It’s an accepted fact that efficient and reliable energy supplies are a precondition for the accelerated growth of the Indian economy.  As indicated in the Economy Survey 2010-2011; India’s energy needs, especially oil and gas, are going to increase at a rapid rate in the coming decades.  Oil and gas constitute around 45 percent of the total energy consumption. The Indian government has followed an integrated approach towards the energy sector, which is still evolving, having a great potential for a prosperous future. Profit linked tax holidays, concessions, presumptive taxation mechanisms, and the recently introduced investment linked incentive, have provided a boost to the sector.

The Direct Tax Code, 2010 (DTC) unveiled by the Finance Minister last year was proposed to replace the extant Indian Income tax Act, 1961, (Act) with effect from April 1, 2012.  The DTC seeks to consolidate and amend the direct tax laws so as to establish an economically efficient, effective, and equitable direct tax system which will facilitate voluntary compliance and help increase the tax GDP ratio. The key motive here is to provide a lucid, flexible, consolidated approach, with the elimination of regulatory functions and the minimizing of litigations and ambiguities. 

While the DTC seeks to rationalize the tax rates, it also introduces new concepts, or provisions for taxation in line with the international best practices, inter alia, anti-avoidance provisions via the introduction of GAAR (General Anti-Avoidance Rule); controlled foreign corporation norms; an EEE scheme of taxation; branch profits tax; and Advance Pricing Agreements.  

The purpose of this article is to articulate the key terms under the proposed DTC and their impacts on the Indian energy sector. 

The DTC proposes to overhaul the existing scheme of profit linked incentives and replace it with investment linked incentives. With regard to the grandfathering of the extant tax holiday available under the Act, DTC proposes to continue with the tax holidays available under the Act.

With this proposed incentivisation, a major hurdle that would crop up in reducing the likely benefits would be the continuation of the Minimum Alternate Tax (MAT) levy on book profits; though MAT credit is permitted to be carried forward for fifteen years (15 years) under the DTC. 

In relation to the specific provisions pertaining to the energy sector per se, the DTC seeks to revamp the existing scheme of taxation as enumerated below.   

Tax Holidays

At the outset, definitions have been proposed under the DTC to disambiguate the existing meaning of the relevant terms for the oil and gas sector.  Unlike the provisions of the extant Act, where “mineral oil” was defined to include petroleum and natural gas, both the words are defined separately under the proposed DTC.  This would have a two way impact: firstly, the separate definitions of ‘mineral oil’ and ‘natural gas’ are sure to give some relief to the litigation surrounding the definitions, and, secondly, it would widen the of scope of business for natural gas for the purpose of tax holidays. 

However, the impediment to the definitions so provided would be the exclusion of the business of “refining of mineral oil” from the definition of ‘business of mineral oil or natural gas’;  thus, in effect, making it ineligible for an investment linked tax holiday vis-à-vis the profit linked tax holiday available under the Act. 

The hitherto available profit linked incentive / tax holiday is proposed to be replaced by the investment linked tax holiday.  In view of this, the profits chargeable to tax are required to be computed by reducing the expenditure incurred wholly and exclusively for the purpose of business from the gross income. 

Gross income is proposed to, inter alia, include income from leasing or transfer of any interest in mineral oil or natural gas rights and any asset used in the business of mineral oil or natural gas; as well as income from demolition, destruction, discarding or transferring of any business capital asset, other than land, goodwill, or financial instruments. 

Business expenditure for the purpose of deduction is proposed to, inter alia, include operating and permitting finance charges; license charges, rental fees or other charges, if actually paid; capital expenditure (excluding land, goodwill, and financial instruments); expenditure on purchase, lease or rental of land or land rights; expenditure on infructuous or abortive exploration and expenditure incurred before commencement of business (both revenue and capital expenditure without any cutoff date for incurring of the expenditure).

The tax incentive is therefore sought to be provided primarily by way of deduction of expenditure on investments, over and above the operating expenditure incurred for the business.  The impact of such a scheme was huge losses in the earlier years of operation for the eligible businesses and the period consumed in recovering such expenditure was deemed a tax holiday. 

The aforementioned computation mechanism has been provided for the business of producing mineral oil or natural gas.  Similar provisions are also available for the business of generating, transmitting, and distributing power; and the business of laying and operating a cross country natural gas or crude or petroleum oil pipeline network for distribution; including storage facilities, as they are an integral part of the network.

While the extant Act, sought to introduce similar provisions with the advent of section 35AD by the Finance (No.2) Act 2009, there are a few variations under the provisions of the DTC, inter alia, the conditions precedent for the expenditure allowable, as capital has been dispensed with; specific categories of allowable expenditure have been provided; and the pre-commencement expenditures in respect of specific categories (whether revenue or capital) are allowable as a deduction.

Presumptive taxation

Under the extant Act, Section 44BB has a non-obstante clause whereby non-resident service providers to the oil and gas industry enjoy a presumptive tax regime wherein 10% of the gross receipts are deemed to be their income and tax is levied at the rate of 42.23% on the income so determined, resulting in an effective tax rate of 4.23%.  Further, the section provides that non-resident service providers, at their option, can claim their actual taxable income to be lower than the deemed income computed as mentioned above, by furnishing duly audited accounts of the business to the tax authorities.

Under the DTC, corresponding provisions are provided in Schedule 14, in terms of which 14% of the gross receipts shall be deemed as profits chargeable to tax in India.  Further, under the DTC, there would be an additional branch profit tax of 15% that would be imposed on the ‘Permanent Establishment’ of the foreign company in India, thereby increasing the effective rate further. 

One of the significant differentiating aspects here would be that the benefit of presumptive taxation is not available under the DTC to service providers of the natural gas exploration companies; as mineral oil has been defined so as not to include natural gas, unlike the existing provisions under the Act. This will result in an undesirable reaction, since in certain cases the outcome of the operations (whether the prospecting/exploration stage would lead to a discovery of natural gas or mineral oil or both) may take several financial years, thereby leading to an uncertain situation for the service providers during the intervening period.

Further, in the DTC, the amount of income determined shall be further increased by excess of the amount of income, if any is actually earned by the assessee. Such an increase goes against the very premise of presumptive taxation, since the taxpayer would end up paying tax on actual income.

Renewable energy

On the renewable energy side, while the Government of India has revamped the regulatory framework for the renewable energy sector with the introduction of the Renewable Energy Purchase Obligation, Renewable Energy Certificates, and generation based incentive schemes for solar and wind power projects, no such incentives have been provided on the direct tax front.  While the DTC seeks to retain the accelerated depreciation for renewable energy devices, as available under the Act, no additional benefits are envisaged under the DTC for such renewable energy devices. 

To add to the despair, the DTC proposes to tax any consideration accrued or received on transfer of carbon credits.  Under the Act, taxation of income generated from carbon credits has been a grey area in the absence of any explicit provisions. 

Further, the provisions in relation to the deduction available from profits and gains derived from the business of collecting and processing or treating of bio-degradable waste for generating power or producing specified bio-degradable waste, also seems missing in the DTC. 

Though the DTC has sought to simplify the existing provisions for tax holidays and concessions for the energy sector, what merits consideration is that the incentive is now linked to a business which is defined to include any trade, commerce, profession, etc., vis-à-vis the concept of “undertaking” under the extant Act!  

Moreover, the question of whether a successor in the business reorganization of the eligible undertaking under the Act, pursuant to the business reorganization after March 31, 2012, would be regarded as a taxpayer who was eligible for the deduction under the Act as on March 31, 2012, remains unanswered.

Another area of consideration would be the absence of provisions for enabling the terms of the Production Sharing Contract (PSC) over the domestic law under the DTC, as available under the extant Act.  While the Act specifically provides for computation of deductions in accordance with the provisions of PSCs entered into between the taxpayer and the Government, under the DTC, such provisions seems to be absent.  Accordingly, the deductions under the DTC are not subject to stipulations contained in PSCs.  Moreover, the lack of guidance on the status of the members of the PSC who constitute an association of persons or a body of individuals will cause some concerns in taxation of the share of incomes of the consortium partners. 

While a lot of uncertainties still surround the DTC in various tax aspects, the same could be resolved before it is finalized by the policy makers.  The road map for a booming energy sector in respect of fiscal initiatives has been set. With the DTC in effect from April 1, 2012, a new tax framework for the energy sector would be in place. But since, in these sectors, the reforms are primarily dependant on policy announcements, the complete framework for industry is yet to be pictured.

The author is a Partner at Amarchand Mangaldas and can be contacted at aseem.chawla@amarchand.com. He is assisted by Ms. Surabhi Singhi, Associate; and Ms. Priyanka Duggal, Associate; at Amarchand Mangaldas.

(The views expressed herein are the personal views of the authors. Independent professional advice should be sought for taking any action on any issue mentioned in this article. The authors accept no legal responsibilities for any consequential incidents that may arise from the errors or omissions contained in this article.)