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Corporate Indirect InternationalM&A Transfer Pricing New Exploration Licensing Policy – V Fiscal aspects Gokul Chaudhri May 9, 2005
BMR & Associates 2 © 2005 BMR & Associates NELP V 1
BMR & Associates 3 © 2005 BMR & Associates Euphoric finds… The significant hydrocarbon finds in the previous few years has set the backdrop for this fifth round of NELP…
BMR & Associates 4 © 2005 BMR & Associates 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
BMR & Associates 5 © 2005 BMR & Associates Fiscal aspects in NELP V 2
BMR & Associates 6 © 2005 BMR & Associates 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
BMR & Associates 7 © 2005 BMR & Associates Purpose of presentation 3
BMR & Associates 8 © 2005 BMR & Associates 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
BMR & Associates 9 © 2005 BMR & Associates Fiscal Scenario 4
BMR & Associates 10 © 2005 BMR & Associates 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
BMR & Associates 11 © 2005 BMR & Associates Income tax 4.1
BMR & Associates 12 © 2005 BMR & Associates 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
BMR & Associates 13 © 2005 BMR & Associates 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
BMR & Associates 14 © 2005 BMR & Associates 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
BMR & Associates 15 © 2005 BMR & Associates 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
BMR & Associates 16 © 2005 BMR & Associates 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
BMR & Associates 17 © 2005 BMR & Associates 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.)
BMR & Associates 18 © 2005 BMR & Associates 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
BMR & Associates 19 © 2005 BMR & Associates Indirect taxes (circulated separately) 4.2
BMR & Associates 20 © 2005 BMR & Associates PSC negotiation 5
BMR & Associates 21 © 2005 BMR & Associates 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
BMR & Associates 22 © 2005 BMR & Associates 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
BMR & Associates 23 © 2005 BMR & Associates Bidding entity 5
BMR & Associates 24 © 2005 BMR & Associates 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
BMR & Associates 25 © 2005 BMR & Associates 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
BMR & Associates 26 © 2005 BMR & Associates 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
BMR & Associates 27 © 2005 BMR & Associates Glossary DDTDividend distribution tax E&PExploration and production FBTFringe Benefits Tax MAT Minimum alternate tax NELPNew Exploration Licensing Policy NPVNet present value PSCProduction sharing contract SRFSSite Restoration Fund Scheme, 1999
BMR & Associates 28 © 2005 BMR & Associates Appendices
BMR & Associates 29 © 2005 BMR & Associates 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)
BMR & Associates 30 © 2005 BMR & Associates 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
BMR & Associates 31 © 2005 BMR & Associates 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
BMR & Associates 32 © 2005 BMR & Associates Transfer to reserve Back Under the Companies Act, 1956, declaration of dividend requires a prescribed transfer to reserve at the following rates: Rate of dividendRate 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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