constitute a part of ‘Government take’?
Levy of FBT on JES expense items?
Cost recoverability of FBT
Some issues
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Indirect taxes(circulated separately)
4.2
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PSC negotiation5
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PSC
Issue
Under Article 17 of the Model PSC, unsuccessful exploration costs incurred in other contract areas is allowed as a deduction against production in the block
However, ‘unsuccessful exploration costs’ is not defined in the PSC
Revenue authorities could try and contend that exploration costs can be considered as unsuccessful only when a field is relinquished
Comments
While negotiating the PSC, the term ‘unsuccessful exploration costs’ could be clearly defined as exploration costs in a field where no commercial discovery has been made by end of the relevant tax year
Unsuccessful exploration costs
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PSC (cont.)
Issue
Under Article 17 of the Model PSC, all exploration and drilling costs are required to be aggregated and allowed as a deduction in year in which commercial production commences (or in ten equal installments from that year)
This provision may be useful if the assessee has only one source of income ie E&P
In case the assessee has alternate source of income, it may be beneficial if the exploration costs are allowed to reduced from the other income earned from non-E&P sources
Comments
The aggregation clause should be allowed as an option in case the assessee has no alternate income sources
Aggregation of costs
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Bidding entity5
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Approach
The choice of the bidding entity has the following relevant aspects:
One entity for each bid or multiple
Indian incorporated entity or overseas entity
Non-E&P businesses
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Bidding entity
As per the Model PSC, all exploration expenses are allowed to be aggregated till year of commencement of commercial production (ie ring fencing around the entity)
Ring fencing can be broken since unsuccessful exploration costs one block should be allowed as a deduction against income of another block
Hence, multiple PSC’s in one entity will allow flexibility of set-off of exploration costs in one block against income of another block
This restricts the flexibility of exit
One entity per bid
Indian company is taxed at the rate of 33.66%. In addition profit distribution attracts DDT of 14.025% (effective rate of 41.82%
Foreign company is liable to tax at the rate of 41.82%
In tax holiday period, corporate tax will not apply but DDT and MAT will continue to apply
Indian vs overseas entity
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Bidding entity (cont.)
Foreign company can repatriate tax free profits in tax holiday period (MAT of 8.415% continues)
Repatriation of profits by Indian entity requires prescribed transfer to reserves
Overseas entity also enables shelter of earning from exchange rate fluctuations since proceeds of profit oil can be remitted directly into an overseas bank account
Indian vs overseas entity (cont.)
E&P businesses will be taxed on a stand alone basis even if other businesses are housed in the same entity
Other businesses in the same entity may allow faster recoupment of exploration costs in case the bidder is able to negotiate the amendment in the PSC (permitting set-off of exploration costs against other businesses)
Restricted ability to exit
Other businesses
Details
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Glossary
DDT Dividend distribution tax
E&P Exploration and production
FBT Fringe Benefits Tax
MAT Minimum alternate tax
NELP New Exploration Licensing Policy
NPV Net present value
PSC Production sharing contract
SRFS Site Restoration Fund Scheme, 1999
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Appendices
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Income tax
Under the Act, assessees acting in consortium are typically treated as an Association of Persons (AOP)
Taxation as AOP may lead to many adverse tax outcomes for consortium members
Section 293A carves an exception to consortiums engaged in E&P and provides that each member will be taxed as an independent assessee
Section 293A
Provides following specific aspects on which PSC’s can make provisions which will override the provisions of the Act:
Infructuous or abortive expenditure
Drilling and exploration expenditure
Depletion of mineral oils
Section 42(1)
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Income tax (cont.)
Provides special provisions for taxation of farm-outs
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
Section 42(2)
Tax holiday for production or refining of mineral oils
Tax holiday for a period of 7 years from commencement of commercial production
Section 80 IB
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Income tax (cont.)
Deductions at the rate of 100% per annum shall be allowed for all expenditures, both capital and revenue expenditures, incurred in respect of exploration and drilling operations
The expenditure incurred in respect of development operations and production operations will be allowable as per the provisions of the Act
All allowable expenditure is required to be aggregated and allowed as a deduction in year in which commercial production commences; alternately, the same can be amortised over 10 tax years
Unsuccessful exploration costs of other contract areas allowed as a deduction against contract areas where commercial production has commenced
Article 17
Contributions is a specified bank account with the State Bank of India towards site restoration costs eligible for 100% tax deduction
Deductions to be in Indian rupees
Section 33ABA
Back
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Transfer to reserve
Back
Under the Companies Act, 1956, declaration of dividend requires a prescribed transfer to reserve at the following rates:
Rate of dividend Rate of transfer to reserve
Upto 10% Nil
10 – 12.5% 2.5%
12.5 – 15% 5%
15 – 20 % 7.5%
More than 20% 10%