Oil exploration, production firms’ farm-in expenses are intangible assets, says CBDT

The Central Board of Direct Taxes (CBDT) has clarified that ‘farm in’ expenditure incurred by oil exploration and production (E&P) companies would be treated as an ‘intangible asset’ and would be eligible for claim of depreciation.

A ‘farm in’ expenditure is incurred when an entity in the oil and gas business acquires a participating interest (PI) from another entity in oil/gas block (s) and becomes part of the production sharing agreement (PSC) entered into with the Central government.

Over the life cycle of an oil and gas block, E&P companies generally buy (farm in) and sell (farm out) their PI in the PSC.

The CBDT’s clarificatory circular has come in response to clarification requests on whether ‘farm in’ expenditure — being in nature of rights — should be allowed to be treated an ‘intangible asset’ under Section 32 (1)(i) of the income tax law.

While taxability of ‘farm out’ is clearly laid, no specific provision had been made regarding treatment of farm in payment which gives to conflict between E&P entities and the Tax Department.

Section 42 (2) of the income tax law provides that in the event of a ‘farm out’, the unamortised expenditure is allowed as a deduction and the surplus is taxed in the hands of the seller while in the hands of the buyer no specific provision has been made in the Income Tax Act.

The CBDT has also acknowledged that it is common international practice for the upstream companies to buy (farm-in) and sale (farm-out) their PI in the PSC [Production Sharing Contracts] or similar contracts with the Government and thereby to share risk, bring new and niche expertise and technologies. In such transactions, PI are treated as interests in rights, licences and obligation under the PSC.

Expert’s take

Neeraj Agarwala, Partner, Nangia Advisors (Andersen Global), said the government has been focusing on ease of doing business in India. They have taken a number of steps to bring down litigation and bring clarify and certainty to the tax regime in India. This circular is one such step, he said.

“This circular will definitely bring cheer to the oil and gas industry and hopefully India will see an increase in domestic and foreign investment and enhance domestic production of oil and gas for the growing economy and population of India,” Agarwala said.

COMMENT NOW