The finance ministry has decided to let Reliance Industries and BP structure their recent deal in a manner that allows the Indian company to recover its exploration costs from the sale proceeds. As per the deal that is yet to be consummated, RIL proposes to sell 30% stake in its 23 oil and gas blocks to London-based energy giant for a consideration of $7.2 billion.
The facility to fully recover its remaining exploration costs on the 23 blocks would help RIL save huge amounts in taxes.
Although the finance ministry no longer encourages tax exemptions and is curtailing them in the proposed direct taxes code (DTC), it is considering being lenient to RIL exclusively for the deal with BP, which was announced in February.
The DTC, currently being vetted by the parliamentary standing committee on finance, is expected to come into force from April 2012.
The Income Tax Act, section 42, allows a hydrocarbon company to deduct from the proceeds of stake sale the exploration costs, that were not recouped from the sale of oil or gas. The proceeds from the stake sale or transfer will be deemed as business income to enable such cost recovery.
For the ministry, large tax exemptions, particularly to individual companies, pinch. That is because the total tax base is finite and when one entity walks away with a major tax break, the government will have to compensate the shortfall in receipts by raising indirect taxes, which hurts the common man, said a person privy to the development.
The ministry therefore, is reluctant to give tax exemptions, especially in the case of large transactions. However, since deduction of exploration costs from the sale or transfer proceeds of oil and gas assets in part or full, treating it as business income, is allowed under the Act, the ministry will not oppose it.
?We cannot prevent the operation of a provision in the law just because it happens to suit a tax payer,? said an official.
In the absence of this express provision, deductability of exploration cost remaining unallowed could have been an issue, said a direct taxes expert with a law firm, who asked not to be named.
A spokesperson for RIL recently told FE that the accounting and taxation treatment for the transaction will be in line with prevalent practices. The spokesperson, however, did not comment on specific details of the deal structuring. RIL hopes to conclude the deal this fiscal itself before the DTC comes into force, which would restrict the set-off of losses (exploration cost not recovered from sale of hydrocarbons) from stake sale proceeds.
This contrasts with the $11-billion Vodafone-Hutch cross-border deal of 2007 that created Vodafone-Essar, that is stuck in a legal dispute over an estimated $2 billion tax liability.
The blocks that are covered by the deal also includes the D6 block in the Krishna Godavari basin, in which production is declining and the company hopes to benefit from BP?s deepwater exploration expertise.