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The oil and gas sector has witnessed several reforms over the past few years such as Open Acreage Licensing Policy, Hydrocarbon Exploration Licensing Policy, change in under recovery sharing mechanism, dynamic pricing of products. Nevertheless, there are several impediments to boosting the oil and gas production, operational efficiency and competitiveness of the sector, removal and resolution of which have been the recurring demand of the industry incumbents.
In the upstream sector, one of the prominent demands of the industry has been the exemption of exploration activity from the levy of GST as this is a non-revenue generating activity. Moreover, the main products of the exploration & production (E&P) sector viz crude oil and natural gas are outside the purview of GST, making the process of getting input tax credit difficult. However, given the shortfall in GST collections, the government of India (GoI) is not expected to provide these concessions.
Additionally, the upstream sector has been demanding rationalization of cess, which currently stands at an ad-valorem rate of 20 percent and sweeps away a substantial part of the upside at higher crude oil prices, thereby, disincentivizing exploration and production. However, given the falling oil and gas production, as well as, moderate energy prices, the likelihood of this demand being met seems remote.
The industry has been demanding that the government consider reducing the minimum alternate tax (MAT) rate for exploration and production operations, which at about 20 percent of book profits is a significant deterrent for investment. The government of India should also clarify the eligibility to avail tax holiday under Section 80-IB of the Act and that the definition of 'mineral oil' that would include natural gas retrospectively, which has been a long-running demand of the industry.
Additionally, in order to rationalize the tax structure, the industry has been demanding that petroleum products viz. crude oil, natural gas, aviation turbine fuel (ATF), motor spirit (MS) and high speed diesel (HSD) be brought under GST to enable a free flow of credits and avoid stranded taxes. However, this reform would need strong political will and building consensus among the states and Centre and it would not be possible with general elections just around the corner.
In order to promote the use of natural gas as fuel, Liquified Natural Gas (LNG) imports should be exempt from customs duty as crude attracts nil duty whereas LNG attracts 2.5 percent duty. Similarly, to encourage more natural gas consumption, the levy of GST on transmission charges should be exempted.
The Finance Act, 2016, has inserted a sunset clause in section 80-IB(9) of the Act to provide that no deduction shall be allowable to an undertaking that begins commercial production of mineral oil after April 1, 2017. As discoveries in blocks take a long time, the withdrawal of deduction for the assessees commencing commercial production after April 1, 2017 will put investors of the blocks to a disadvantage. Accordingly, the industry has been demanding that the sunset clause should relate to the acquisition of new blocks after April 1, 2017, and not those commencing commercial production on the said date.
The benefit of deduction under section 35AD may also be extended to city gas distribution entities to encourage higher investment in city gas distribution business. Currently, a deduction under section 35AD of the Act in respect of capital expenditure is allowed for laying and operating a cross country natural gas or crude or petroleum oil pipeline network for distribution.
To promote gas as a fuel, removing hurdles of infrastructure and levies is necessary. Setting up of a gas trading hub should be prioritised. However, with strong resistance, divergent views of several industry incumbents and several conditions precedent, implementation of the same seems remote.
ICRA expects the subsidy requirements for under recoveries to remain high considering moderately high crude oil prices, increasingly active management of production by OPEC and others, high dependence on crude imports and depreciation of rupee vis-a-vis the dollar.
Nonetheless, actual subsidy allocation could fall short of requirements as the pressure on fiscal is apparent. Also, with the pressure on government finances, the target for revenues from disinvestment is expected to remain high which may lead to sale/consolidation of oil sector PSU, large dividend payouts, and share buy backs.