The goods and services tax (GST) that was conceptualised 16 years ago is finally taking shape and is likely to be implemented soon, marking the beginning of a new era in indirect taxation in India. The system is currently fraught with challenges such as multiplicity of taxes, the cascading effect of taxation and double taxation. GST will have an impact on the entire value chain of operations, and will have far-reaching implications for all industries across all sectors.
GST is a value added tax (VAT) that is levied at all points in the supply chain, with credit allowed for any tax paid on procured inputs. The roll-out of GST will not only simplify taxation anomalies and procedures, but also reduce the transaction cost by removing the cascading tax effect. It will transform the country into a single market, and increase the tax base by imposing a comprehensive tax and ensuring an efficient tax administration.
Several loose ends need to be tied up before the new tax regime can be implemented. At present, there is a lot of uncertainty regarding the taxation rates, the registration threshold for states, taxation of interstate trade and the compensation to states for revenue loss. Therefore, it is unlikely that the government will be able to introduce GST on April 1, 2017 as scheduled. The finance minister recently indicated that the roll-out may be deferred to June 1, 2017. Nonetheless, given the pace of progress, it is expected that GST will become a reality in India during the current year.
The government is counting heavily on the introduction of the new tax regime, which is being considered a game changer for a number of sectors. While the unified tax regime is likely to benefit most of the sectors, the overall impact on the oil and gas sector is expected to be negative. A major reason that can be attributed to this is the fact that GST is not being implemented across the whole sector. While the inclusion of products such as liquefied natural gas (LPG), naphtha, kerosene and fuel oil under the GST ambit bodes well for the sector, the exclusion of five major products – crude oil, motor spirit, aviation turbine fuel, high speed diesel and natural gas – will result in non-creditable tax costs in the initial years. Thus, compliance with a dual tax regime is expected to hurt the profit margins of companies in the sector.
Impact on upstream companies
The impact of GST on any segment depends on the types of goods produced and services rendered. Typically, procurements for upstream oil companies are categorised into exploration, drilling, project execution and operations. At the exploration stage, oil companies generally rope in foreign players for seismic data recording, data interpretation, and consultancy services. The impact of GST on this segment will be determined by the place of supply of services and the location of the supplier.
At present, for the drilling stage, a service tax is payable. The proposed GST rates for the same are 6 per cent, 12 per cent and 18 per cent (any of these rates may eventually be fixed). The final impact of GST will be on the valuation of the drilling rig operator. “Free of charge” supply between oil companies and rig operators does not qualify as “supply” under the model GST law.
With regard to projects, upstream companies engage a service provider for setting up the platform. In doing so, works contract services are procured by oil companies. Under the present law, a service tax and a VAT are paid at applicable rates. Such contracts are usually split for the unambiguous calculation of taxes. In a single-contract structure, there is a possibility of tax benefits being challenged by authorities. However, there are issues with respect to the splitting of contracts under GST. These pertain to rate arbitrage (or difference) between the supply of goods and the supply of services, the scope of splitting the contract into multiple contracts, a mechanism or yardstick for determining the principal supply in a “composite supply”, etc.
For upstream companies’ operations, a service tax is currently payable. Under the new regime, GST will be levied on the supply of maintenance services. In case consumables or other goods are sold as a part of the annual maintenance contract, there can be two situations. In the first case, if separate invoices are raised for each supply of goods, GST will be payable on these supplies at applicable rates. In the second case, if the contract is treated as a works contract then the whole contract will be treated as a supply of service, and issues may arise regarding the rates applicable.
A key area of ambiguity is the tax treatment of revenues from operations in oilfields that are located beyond 12 nautical miles from a state’s boundary. It is still unclear whether such assets will be taxed by the central government or the state government. (Bombay High is beyond 12 nautical miles from Maharashtra.) Meanwhile, the crude oil sold by upstream oil companies will continue to be taxed under the present laws, since petroleum crude is not subsumed within GST. The fate of the national calamity contingent duty and the oil cess is not clear, as these have not been specifically subsumed.
Impact on midstream companies
The midstream segment involves the transportation of crude and refined petroleum products (by pipeline, rail, barge, oil tanker or truck), their storage and wholesale marketing. In case midstream companies are not involved in the purchase and sale of oil, their activities will be regarded purely as a service and will be within the scope of GST. However, with regard to the specific tax incidence, there are several grey areas.
For input services, clarity is required on whether the construction of a complete pipeline system (including substations and other structures) will qualify as the “construction of immovable property” (so as to curtail oil companies from receiving input tax credit of works contract services), whether separate contract/pricing is necessary to mitigate exposure, etc. As far as the output services of midstream companies are concerned, the charter hire of vessels will qualify as a supply of a service and will be taxed accordingly under the GST regime.
Impact on downstream companies
The downstream segment commonly refers to the refining of petroleum crude oil and the processing and purifying of raw natural gas, as well as the marketing and distribution of products derived from crude oil and natural gas. The input of downstream companies is outside the scope of GST, whereas the output consists of products, some of which are within the GST ambit while others are outside it.
For transporting refined products to consumers or dealerships, the proposed GST rates are 6 per cent, 12 per cent and 18 per cent (any of these rates may eventually be fixed). For the output, present taxes are to continue on the sale of petrol and diesel. However, GST will be levied on the supply of petrochemical products such as butane, propane, etc.
Due to the dual regime (with the exclusion of petrol and diesel from the GST net), downstream companies will operate under both the extant laws as well as under the proposed law. Thus, there will be an additional compliance burden on downstream companies (players will have to comply with the procedural compliances prescribed under both the laws). Besides, companies will have to maintain multiple financial records, catering to the requirements of both regimes.
The GST law, in its current form, excludes a significant portion of the oil and gas sector. This is likely to hurt the margins of a number of players in the sector. The compliance with dual taxation regimes will be tedious too. The benefits of “one nation, one tax” will certainly not be realised by the hydrocarbon industry, unless the law is changed and uniformity is assured with regard to its implementation.
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