ET Intelligence Group: There seems to be no end to ‘taxing’ woes of upstream oil companies such as Oil and Natural Gas Corporation (ONGC), Oil India and Cairn India.

In a recent clarification, the Central Board of Excise and Customs (CBEC) stated that the companies are liable to pay 15% service tax on royalty paid to the central and state governments under the system of reverse charge for extraction of hydrocarbon since it is a periodic payment.

According to tax rules, when a service receiver pays service tax, it is called reverse charge.

This may reduce the projected earnings growth of companies by 3-6% for FY17. In addition, the implementation of Goods and Services Tax (GST) is likely to increase the service tax rate, which will increase the impact on earnings.

Taking the reference from service tax on the wireless spectrum, treated as a natural resource, CBEC has clarified that licence granted for exploration of natural resources is a taxable service and any periodic payments such as royalty is liable for service tax.

There is a separate litigation in the Supreme Court on whether royalty itself should be considered as a tax or a rent — if latter, service tax will indeed be applicable. At present, upstream companies pay royalty at 10% of the realised price of hydrocarbons. If a hydrocarbon field is onshore, the royalty is shared between state and central governments equally. For offshore fields, royalty is paid to the Centre.

ONGC paid Rs 8,959 crore of royalty (11.4% of sales at Rs 78,565 crore) in FY16. If service tax is applied on royalty, the projected earnings of ONGC may fall by 2.9% and 3.0% to Rs 21.9 and Rs 23.9 for FY17 and FY18, respectively.

Oil India’s forecasted earnings may be pared by 6.2% and 6.5% to Rs 33.6 and Rs 35.4 by similar comparison.

The stocks of have surged 8-23% in the past three months on easing regulatory overhang. However, the inclusion of service tax is expected to affect further upside. In addition, the sizable capex, lack of volume growth visibility and low return ratios, priceearnings multiples may be restricted to 10-11 in the coming quarters.