GENERAL INDUSTRY BACKGROUND

  • India has always been an import dependent nation in the Oil and Natural Gas (“O&NG”) sector.1
  • The Ministry of Petroleum and Natural Gas, India (“Ministry of PNG”), had predicted that by 2015–16, India’s demand for gas is set to rise to 124 Million Tonnes Per Annum (MTPA) against a domestic supply of 33 MTPA and higher imports of 47.2 MTPA, which still leaves a shortage of 44 MTPA.2
  • O&NG industry contributes over 15% to the nation’s GDP and the landscape in the O&NG sector promises to be dynamic with scope for growth of business entities and development of the sector.
  • According to Ministry of PNG, India has total reserves of 763.476 million metric tons of crude oil and 1488.73 billion cubic meters of natural gas as on April 1, 2015, but in spite of such domestic potential nearly three-fourths of the requirement of crude oil is imported from the Middle East, with the largest crude oil exporters to India being Saudi Arabia and Iraq.3

Union Govt., under the Constitution of India, 1950 (“Constitution”) has the power to legislate in respect of O&NG. Legislative powers are conferred on the Union Govt. under Entry 53, to List I of Schedule VII of the Constitution.4

From an industry perspective, O&NG industry is divided into three major sectors:

  • Upstream: Comprises activities pertaining to exploration, recovery and production of O&NG. In industry parlance it is simply called Exploration and Production (“E&P”).
  • Midstream: Processes, stores, markets and transports commodities such as crude oil, natural gas, natural gas liquids (liquefied natural gas such as ethane, propane and butane) and sulphur.
  • Downstream: Refers to the refining of crude oil and the selling and distribution of natural gas and products derived from crude oil.

IMPORTANT TRENDS IN THE INDUSTRY

  • The introduction of the Hydrocarbon Exploration and Licensing Policy (“HELP”) in 2016 in order to revamp the oil and gas sector and address various industry concerns in the The New Exploration and Licensing Policy (“NELP”) regime.
  • A shift to a revenue sharing contract model from the production sharing contract regime.
  • The introduction of the Discovered Small Fields Policy and Bidding Round, 2016, which aims to develop and commercialize production from the already discovered small fields and marks India’s moves towards a new era of hydrocarbon production.
  • The high growth trends in the Indian economy coupled with the growing middle class in India is resulting in higher spending on cars and airline tickets5 (especially the former), and as a result 2016 has seen the fastest ever growth in consumption of petrol.6 India is now underway to becoming one of the largest oil consumers globally, entering the same league as USA and China7.
  • In O&NG industry, India has since 2014 primarily allowed Foreign Direct Investment through the automatic route:

    · up to 100% in areas such as exploration of oil and natural gas fields, infrastructure & marketing related aspects of the industry, refining in the private sector, etc.; and

    · up to 49% in PSUs engaged in petroleum refining.

  • Due to drop in global oil prices, there has been a rise in high-stake cross-border disputes in the O&NG space.

MAJOR PLAYERS

The major industry players in India’s O&NG sector currently are:

  • Upstream Sector: Oil and Natural Gas Corporation, Oil India Limited, Crain Energy
  • Midstream Sector: Indian Oil Corporation, Gas Authority of India
  • Downstream Sector: Indian Oil Corporation, Bharat Petroleum Corporation Limited, Hindustan petroleum

Further, the key players globally are: Gazprom (Russia), Rosneft (Russia), Exxon Mobil (USA), PetroChina (China), British Petroleum (BP), Royal Dutch Shell (Netherlands), Chevron (UK), Petrobras (Brazil), Lukoil (Russia), Total (France).

VARIOUS LAWS APPLICABLE TO THE O&NG INDUSTRY IN INDIA

  • The Petroleum Act, 1934: The act regulates the import into India, transfers within, storage, production, refining and blending of petroleum and deals substantially with midstream activities.
  • The Oilfields (Regulation and Development) Act, 1948: The act constitutes the basic statute for licensing and leasing of petroleum and gas blocks by the Union Government, empowering the same with broad authority to make rules providing for the basic regulation of oilfields and for the development of mineral oil resources. Along with Petroleum Rules, the Oilfields Act governs grant of Production Exploration Licenses and mining leases.
  • The Petroleum and Natural Gas Rules, 1959: The rules provide a framework for grant of exploration licenses and mining leases, and together with the Petroleum Act, 1934, regulate the sale and distribution of petroleum and petroleum products.
  • The Petroleum and Natural Gas Regulatory Board Act, 2006: The act provides for the setting up of the Regulatory Board to regulate the refining, processing, storage, transportation, distribution, marketing and sale of petroleum, petroleum products and natural gas (excluding production of crude oil and natural gas).
  • The New Exploration and Licensing Policy (“NELP”): NELP was formulated by the Union Government and the Directorate General of Hydrocarbons (“DGH”) as the nodal agency in 1997-98 to provide a level playing field to both public and private sector companies in E&P of hydrocarbons, though NELP is not law by itself and is not passed in exercise of any rule-making powers. NELP promotes investments in E&P sector by facilitating allotment of exploration blocks through international competitive bidding. Although the NELP regime was successful in the early days, but NELP VIII and IX is often criticized for its failure to attract widespread participation by large international oil and gas operators and since 2009, and it has been the endeavor of the Union Govt to change the model.
  • The Hydrocarbon Exploration and Licensing Policy (“HELP”): HELP aims to enhance domestic oil and gas production by encouraging exploration in sedimentary basins, and introduces a number of measures including a uniform license regime for conventional as well as non-conventional hydrocarbons, an open acreage licensing policy, a revenue sharing model and freedom in marketing and pricing (subject to certain limits).8

TAX LAWS AFFECTING THE O&NG INDUSTRY

Corporate Income Tax

Resident companies are taxed at the rate of 34.61% (rates mentioned herein are the maximum effective rates inclusive of applicable surcharge and education cess and secondary and higher education cess) and non-resident companies are taxed at the rate of 43.26% on net taxable income. While residents are taxed on their worldwide income, non-residents are only taxed on income arising from sources in India. A company is said to be resident in India if it is incorporated in India or if its place of effective management for that year is in India. A minimum alternative tax is payable at the rate of around 21.34% (18.5% plus surcharge, education cess and secondary and higher education cess) if the Non-Resident has a Permanent Establishment in India.

Non-residents in the business of supplying plant, machinery, facilities or services in connection with prospecting or extraction of mineral oils are subject to a presumptive tax regime, wherein taxable profits are deemed to be 10% (plus surcharge and education cess) of the gross revenues.

A number of special allowances and incentives have been provided which are relevant to the oil and gas industry in India:

  • With respect to exploration and production activities, a special allowance may be claimed in relation to infructuous or abortive exploration expenses, drilling or exploration activities, and depletion of mineral oil in the mining area (subject to the terms of the agreement with the Government).
  • An allowance may be claimed with respect to capital expenditure incurred in laying and operating a cross-country natural gas, crude or petroleum oil pipeline network for distribution, including storage facilities.
  • A special allowance of up to 15% may be claimed with respect to cost of a new plant or machinery (where the cost exceeds INR 250 million) acquired and installed before March 31, 2017.
  • With effect from April 1, 2014 income earned by a foreign company from sale of crude oil to any person in India is exempt from income tax if the income is earned in Indian currency, the agreement is entered into or approved by the Central Government, the agreement and foreign company is specifically notified by the Central Government and the foreign company does not have any other activity in India. With effect from April 1, 2016, the exemption is also available on income earned by a foreign company from storage of crude oil in any facility in India and sale therefrom to any person resident in India.
  • Accelerated depreciation at the rate of 60% is available for plant (with a few exceptions) used by mineral oil concerns. New machinery or plant acquired and installed after March 31, 2005 may be subject to additional depreciation of 20%. Additional depreciation of 35% on new plant or machinery acquired and installed between April 1, 2015 and April 1, 2020 for the purpose of an undertaking set up after April 1, 2015 in a notified backward area in either of the states of Andhra Pradesh, Telangana or West Bengal.
  • A 7 year tax holiday is available for undertakings engaged in commercial production of natural gas in licensed blocks if the undertaking begins the commercial production between April 1, 2009 to March 31, 2017.
  • Business losses can be carried forward for a period of 8 years, subject to a 51% continuity of ownership test.

Dividends

Dividends distributed by Indian companies are subject to a dividend distribution tax at the rate of 20.36% payable by the company. However, no further Indian taxes are payable by the shareholders on such dividend income once dividend distribution tax (“DDT”) is paid. Having said that, a shareholder being an individual or Hindu Undivided Family (“HUF”) is taxed at 10% if the aggregate amount of dividend received in a year exceeds INR 1 million. An Indian company would also be taxed at the rate of 23.07% on gains arising to shareholders from distributions made in the course of buy-back of shares.

Capital gains

Tax on capital gains depends on the period of holding of a capital asset. Short term gains may arise if the asset is held for a period lesser than 3 years (or 1 year for listed securities and 2 years for unlisted shares). Long term gains may arise if the asset is held for a period more than 3 years (or 1 year for securities listed securities and 2 years for unlisted shares). Long term capital gains earned by a non-resident on sale of unlisted securities may be taxed at the rate of 10.81%. Long term gains on sale of listed securities on a stock exchange is exempt, and only subject to a securities transaction tax (“STT”). Short term gains earned by a non-resident on sale of listed securities (subject to STT) is taxable at the rate of 16.22%, or at ordinary corporate tax rate with respect to other securities. India also has taxes non-residents on the transfer of foreign securities the value of which are substantially (directly or indirectly) derived from assets situated in India, (for this purpose more than 50% of the value of the foreign share must be derived from assets located in India).

Withholding taxes

Tax would have to be withheld at the applicable rate on all payments made to a non-resident, which are taxable in India. The obligation to withhold tax applies to both residents and non-residents. Withholding tax obligations also arise with respect to specific payments made to residents. Failure to withhold tax could result in tax, interest and penal consequences.

Double tax avoidance treaties

India has entered into more than 80 treaties for avoidance of double taxation. A taxpayer may be taxed either under domestic law provisions or the tax treaty to the extent it is more beneficial. A non-resident claiming treaty relief would be required to file tax returns and furnish a tax residency certificate issued by the tax authority in its home country. Certain tax treaties such as the treaties with Mauritius, Singapore, and Netherlands provide significant relief against Indian withholding tax on capital gains and interest income in specific circumstances. However, recently the tax treaty with Mauritius has been amended to remove the capital gains relief on shares in Indian companies acquired after April 1, 2017. The Singapore tax treaty is also expected to be amended along similar lines. Having said that, the Mauritius tax treaty has also been amended to provide significant relief against Indian withholding tax on interest income.

Anti-avoidance

A number of specific anti-avoidance rules are enforced in India. Cross-border transactions between related parties would be viewed for tax purposes on an arm’s length basis. Transfer pricing rules apply to certain domestic transactions as well. India does not have any thin capitalization rules at the moment. However, effective from April 1, 2017 wide general anti-avoidance rules (“GAAR”) shall be implemented to tax or disregard certain ‘impermissible avoidance arrangements’ that are abusive or lack commercial substance. GAAR is likely to impact some of the conventional tax optimization structures for India. It has also been clarified that while structures in place before April 1, 2017 will be grandfathered, continuing violations may not be allowed. Hence there is some ambiguity in that respect.

Indirect Taxes

Indirect taxes are imposed at the federal and state level. This includes service tax, customs and excise duty, value added tax (“VAT”) and central sales tax. Service tax is payable by the service provider at the rate of 15% on all services except for services specified in a negative list. Services provided outside the taxable territory of India is not subject to service tax. The rate of customs, excise duty and VAT varies depending on the product. Certain petroleum products may be subject to additional duties. India is in the process of introducing a goods and services tax (“GST”) to consolidate and harmonize all indirect taxes on a value added basis. The Parliament has recently passed a constitutional amendment introducing GST, which should be ratified by at least half of the state legislatures in India. The implementation of GST will also require the cooperation of the central and state governments, which is still awaited. Once implemented, it is expected that many of the state taxes and central taxes will be subsumed into the GST tax. However, there are petroleum products are likely to be kept out of the GST regime for a while at least.

CONCLUSION

It must be noted that from an economical and financial perspective, investment in O&NG is lucrative with substantial prospects in India. Given the growing demand for crude oil in India and its wide application in household and industrial activities, it would be seen that demand for this investment is not likely to decline in India. While the Union Govt. resolves teething issues in the O&NG sector, the landscape in the O&NG sector promises to be dynamic with scope for growth for business entities and development of the sector.


1 Source: http://indiainbusiness.nic.in/newdesign/index.php?param=industryservices_landing/345/1 (Accessed on August 19, 2016)

2 Source: http://www.petroleum.nic.in/docs/pngstat.pdf (Accessed on August 19, 2016)

3 Source: http://www.petroleum.nic.in/docs/pngstat.pdf (Accessed on August 19, 2016)

4 Regulation and development of oil fields and mineral oil resources; petroleum and petroleum products; other liquids and substances declared by Parliament by law to be dangerously inflammable. (Accessed on August 19, 2016)

5 Source: http://www.ft.com/cms/s/0/bacac870-4f46-11e6-8172-e39ecd3b86fc.html#axzz4HmVvPVE3 (Accessed on August 19, 2016)

6 Source: http://auto.economictimes.indiatimes.com/news/oil-and-lubes/india-in-drivers-seat-as-fuel-demand-roars-at-fastest-rate-ever/51450783; http://www.bloomberg.com/news/articles/2016-04-13/india-s-fuel-demand-rises-to-record-on-gasoline-diesel-growth (Accessed on August 19, 2016).

7 Source: http://indiainbusiness.nic.in/newdesign/index.php?param=industryservices_landing/345/1 (Accessed on August 19, 2016).

8 Source: http://pib.nic.in/newsite/PrintRelease.aspx?relid=137638 (Accessed on August 19, 2016).

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