Budget 2017: Should take the right steps to rejuvenate energy sector

BMR AdvisorsEnergy demand in India has been continually growing on the back of stable GDP growth and increased disposable income. For India, a country primarily dependent on fuel imports (~70 to 75 percent) for meeting its energy demand, ensuring energy security is of utmost importance. The significance of energy security objective is enhanced particularly in wake of the tumultuous price fluctuation of primary fuel, i.e. crude oil. The Government has set a target to reduce import dependence by 10 percent by fiscal 2022 and is making a concerted effort with increased focus on boosting domestic output, promoting use of alternate energy sources, and enhancing the refining capacity and quality.2016 was a busy year of policy overhaul for the energy sector. The government introduced policy reforms, with the new Hydrocarbon Exploration and Licensing Policy (‘HELP’) replacing the earlier NELP regime. HELP ushers in a uniform licensing framework to permit exploration of conventional as well as non-conventional hydrocarbons; demand based bidding under an Open Acreage Licensing Policy (‘OALP’) instead of extant cyclical bidding rounds; shift from an archaic cost recovery model to a more progressive revenue sharing model with minimal micro-management by the Government; and grant of pricing and marketing freedom. The government also commissioned the largest public sector refinery in Odisha in 2016.While auction of oil and gas blocks under the new HELP regime is yet to take place, auction of 43 discovered small fields as a pilot for the new revenue sharing model (concluded in November 2016) elicited mixed response from the industry. As crude prices reach a competitive range between USD 55 to USD 60, the exploration in India could witness interest from domestic and international players. Certain developments were witnessed in the power sector too, with steps being taken for advancement of the various government initiatives towards the aim of ‘24x7 power for all’. The daunting commissioning target of 175 GW of installed capacity of renewable energy by 2022, however, received a temporary setback as the developers grappled with financing concerns and nosediving tariffs. It is in this backdrop that energy sector is looking upto Union Budget 2017 as the springboard to achieve sustained growth trends, as well as with hope to redeem certain legacy tax and regulatory issues.Key expectationsDirect taxOil & Gas• In view of the plan to phase out / rationalise tax holiday provisions and lower the headline corporate tax rate to 25 percent, the Government should consider granting accelerated write-off to Exploration and Production (‘E&P’) businesses in respect of development and production expenditure. Either of the following mechanisms may be considered: Investment allowance under section 35AD of the Income-tax Act, 1961 (‘ITA’), similar to that extended for infrastructure projects (vide Finance Act, 2016); or 100 percent deduction of development and production costs under section 42 of the ITA. • Consider exempting / rationalizing levy of MAT for E&P activities; the present MAT rate of ~20 percent on ‘book profits’ acts as a deterrent in the overall investment decision-making for high-risk and capital intensive upstream operations.• With respect to the extant tax holiday provisions under section 80-IB(9) of the ITA available to entities engaged in E&P activities, the government should consider the following: Rationalisation of sunset clause for tax holiday: Phasing out of the deduction should be with respect to Production Sharing Contracts (‘PSCs’) entered into on or after April 1, 2017, and not undertakings commencing commercial production after such date, such that PSC bid on the basis of tax holiday be grandfathered. Extend tax holiday period from 7 years to 15 years or for a period of any 10 consecutive years out of block of 15 years from commencement of commercial production. Clarify the meaning of the term ‘mineral oil’ to include natural gas (irrespective of the NELP rounds), eligible for tax holiday, in line with the Gujarat High Court in the case of Niko Resources Ltd vs Union of India¹ and assurance held out by the Finance Minister in the Parliament. Clarify that each oil well / cluster of oil wells would be considered as an ‘undertaking’ for the purpose of tax holiday, and not the contract area under the PSC. The Gujarat High Court in the case of Niko Resources Ltd (supra) has read down the retrospective amendment by way of insertion of Explanation to section 80-IB(9) of the ITA with respect to all blocks licensed under a single contract, being treated as a single undertaking.• Amend section 42(1) of the ITA to provide for deduction of infructuous or abortive expenditure in the year of incurrence of expenditure without any condition of surrender as the existing requirement of surrendering the area sometimes induces the exploration company to surrender the area without fully exploring it.• Remove the existing ceiling (of 20 percent contractors’ profits) on deduction of contribution to site restoration fund. Also, permit businesses to maintain the fund in freely convertible foreign currency.• Clarify that offshore platforms used for various oil exploration / extraction activities and other incidental activities such as providing accommodation should be classified as ‘plant and machinery’ for the purpose of claiming depreciation under the ITA.Power & Renewables• Roll out of geography-based tax incentives for renewable energy sources (solar parks, wind energy farms etc.) similar to those for Special Economic Zones (‘SEZs’).• Extend investment linked deduction under section 35AD of the ITA for undertakings engaged in generation and / or distribution and transmission of power (including renewable energy), similar to infrastructure projects (granted vide Finance Act, 2016).• Extend / clarify that reduced corporate tax rate (of 25 percent) under section 115BA of the ITA is applicable to businesses engaged in generation and / or distribution and transmission of power.• Consider exempting / rationalizing levy of MAT for power generation business. The present MAT rate of ~20 percent on ‘book profits’ materially neutralizes the economic benefit of accelerated tax depreciation available to power business, especially in renewable sector. Also, with the proposed reduction in corporate tax rate to 25 percent, the rationale for levy of MAT needs to be reconsidered.• Introduce weighted deduction in respect of expenditure incurred on energy efficient and carbon emission reduction technologies, considering that such technologies are expensive. Further, clarify that sale of carbon credits earned on account of such technology are capital receipts, not liable to tax in India. Indirect tax Oil & Gas• Reduction in customs duty payable on import of capital goods for setting up new refineries may be considered to incentivise further refinery setups in the country.• Reduction in customs duty (presently 5 percent) on goods imported for liquid and natural gas pipelines notified as project imports under Chapter 98 of Customs Tariff Act. • Import duty on LNG (presently 5.15 percent) should be reduced to promote use of LNG, a much better and cleaner fuel over other alternatives, such as, crude oil. Alternatively, existing exemptions which are restricted to few sectors (such as, Power) may be extended to other sectors as well. • Taxation of services provided by the Government to business entities under reverse charge has led to ambiguity around taxability of royalty and profits payable by the oil companies to the government in terms of PSCs. Considering high exposure of 15 percent service tax, an exemption or suitable clarification for non-taxability of such payments should be brought in.• 20 percent ad valorem rate of Oil Industry Development (‘OID’) cess may be a major area to optimize the tax structure for petroleum sector by reducing the cess rate.Power & Renewables• In line with sops available to Solar sector, Wind Energy sector needs a big push by extending excise duty and custom duty exemptions to various equipment used for building and operating wind turbines.• Service tax payable on various procurements by power sector becomes a cost owing to absence of output service tax liability for this sector. Exemption for services provided to Power sector may be considered to improve their efficiency.• Solar parks may be considered to enjoy same status as that of SEZs.While the tax woes of non-resident oilfield service providers pertaining to applicability of section 44BB of the ITA have been largely addressed by the Supreme Court ruling² and a fair degree of acceptance thereof by the revenue, various other legacy tax issues remain to be resolved, which have continually led to expensive and protracted litigations. This has been a major irritant for investors, and in certain way, has taken the sheen off government’s initiative to encourage FDI flows into this strategic sector. The country is on the verge of transitioning into GST regime which will subsume most of existing indirect taxes within its ambit. While the timelines are still uncertain, it must be ensured that the present tax sops for energy sector are maintained by incorporating necessary grandfathering provisions under the new regime as this sector continues to be the backbone of the Indian economy. It is imperative that Union Budget 2017 recalibrates some of Government’s well-intentioned policy initiatives to resurrect the flagging investment momentum in the energy and power sectors.1. [2015] 374 ITR 369 (Guj)2. ONGC Ltd vs CIT [2015] 233 Taxman 495 (SC)