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Monday, Nov 17, 2003

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Tax benefits: It's win-win for Gujarat, Reliance

Balaji C. Mouli

The prescription involved a three-way split of the CST. One-third of CST was to be absorbed by Reliance, another third as `surcharge' levied on petro-products sold in Gujarat, and another through a hike in retail prices in the rest of the country.

New Delhi , Nov. 16

THE amount in question is around Rs 500 crore. Indian Oil Corporation and other public sector oil marketing companies are set to get this sum from the Union Government in fiscal 2003-04.

This is on top of a similar sum in the previous year as reimbursement of Central Sales Tax (CST) dues on petroleum products sourced from Reliance Industries' refinery at Jamnagar, Gujarat. It is labelled in the budget papers as `Compensation to refineries on account of irrevocable State taxes.'

This means that the taxpayers across the country and not the consumers of Reliance's petro-products are going to fill the coffers of the Gujarat State for a levy imposed by the latter. Also, this provides Reliance interest-free funds for 15 years since its 31-million tonne refinery, like any new refinery in a State, gets tax benefits from the Gujarat Government.

Refineries, generally, are paid `import parity' price by the marketing companies, which is the sum of the landed cost of the product plus customs duty. In case the product is moved to another State and then sold, CST is attracted provided the marketing and refining companies are separate entities. In case of a single entity, it amounts to a depot transfer and hence no CST levy.

In the past, between 1967 and 1999, CST levy in the petroleum sector by a State was paid for by consumers in the State through imposition of a `surcharge' by the oil marketing companies on products sold in the State.

To make good the CST, the refinery could also forego its margins and take a hit on the import parity price, in order to bill the CST to the marketing company. Alternatively, it could take a waiver in its contract with the State as envisaged in the State industrial policy, which allows for waiver or deferment of CST for a specified period of time.

The deviation regarding CST in the case of Reliance was made way back in 1999 when the refinery came up. Reliance has no retail outlets and each and every inter-State transaction encounters CST levy.

The adoption of the three-decade-old principle would have meant that the prices of petroleum products in Gujarat would have risen by at least Rs 3 to Rs 4 per litre.

To avoid this unpalatable price rise, what were the options before the State, the oil marketing companies and Reliance itself?

Reliance had written to the Petroleum Ministry that it wanted deferment of the CST on all products sold to the public sector oil companies. Reliance preferred the deferment option to the waiver option in the State industrial policy since it would mean that the entire CST amount would be available for it as interest-free funds for up to 15 years. In case it opted for the waiver option, there was no question of billing the marketing company and, in turn, keeping the interest-free funds for up to 15 years.

The deferment option made sense provided the refinery major was remunerated import parity price plus CST on the products. The contracted sale price to the public sector oil companies was the `import parity' price at the port locations for the contract period 2002-04 (prior to which consumers across the country paid for the freight). Hence, in this case, historical practise would have meant levy of a surcharge in Gujarat to make good the CST.

Given the magnitude of the surcharge, the Centre stepped in to help avert a potential crisis owing to the steep price rise in mass consumption oil products. Through a Cabinet decision in 2000, it came up with a `one-third' formula. The prescription involved a three-way split of the CST. One-third of CST was to be absorbed by Reliance, another third as `surcharge' levied on petro-products sold in Gujarat, and another third through a hike in retail prices in the rest of the country. In other words, the oil companies were liable to pay two-thirds of the CST bill to Reliance.

So, with the Centre's one-third absorption decision on hand, what did Reliance opt for in its contract with Gujarat?

Since it was getting only two-thirds amount from the oil companies, Reliance opted for a part deferment (two-thirds) and part waiver (one-third) in regard to CST payment to the State Government, corresponding to payments it received from the oil companies.

The State oil marketing companies - Indian Oil Corporation, Hindustan Petroleum Corporation Ltd and Bharat Petroleum Corporation Ltd - had locked into a purchase agreement for around 13 million tonnes annually from the refinery's inception in 1999 since Reliance did not have a retail network of its own. Nor was it allowed to set up retail outlets in 1999. The gates were thrown open in 2002 and the contract valid till 2004, presumably to give Reliance time to set up its own retail outlets.

Meanwhile, the Cabinet's `one-third' decision to undertake price hikes in Gujarat as well in other States was not implemented by the oil companies in toto. Hence, the `surcharge' raised from across the country was not good enough to compensate Reliance and, in turn, the State.

How did the oil companies handle the deficit amount?

Prior to April 1, 2002, when the Administered Pricing Mechanism operated, this deficit was reflected as under-recoveries on sale of petrol, diesel, LPG and kerosene across the country in the Oil Pool Account. The OPA was a mechanism adopted by the Centre to manage the subsidies on sale of LPG and kerosene through over-pricing petrol and diesel.

With the dismantling of APM, unbundling of accounts took place. The deficit on Reliance's CST claim was to the tune of Rs 500 crore, which was compensated through budgetary allocation by the Centre under the head "Irrevocable Taxes" in 2002-03.

In effect, the Centre's scheme gave Reliance the ability to sell 13 million tonnes of products at import parity price plus CST in a manner that other States pay for the CST gains for Gujarat and also provide the company additional working capital.

In addition, in the APM period, the consumers across the country paid for a portion of CST accruing to Gujarat. In the post-APM period, it was the taxpayer who was paying the same.

So, how much did the State of Gujarat and, in turn, Reliance gain? Rough estimates indicate that it could be up to a Rs 1,600-crore gain for Gujarat and an equal amount as interest-free funds for Reliance for up to 15 years.

Had there been complete deregulation in the petro-retailing business then Reliance would have been allowed to retail petro-products from the beginning. A reasonable simulation of this scenario should throw up the appropriate CST amount that should have been billed.

Currently, a look at the data on sale of petro-products indicates that retail sale constitutes around 85 per cent and bulk sale the remaining 15 per cent (2002-03 data). Bulk (direct) sales attract CST, while retail sales do not for the following reason. In a retail transaction, transfer of products across the State is on an inter-depot basis, which does not attract CST. From the depot, the product finds its way to the retail outlet, hence attracting only local sales tax in the State where the sale is transacted.

In other words, if Reliance sold in the retail segment of a neighbouring State, whilst paying CST, it would be non-competitive since competing oil companies would not pay any CST. Hence, Reliance would have been able to collect CST only on 15 per cent of the inter-State transactions and not 67 per cent (two-thirds billing on the oil marketing companies) that has been claimed since 1999.

However, attaining even this level of non-retail sale by Reliance can be questioned for a variety of reasons. A good chunk of consumers include the private sector-shy Defence and Railways. Further, it is assumed that Reliance would have immediately established itself across the country. Also, other oil marketing companies would have given away their non-retail sale willingly to Reliance and the private sector refinery major would not offer any discounts to get new non-retail consumers.

Had Reliance crossed these barriers, it would have managed to collect a mere Rs 400 crore over the last four years instead of around Rs 2,000 crore that it has from the Budget. Importantly, had the Government not made a Budgetary allocation to pay Rs 500 crore per annum, IOC or any of the other oil marketing companies would not have been obligated to pay the amount and Reliance would have had to absorb the entire CST to sell the product to the oil marketing companies. Or, it would have had to amend the tax agreement with the State of Gujarat and go in for a complete CST waiver.

But for now it's a win-win situation for both Gujarat and Reliance. While Gujarat gets double advantage of tax benefits and political mileage paid for by other States, Reliance can boast of an assured capacity utilisation of its refinery. All this at the cost of the national taxpayer!

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