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Energy firms must pay service tax on royalties paid to govt
May, 04th 2016

For India’s oil and gas companies struggling with a near-halving of prices in the last one year, a fresh levy awaits in the new financial year.

Energy explorers such as Oil and Natural Gas Corp. Ltd, Reliance Industries Ltd and Cairn India Ltd must cough up service tax on the royalties they pay the government with effect from 1 April, under a recent finance ministry decision. According to the Central Board of Excise and Customs (CBEC), when the government grants licence to a company to exploit a natural resource, it is a taxable service, and hence liable for service tax.
Usually, service tax is paid by the entity that provides the service, but in certain cases such as this, it is the liability of the party that receives the service to remit the levy under a system called reverse charge.

The CBEC issued a circular on 13 April, primarily relating to service tax liability on use of wireless spectrum, which is considered a natural resource. The note clarified that all periodic payments such as royalty on use of natural resources attract a service tax. According to a finance ministry official, who asked not to be named, the same logic applies to royalty payments on oil and gas fields as well.

Company executives Mint spoke to said, on condition of anonymity, that they are working on a representation to the government seeking relief.

Oil and gas producers now pay 10% of the price realized as royalty on the sale of hydrocarbons to the central government if the field is offshore and 5% to the respective state government if it is onshore. The latest finance ministry decision means the company will have to pay a 14.5% service tax on the royalty amount as well. The effective service tax rate could go up to 15% when the proposed Krishi Kalyan cess kicks in on 1 June.

In 2014-15, ONGC, India’s largest oil producer, paid `11,607 crore as royalty to the government. Figures for FY2016 are not available. Cairn India, which accounts for about 27% of India’s oil output, paid `1,532 crore net royalty to the exchequer in 2015-16 as per results announced on 22 April. Reliance Industries did not give details of its royalty payments separately in its 2015-16 results.

“Producers of polluting fuels should willingly pay service tax on the applicable royalty. Energy companies should not be guided solely by their own bottom lines; they should be concerned about the society’s bottom line as well,” said the ministry official quoted above.

The CBEC circular on levy of service tax on services provided by the government to businesses says that one-time payments for natural resources are exempt, but not any periodic payments. Oil companies pay royalty on a monthly basis.

Two industry executives, who did not wish to be named, said they were worried that field officers of the service tax department may interpret this new provision of taxing periodic payments to demand tax on some other payments that they make at various stages in their business.

For example, oil and gas companies pay what is called dead rent on fields that are yet to commence production and then a regular share of profit from the sale of hydrocarbons once production commences, which is called profit petroleum. Profit petroleum is paid on a quarterly basis. The central government received `10,756 crore from offshore fields as royalty and profit petroleum in 2015-16, as per budget documents. In 2015-16, Cairn India paid a net profit petroleum of `2,364 crore.

What rankles energy companies more is that unlike telecom service providers, who are also covered by the new rule, they cannot claim any tax credit on the service tax paid. Telecom companies can use the credits earned on the tax paid on spectrum user charges to meet the tax liability on the final services given to phone users under a system of input tax credit. Since there is no excise duty on the crude oil produced, service tax credits on various payments become a cost. This hurts producers because crude oil produced in India is sold at the prevailing international prices, not at a cost-plus formula. (Under Cenvat credit rules, service tax credits can be used for paying excise duty liability and vice versa. There is only a 20% cess and a `50 per tonne national calamity contingency duty on crude production, which cannot be paid using tax credits.)

Wherever tax credits are accumulated because the output of an industry is exempt from service tax or excise duty, the government’s natural response is to offer to make the output also taxable so that there are fewer distortions in the system. This means crude oil production could face excise duty. The finance ministry is likely to make this proposition when companies make their representation.

“Imposition of non-creditable service tax on government services for oil and gas upstream companies is going to increase the cascading impact of taxation, thereby leading to higher cost of fuel for all industries and to the common man,” said Hemal Zobalia, partner, Deloitte Haskin & Sells.

“Royalty paid to the government assumes in part the character of a tax and hence should not be subject to tax again as that would amount to tax on tax. The government should appropriately clarify this point to avoid any disputes,” said R. Muralidharan, senior director, Deloitte in India.

Zobalia said various customs and excise duty exemptions were given in the past to oil and gas producers so that they are not burdened with taxes. “It is better to provide full exemption to oil and gas sector from this new (service tax) proposition. In cases where government does not want to carve out oil and gas sector from the impact of this amendment, clarity on service tax applicability is warranted on each payment made by upstream companies to government such as dead rent, royalty, profit petroleum etc.,” Zobalia said.

Oil and gas producers had a bad year in 2015-16 due to a 46% decline in global oil prices with companies realizing roughly $40 per barrel on an average.

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