1. Regulatory and Legal Issues for Gas Sector:
Gas Infrastrucutre in Kerala – Engine of Economic Growth
S P Singh
December 13, 2010

2. Contents Introduction
Key foreign investment regulations relating to Petroleum & Natural Gas Sector
Foreign Direct Investment (‘FDI’) Policy
External Commercial Borrowings (‘ECB’) Policy
Key tax regulations
Direct Taxes
Current tax regime
Direct Taxes Code, 2010
Indirect Taxes
Relevant provisions
Goods & Service Tax (‘GST’)
Budget 2011 – Time to ring the bells
Conclusion

3. Introduction

4. Importance of Natural Gas
Gas complements the oil industry to address the issue of energy security
Gas can directly replace oil as a transport fuel – Compressed Natural Gas (‘CNG’)/Diesel (gas to liquid)
Vis-a-vis oil, more diverse distribution of reserves
Liquefied Natural Gas (‘LNG’) together with pipeline routes connect geographically diverse producing centres and consuming markets
Eco-friendly
Safer than Liquefied Petroleum Gas (‘LPG’), as it is lighter than air
Source: BP Statistical Review 2010
Source: Integrated Energy Policy

5. Infrastructure and Consumption of Hydrocarbons in Kerala
Growth of petroleum products in Kerala and India in 2009
Product
% Growth in Kerala
% Growth in India
Gasoline (MS)
14.0
13.9
HSD
5.9
8.9
SKO
2.8
0.0
LPG
9.4
6.2
LPG-Domestic
7.6
Auto LPG
31.2
Key upcoming natural gas infrastructure:
Petronet LNG’s 2.5 MMTPA regasification terminal at Kochi expandable to 5.0 MMTPA
Assured long term supply for 20 years upto 1.44 mmtpa LNG from Exxon Mobil’s Gorgon Project, Australia
GAIL’s 1114 km Kochi – Kanjikkod – Mangalore/ Bangalore pipeline with a capacity of 16 MMSCMD at an approx cost of Rs Cr.
Both of above gas infrastructure would be the catalyst for gas market growth in the southern India
HSD, LPG and SKO would be main products to be replaced by gas in future in Kerala for industrial, transportation, commercial and domestic uses.
MS stands for ‘Motor Severe Oil’
SKO stands for ‘Superior Kerosene Oil’
LDO stands for ‘Light Diesel Oil’
HSD stands for ‘High Speed Diesel’

6. Key foreign investment regulations relating to Petroleum and Natural Gas Sector

7. Foreign Direct Investment Policy
Instruments covered under FDI:
Equity shares,
Preference shares,
Convertible Debentures
Sector
FDI cap
Conditions
Other than Refining and including market study and formulation; investment/ financing; setting up infrastructure for marketing in
Petroleum & Natural Gas sector
100% under automatic route
Subject to sectoral Regulations
issued by Ministry of
Petroleum & Natural Gas (‘MoPNG’)
Refining
49% in case of PSUs with FIPB approval,
100% in case of Private Companies under automatic route
Subject to Sectoral policy
and no divestment or dilution of
domestic equity in the existing
PSUs.

8. Foreign Direct Investment Policy (contd..)
Automatic Route not available if existing Joint Venture (‘JV’) or technology transfer/ trademark agreement in 'same' field
Exceptions:
Investments by Venture Capital Funds registered with the Security and Exchange Board of India (‘SEBI’),
investment by either of the parties is less than 3%, and
existing venture/collaboration is defunct or sick
‘Conflict of interest‘ clause may be provided for in JV agreements to safeguard the interests if the foreign partner decides to set up another JV or a Wholly Owned Subsidiary ‘(WOS’) in the same field
Payments for royalty / lumps sum fee for technology transfer are now covered under automatic route without any monetary ceiling – No threshold

9. External Commercial Borrowings Policy
Companies engaged in mining, refining and exploration are eligible to avail ECB:
Under Automatic Route: upto USD 500 million,
Under Approval Route: additional amount of USD 250 million where average maturity period is more than 10 years
Companies engaged in transportation and distribution not eligible
Prohibited End Use:
On-lending
Investment in capital market
Acquiring a company (or a part thereof) in India
Real estate excluding development of Integrated townships
Working capital requirements of the company
General corporate purposes
Repayment of existing Rupee loans

10. Key tax regulations

11. Direct Taxes Current Tax Regime
Special tax regime under Production Sharing Contracts (PSCs) signed with the Government of India
Each member to be assessed in respect of its own share of income in the same status in which it has entered into the agreement with the Central Government
Special provisions for determination of taxable income for business of extraction, prospecting of mineral oil,
Seven (consecutive) years tax holiday for "undertakings" engaged in production of “mineral oils” starting from the year in which it commences commercial production,
Controversy created by Memorandum explaining the Finance Bill whether mineral oil includes natural gas - still exists
Tax holiday to be available to companies in respect of natural gas production where the oil and gas blocks have been awarded under New Exploration Licensing Policy (‘NELP’) VIII and Coal Bed Methane (‘CBM’) IV round of bidding
Infructuous or abortive exploration expenses
Expenditure incurred in respect of drilling or exploration activities or services
Expenditure incurred or physical assets used in respect of drilling or exploration activities or services
Depletion of mineral oil in the mining area
Balance expenditure on transfer of interest including treatment of recoupment of expenditure
Controversy created by Memorandum explaining the Finance Bill whether mineral oil includes natural gas
Position after Finance Bill, 2009
Proposed to be available to companies in respect of natural gas production where the oil and gas blocks have been awarded under NELP VIII round of bidding
Undertaking - All blocks licensed under a single contract, which has been awarded under NELP announced by the Government 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 manner, shall be treated as a single undertaking.

12. Direct Taxes Current Tax Regime
Shift from profit linked incentives to investment linked incentives
Companies engaged in the business of laying and operating a cross-country natural gas or crude or petroleum oil pipeline network for distribution allowed an investment linked incentive, subject to fulfillment of the following prescribed conditions:
Make available not less than one-third of total pipeline capacity available for use on common carrier basis by any person other than the Company or an Associated Enterprise
Total pipeline capacity to be made available for use on common carrier basis will be as specified below
‘one-third’ for a natural gas pipeline network and
‘one-fourth’ for petroleum product pipeline network
Minimum Alternate Tax (MAT) increased from 15% to 18% w.e.f. April 01, 2011
Surcharge for domestic companies reduced from 10% to 7.5%. w.e.f. April 01, 2011

13. Direct Taxes
Direct Taxes Code, 2010 (Proposed to be applicable from April 1, 2012)
Generic Income & Rate Proposals
Corporate tax rates to be uniform for domestic as well as foreign companies at 30%
Tax exemptions removed
MAT
MAT levied at the rate of 20% on book profits for companies
Tax credit for a financial year to be allowed shall be the excess of tax on book profit over normal income tax
Tax credit allowed to be carried forward till 15 Financial Years from the year immediately succeeding the Financial Year in which such tax credit becomes allowable

14. Direct Taxes
Direct Taxes Code, 2010 (Proposed to be applicable from April 1, 2012) – specific reference to Petroleum & Natural Gas Sector
Specific provisions relating to Oil and Gas Industry prescribed in Direct Tax Code:
Companies engaged in laying and operating a cross country natural gas or crude or petroleum oil pipeline network for distribution (Thirteenth Schedule)
Specified capacity of total pipeline to be made available for use on common carrier basis in accordance with the Petroleum and Natural Gas Regulatory Board (‘PNGRB’)
Companies engaged in the business of prospecting or extraction or production of mineral oil or natural gas (Eleventh Schedule)
Natural gas eligible
No specific condition of having entered into agreement with Central Government
Comprehensive new provisions and cover not only computation of deductions but also define rules for determining income
Significant shift in allowability of deductions for tax purposes considering the special needs of the industry
Expenditure on land allowed fully
Capital expenditure allowed completely (as opposed to depreciation)

15. Indirect Taxes – Relevant provisions
Concessional duty of Customs of 5% under Project Imports Scheme on machineries etc. required for Pipeline projects for transportation of natural gas
Coal and crude oil enjoy ’declared good’ status for VAT purposes - VAT rate is 4% across States
Natural gas does not enjoy the status of ‘declared goods’ and therefore, subject to varying VAT rates (as high as 12.5% and even more)
Some states do not permit input credit in levy of VAT on gas thereby resulting in higher taxation
Supply of gas by pipeline, whether inter-state sale or local sale – No clarification issued in this regard
Service tax paid on services availed in relation to laying of pipeline and other related services is not available for set off and becomes the part of the cost of the project
Concessional rate of Basic Customs Duty (BCD) 5% is applicable on the import of goods, machinery and equipment for oil and gas activities under project import scheme.
Crude oil along with other products have been declared under the Central Sales Tax Act as being goods of ‘special importance’ in the inter-state trade or commerce, it cannot be sold at a VAT/ CST rate higher than 4%.
Natural gas not accorded the same status
VAT credit is not available in case of petroleum products in the State of Kerala
- Service tax paid on input services used in laying down of pipeline becomes cost in the absence of output service tax/ excise duty liability.

16. Indirect Taxes - GST First Discussion Paper
A final view as to whether Natural Gas would be covered under GST is yet to formulated and is subject to further deliberations
Task Force Recommendations
Natural gas should be subjected to GST with all the benefits of input credit as in the case of other normal goods.
- Clarity is required regarding the inclusion of the petroleum sector including Natural Gas under the GST - since there are varied views within the Government on the same

17. Budget 2011 Time to Ring the Bells

18. Expectations from Budget 2011
Clarification as to availability of investment linked incentive for City Gas Distribution (‘CGD’)
Deduction under section 80IB(9) of the Income-tax Act, 1961 (‘Act’) should also be made available for production of natural gas in blocks licensed under earlier NELP and CBM rounds of bidding
Allowance of infructuous or abortive exploration expenses without the surrender of area
Allow deduction under section 37 of the Act for the expenditure incurred on drilling and exploration activities in overseas blocks by Indian companies even where Indian companies do not enter into agreement with the Central Government
Undertakings should be given option of claiming tax holiday under section 80IB(9) of the Act at any time during the first 15 years after commencement of commercial production since in actual terms, Companies do not earn profits in their initial years of operation
Exemption of Oil and gas companies from paying taxes in terms of section 115JB of the Act (‘MAT’) to promote the Exploration and Production sector

19. Expectations from Budget 2011 (Contd.)
‘Farm-in-costs’ shall be recognized as an intangible assets eligible for depreciation under section 32 of the Act
A provision of considering “each well” as undertaking in the Explanation to section 80IB(9) of the Act or the explanation applicable only prospectively
Infrastructure status to be provided to companies engaged in transportation and distribution for the purposes of ECB regulations
Zero customs duty on Liquefied natural gas (‘LNG’)/ Natural Gas and on LNG infrastructure facilities
Clarity on inclusion of Natural Gas under GST regime

20. Conclusion

21. Need for help and support from the Government
Clarity on policies,
Infrastructure status to transportation and distribution companies for ECB,
Clarity on investment linked incentives to CGD,
Tax holiday for natural gas for pre- NELP VIII and CBM IV blocks,
Zero customs duty on LNG/ Natural Gas and on LNG infrastructure facilities,
Declared goods status to natural gas,
Exemption from service tax to services used in upstream sector

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