Corporate Indirect InternationalM&A Transfer Pricing New Exploration Licensing Policy – V Fiscal...

Corporate Indirect International M&A Transfer Pricing

New Exploration Licensing Policy – VFiscal aspects

Gokul ChaudhriMay 9, 2005

BMR & Associates© 2005 BMR & Associates2

NELP V1


Euphoric finds…

The significant hydrocarbon finds in the previous few years has set the backdrop for this fifth round of NELP…


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


Fiscal aspects in NELP V

2


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


Purpose of presentation

3


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


Fiscal Scenario4


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


Income tax4.1


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


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


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


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



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



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.)



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


Indirect taxes(circulated separately)

4.2


PSC negotiation5


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


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


Bidding entity5


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


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


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


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


Appendices


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)


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


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


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%

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