Tax breaks for oil discovery

With India's emergence on the global canvas, energy security has attained unprecedented importance. Empirical evidence shows a direct correlation between the development of an economy and increase in energy consumption. Hence, with economic development, per capita energy consumption in India is bound to increase.

India has traditionally relied on fossil fuel as a primary source of energy. As domestic supply of crude is limited, the country relies heavily on imports. According to a recent report by the Petroleum Planning and Analysis Cell under the Ministry of Petroleum, our oil import dependency has increased from 74 per cent in 2002-03 to 83 per cent in 2010-11. This is projected to increase beyond 90 per cent unless domestic crude production grows significantly. On the contrary, however, domestic production has mostly stagnated over the last 10 years, barring the recent discovery in Rajasthan.

Tax and other bottlenecks

High investment, inherent risks and along gestation period are the chief characteristics of the exploration business. In India, the lack of exploration technology, funding constraints and uncertainty in the fiscal regime have emerged as the major bottlenecks in the sector. In the light of the constraints and global experiences, private participation is crucial for the development of the oil sector.

Recognising the need to encourage private participation, the Government introduced the New Exploration Licensing Policy (NELP) for allotment of oil blocks, which managed to attract private interest in the initial stages. However, uncertainty in tax regime and other commercial aspects have taken the sheen from this auction process. Only 13 Production Sharing Agreements have been signed out of the 34 blocks announced under the IXth round of auction.

The steady increase in demand coupled with the magnitude of import dependency necessitates more private participation in the sector. Based on global experiences, it is clear that certainty and incentives in the fiscal regime can help attract private participation.

Financial sops for exploration

In order to incentivise the exploration industry, the Government may consider allowing 200 per cent weighted deduction for exploration expenses incurred by oil companies. This would translate into an enhanced deduction of Rs 200 for every Rs 100 incurred. As the expense claim can be made only where the exploration is successful, the outflow would be relevant only when there is successful production of oil. This regime has worked well in some of the developed economies.

As technology has been one of the key constraints in the development of the domestic sector, the Government may consider providing a weighted deduction for expenses incurred on R&D in exploration technology. Taking a cue from countries such as Canada, the US and Australia, this would not only incentivise the oil companies but also encourage development of indigenous technology.

Oil exploration services including acquisition and interpretation of geological data, drilling and so on constitute a major cost component of the exploration business. These services are currently liable for service tax at 12.36 per cent, which increases the overall cost of exploration. Learning from the Brazilian experience, the Government may consider deferring service tax collection until after commercial production from the oil block. This would improve liquidity for the exploration companies.

The above fiscal measures, among others, would help reduce the overall cost of exploration, thereby making the sector attractive to private players. As energy security is a matter of national interest, the Government should find ways to encourage the sector and reduce over-reliance on imports.

The author is Partner, Tax, KPMG in India

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