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Gujarat HC Order: Relief To Oil & Gas Sector?

Published on Mon, Apr 06,2015 | 15:23, Updated at Mon, Apr 06 at 15:23Source : 

By: Dhinal Shah, Partner - Tax & Regulatory Services, EY India

Whether Cluster of Oil Wells constitutes an undertaking for tax benefit or not under Income Tax Act?

Gujarat High Court strikes down the Explanation to Section 80-IB(9) inserted by Finance (No. 2) Act, 2009 with retrospective effect from 1.4.2000 considering it as an ultra vires to Article 14 of the Constitution of India

Gujarat High Court in a recent case of Niko Resource Limited v Union of India delivered a landmark judgement considering the Explanation added to the Section 80-IB(9) of the Act with retrospective effect from the law as an ultra vires to the Constitution of India. This has come as a major relief for the oil and gas sector. The Gujarat High Court in this case has adjudicated upon issue that the whether the cluster of wells producing mineral oil well considered as a separate undertaking and eligible for tax deduction under section 80-IB(9) of the Act.

Section 80-IB(9) of the Income Tax Act, 1961 (‘the Act’) provides a deduction of 100% profits for a period of seven consecutive years if the following conditions are fulfilled:

   (i) The undertaking is located in any part of India

   (ii) The undertaking has started commercial production of mineral oil

   (iii) The commercial production has been started on or after 1 April 1997

Further an Explanation to this section was introduced vide the Finance (No. 2) Act, 2009 which read as under:

“Explanation.—For the purposes of claiming deduction under this sub-section, all blocks licensed under a single contract, which has been awarded under the New Exploration Licencing Policy announced by the Government of India vide Resolution No. O-19018/22/95-ONG.DO.VL, dated 10th February, 1999 or has been awarded in pursuance of any law for the time being in force or has been awarded by the Central or a State Government in any other manner, shall be treated as a single “undertaking” .”


· The Petitioner Niko Resources Limited (“Niko” or “the assessee” or “the Petitioner”), a company incorporated in Canada, is engaged in the business of prospecting for, exploration and production of mineral oil in India. Niko entered into a Production Sharing Contract (“PSC”) with the Government of India to develop oilfields in Hazira, in the state of Gujarat.

· The Petitioner had developed a cluster of wells in phases and termed each well as a separate undertaking for the purpose of claiming the deduction under section 80-IB(9).

· The Revenue alleged that the cluster of well was to be considered a single undertaking only and accordingly both the Revenue and the Petitioner were in cross appeal before Ahmedabad ITAT.

· On appeal by the Petitioner, the ITAT, by its order dated 29th February 2008, held that each well/cluster of wells constituted a separate undertaking and therefore the Petitioner was entitled to a deduction under Section 80-IB(9) in respect of profits derived from each such well/cluster of wells for a period of seven consecutive years from the commencement of the commercial production, in each such undertaking, consisting of a well/cluster of wells.

· The ITAT thereafter allowed similar claims for the Assessment Years 2000-01, 2002-03 and 2003-04.

· Hence the ITAT was of the view that the deduction under section 80-IB(9) of the Act, shall be allowed to the assessee considering each well as a separate and distinct undertaking.

Amendment to Provisions Retrospectively

Finance (No. 2) Act, 2009 introduced an explanation to section 80-IB(9) defining the term "undertaking” to mean "all blocks licensed under single contract" with retrospective effect from 1.4.2000.

Based on this,the claim of the Petitioner for considering each well as a separate undertaking under section 80-IB(9) was disallowed by the AO for AY 2006-07. The Petitioner has been claiming benefit of deduction of 100% of the profits and gains from the production of mineral oil and natural gas under Section 80-IB(9) as it stood prior to an amendment to Section 80-IB(9) of the Act which was introduced by the Finance (No.2) Act 2009.

The Petitioner then filed a writ petition before the Gujarat High Court challenging the constitutional validity of the explanation added to Section 80-IB(9).

Assessee’s Contentions

In these proceedings, the constitutional validity of the amendment to sub-Section (9) of Section 80-IB and Explanation added to it under the Act by the Finance (No.2) Act, 2009, has been challenged considering it as an ultra vires to Article 14 of the constitution.

Further there arose a question as to whether the assessee was eligible to claim the deduction under section 80-IB(9) since the deduction was only available on the commercial production of the mineral oil and not on the production of natural gas which the assessee was engaged into.

Department’s contentions

The department on the other hand contended that any legislation cannot be struck down on the basis of Article 14 alone. The department further contended that the as per Clause 3 of the PSC entered by the assessee, the contract area meant to be the entire area of the block and not one or a cluster of wells. Hence the deduction has to be allowed considering a cluster of wells as a single undertaking and not a separate undertaking.

Issues before the High Court

(1) Whether the amendment to Section 80-IB(9) adding an explanation to the section considering the term “undertaking” to mean “all blocks licensed under single contract” was valid under as per the Article 14 of the constitution? Was the deduction under section 80-IB(9) available considering each undertaking as a separate undertaking?

(2) Was the assessee who was involved in the production of natural gas, be allowed the deduction under section 80-IB(9) considering the natural gas at par with Mineral Oil?

(3) Whether the Petitioner had accrued any vested right which was being taken away by the amendment to the section-80IB(9)?

High Court’s Observations and Judgement

> Whether Mineral Oil includes Natural Gas?

The High Court when considering whether natural gas is encompassed within the meaning of mineral oil and whether the assessee’s engaged in the production of natural gas were eligible for the deduction for under section 80-IB(9) first referred to the provisions of the Act. Since the term natural gas was not defined anywhere in the Act, the High Court heavily relied upon the judgement of the Hon’ble Supreme Court in the case of Association of Natural Gas and others v. Union of India and others[1], and held that the term mineral oil includes and has always included natural gas.

> What is an undertaking and whether deduction is allowed undertaking wise?

· The High Court held that though the expression “Undertaking” has not been defined under the Act, it has acquired a well defined meaning through consistent judicial decisions commencing from the case of the Hon’ble Supreme Court in the case of Textile Machinery Corporation Limited, Calcutta v. the Commissioner of Income Tax, West Bengal Calcutta[2].

· The expression ‘Undertaking’ is used in various provisions of the Act, while conferring the benefits under different schemes. It is clear that in the present case of the Petitioner, the wells are separate independent units which existed on its own as a financially and technically viable unit capable of earning income. Further there was a substantial investment in each well and this resulted in a new undertaking. Also the production of the revenue was independent by each well and it was not dependent upon other units. These were the principles laid down by the Hon’ble Supreme Court in the case of Textile Machinery Corporation Limited (supra) to consider a unit as an undertaking. Accordingly, there was no harm in considering the oil wells as a separate undertaking.

· It is clear that commercial production of mineral oil happens from every Development Area/Field consisting of a well or cluster of wells with a Development Plan being approved for every Development Area/Field thereby making every Development Area/Field as an independent economic unit. Every Development Area/Field is thus an “Undertaking”.

· Further the High Court observed that the Central Government has always been aware that there are more than one undertaking in each Block of the natural gas/mineral oil basin and it has acted on the same premise while acting approving more than one Commercial Discovery in each Development area of a Block.

> What is the vested right of the Petitioner?

· The right given to the Petitioner on for enjoying 100% deduction for 7 years was a vested right and the vested right enjoyed by a Petitioner can be taken away only if the law specifically or by necessary implications provides to do. Under Article 300A of the Constitution no person can be specifically deprived of his vested right without following the rule of law. In the present case the Petitioner was allowed the benefit of claiming deduction under section 80-IB(9) considering each well as a separate undertaking and hence the vested right to claim the deduction had arose by the judgement of the ITAT.

> Is an amendment affecting vested right of the Petitioner valid?

· It is the prerogative of the Parliament to amend the law with retrospective effect; however such retrospective amendment shall be reasonable and not arbitrary and should never take away the fundamental rights of the person which is granted by the Constitution.

· The Explanation is not a nonobstante clause, notwithstanding any law or decision, it proceeds under the presumption that an existing ambiguity is sought to be clarified when, in reality, there is none. In fact, the usage of the expression “single” before the term ‘undertaking’ in the explanation evidences the legal understanding that the undertaking is not synonymous to assessee and an assessee can have more than one undertaking doing the same or distinct business as long as they are independent stand alone units.

· The High Court pondered over the contention raised by the Counsel for Department and held that the argument of learned counsel for the respondent is that the moment the first well starts commercial production of mineral oil, the clock of seven year tax holiday starts ticking and even if the other wells may have been explored or discovered or started commercial production after two, three or about the end of four years period, the Petitioner would be entitled only to a limited part of tax holiday which may be three or four years which may be available when the commercial production starts in a well, as the period of seven years tax holiday has to be counted from the date the first well started commercial production. This was not mentioned either in the PSC or in the petroleum tax guide.

· From the speech of the Finance Minister while moving the Finance (No.2) Bill 2009, it appears that he was to define the term “undertaking” in the context of mineral oil which was subject matter of considerable dispute. The assessees who are claiming every well in a block licensed, constitutes a single undertaking entitled for tax holiday separately for each well.

· According to the Finance Minister, the view taken by the assessee was against the legislative intent. What was the legislative intent when 100% tax deduction on profits and gains was granted by the legislature was neither stated nor explained by the Finance Minister. The expression “legislative intent” was used by the Finance Minister in the Bill to impose Income Tax on the Petitioner by withdrawing tax holiday which was vested in the Petitioner from an earlier point of time. Under the garb of clarification or defining the term “undertaking”, the Finance Minister by amendment almost withdrew the benefit of tax deduction substantially.

· The amendment in the cases, where already benefit had accrued and vested in the assessee could not be taken away by giving retrospective amendment to Section 80-IB(9) which is nothing but a substantive provision inserted by amendment and it can only operate prospectively and not retrospectively.  The legislature or the Parliament had by inserting the Explanation had widened the main Section 80-IB(9) and imposed an altogether new tax by widening the tax net which would be applicable for different periods depending upon the date of starting commercial production which would be substantive change in the law with different tax liability. Such substantive provision could only be construed prospective in operation.

· Accordingly the amendment to the Section 80-IB(9) was of a nature which took away the accrued and vested rights of the Petitioner which had matured after the decision of the ITAT and hence the amendment to Section 80-IB(9) breaches the rule of law and violates Article 14 of the Constitution and therefore it is ultra vires to the Article 14 of the Constitution and needs to be struck down.

Thus Hon’ble High Court of Gujarat has struck down the amendment made in section 8oIB(9) defining undertaking for the purpose of claim of deduction. This will bring substantial relief to Oil and Gas sector.

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