Budget impact on oil and gas sector: EY

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Although, the Finance Minister recognised the importance of oil and gas sector in his speech, but the incentives provided to the sector do not appear to be in line with the expectations. On the policy front, the announcements made in the budget speech with respect to setting up gas transportation network is a positive step as it attempts to provide a road map for creation of necessary infrastructure for transportation of gas all over the country. On the issue of deregulation of auto fuel prices, the Finance Minister has disappointed the Industry by proposing yet again a new expert group, to advice on a viable and sustainable system for pricing of petroleum products.

On the direct tax side, the Budget has proposed a tax holiday of 7 years on production of natural gas from the blocks proposed to be licensed under the NELP - VIII round, however, the provisions are silent in respect of tax holiday for natural gas production from pre-NELP as well as NELP I to NELP VII blocks. Further, the tax holiday provisions are also silent on production of gas from Coal Bed Methane (CBM) blocks. The uncertainty with respect to tax holiday on commercial production of natural gas had surfaced during the last budget where it was suggested that the definition of mineral oil for the purpose of tax holiday does not cover natural gas. In view of raising concerns from the industry, the tax holiday has been re-introduced to help attract investment in the upcoming NELP VIII rounds, but has left the existing players in a dilemma.

The existing provisions provide a tax holiday of seven years to an 'undertaking' engaged in production of mineral oil. The Budget proposes an explanation to clarify the meaning of the term 'undertaking'.  As per the proposed explanation, all blocks licensed under a single contract, awarded under the NELP or any other law in force, would be treated as a single undertaking. The term 'undertaking' had not been specifically defined in the domestic law and based on judicial precedents on interpretation of the term 'undertaking', a part of an area in a block could have been considered as an 'undertaking'. The Budget proposes a restricted definition of term 'undertaking', thereby limiting the tax holiday benefit to the initial 7 years of production in the entire block. This amendment is proposed retrospectively from April 1, 1999.

For the midstream sector, the existing tax holiday is proposed to be replaced with an investment linked tax incentive scheme, which may not be as beneficial. The Budget proposes withdrawal of tax holiday granted to undertakings engaged in the business of laying and operating cross-country natural gas distribution network including pipelines and storage facilities being an integral part of such a network. This tax holiday incentive was available for a period of 10 years with a flexibility to claim the tax holiday in a block of 15 years.  As per the proposed amendment, the companies engaged in the business of laying and operating cross country pipelines for natural gas or crude or petroleum oil pipeline network would be allowed to claim entire capital expenditure other than expenditure incurred on land, goodwill or financial instruments, incurred for this specified business as a deduction in the year in which such expenditure is incurred. Any loss arising from such claim is proposed to be carried forward indefinitely but it can be set off only against income from specified business.

The tax holiday on refining activities, which was partially withdrawn in the last year's budget is also proposed to be restored for all refineries which commence operation till March 31, 2012.

As regards indirect taxes, the scope of service tax has been widened to include all offshore activities within 200 nautical miles from India baseline which will increase the impact of service tax cost on the upstream players.

In summary, the Budget 2009 does not appear to be all positive for the oil & gas industry.

Raju Kumar is a senior tax professional with Ernst & Young, India.