Section 42 of Income-Tax Act, 1961 deals with Special provision for deductions in the case of business for prospecting, etc., for mineral oil..
[(1)] For the purpose of computing the profits or gains of any business consisting of the prospecting for or extraction or production of mineral oils in relation to which the Central Government has entered into an agreement with any person for the association or participation [of the Central Government or any person authorised by it in such business] (which agreement has been laid on the Table of each House of Parliament), there shall be made in lieu of, or in addition to, the allowances admissible under this Act, such allowances as are specified in the agreement in relation—
(a) to expenditure by way of infructuous or abortive exploration expenses in respect of any area surrendered prior to the beginning of commercial production by the assessee ;
(b) after the beginning of commercial production, to expenditure incurred by the assessee, whether before or after such commercial production, in respect of drilling or exploration activities or services or in respect of physical assets used in that connection, except assets on which allowance for depreciation is admissible under section 32 : [***]
[Provided that in relation to any agreement entered into after the 31st day of March, 1981, this clause shall have effect subject to the modification that the words and figures “except assets on which allowance for depreciation is admissible under section 32” had been omitted; and]
(c) to the depletion of mineral oil in the mining area in respect of the assessment year relevant to the previous year in which commercial production is begun and for such succeeding year or years as may be specified in the agreement; and such allowances shall be computed and made in the manner specified in the agreement, the other provisions of this Act being deemed for this purpose to have been modified to the extent necessary to give effect to the terms of the agreement.
[(2) Where the business of the assessee consisting of the prospecting for or extraction or production of petroleum and natural gas is transferred wholly or partly or any interest in such business is transferred in accordance with the agreement referred to in sub-section (1), subject to the provisions of the said agreement and where the proceeds of the transfer (so far as they consist of capital sums)—
(a) are less than the expenditure incurred remaining unallowed, a deduction equal to such expenditure remaining unallowed, as reduced by the proceeds of transfer, shall be allowed in respect of the previous year in which such business or interest, as the case may be, is transferred;
(b) exceed the amount of the expenditure incurred remaining unallowed, so much of the excess as does not exceed the difference between the expenditure incurred in connection with the business or to obtain interest therein and the amount of such expenditure remaining unallowed, shall be chargeable to income-tax as profits and gains of the business in the previous year in which the business or interest therein, whether wholly or partly, had been transferred :
Provided that in a case where the provisions of this clause do not apply, the deduction to be allowed for expenditure incurred remaining unallowed shall be arrived at by substracting the proceeds of transfer (so far as they consist of capital sums) from the expenditure remaining unallowed.
Explanation.—Where the business or interest in such business is transferred in a previous year in which such business carried on by the assessee is no longer in existence, the provisions of this clause shall apply as if the business is in existence in that previous year;
(c) are not less than the amount of the expenditure incurred remaining unallowed, no deduction for such expenditure shall be allowed in respect of the previous year in which the business or interest in such business is transferred or in respect of any subsequent year or years:
[Provided that where in a scheme of amalgamation or demerger, the amalgamating or the demerged company sells or otherwise transfers the business to the amalgamated or the resulting company (being an Indian company), the provisions of this sub-section—
(i) shall not apply in the case of the amalgamating or the demerged company; and
(ii) shall, as far as may be, apply to the amalgamated or the resulting company as they would have applied to the amalgamating or the demerged company if the latter had not transferred the business or interest in the business.]]
[Explanation.—For the purposes of this section, “mineral oil” includes petroleum and natural gas.]
Now let us understand the section with latest case laws judicial pronouncement
- In the case of Joshi Technologies International Inc. v. UOI, 374 ITR 322, it was held that Where the production sharing contract entered into between the assessee with Ministry of Petroleum and Natural Gas did not incorporate clause for granting benefits under section 42 of the Act, it cannot be said the failure to incorporate the same in the contract was not inadvertently omitted and, therefore, assessee was not entitle for deduction under section 42 of the Act .
- ITAT Ahmedabad in the cases of Gujrat State Petroleum Corp Ltd v JCIT, ITA No. 2359 & 2360 / Ahd/ 2000 dated January 31, 2008 held that For computing book profits under section 115JA, deduction under section 42 of the Act is not available The taxpayer, an oil and gas exploration company, was liable to pay tax on book profits computed under section 115JA of the Act. Section 115JA of the Act creates a legal fiction by deeming 30 percent of the book profits to be its total income on which tax is levied. The taxpayer claimed deduction under section 42 of the Act while computing the book profits. Section 42 is applicable in computing profit of the business of prospecting for or extraction or production of mineral oil and allows expenses by way of infructuous or abortive exploration etc. The tax officer disallowed the claim under section 42 of the Act on the ground that section 115JA of the Act did not provide for such a deduction. The taxpayer contented that since section 42 of the Act was a special provision for deduction in the case of business for prospecting or for extraction of mineral oil, the fiction created had to be given effect to and the fiction enacted under section 115JA of the Act would not operate on the basic principle that there could be no fiction on fiction. The Tribunal observed that there was no doubt that a legal fiction had been created in section 42 of the Act, but it was relevant only for the purpose of computation of income under the head “profits and gains from business or profession”. If such fiction was extended into section 115JA of the Act, then the purpose of introducing Minimum Alternative Tax under section 115JA of the Act would be defeated. It held that the two fictions had to exist harmoniously and one should not destroy the other. With this, the Tribunal decided the issue against the taxpayer and held that section 42 of the Act cannot override section 115JA of the Act
- Commercial production of natural gas amounts to production of ‘mineral oil’ for purpose of tax holiday under section 80IB(9) of the Income-tax Act, 1961; each well or a cluster of wells producing ‘mineral oil’ could be a separate undertaking eligible for tax holiday The taxpayer, a company based in Canada, was engaged in the business of prospecting for, exploration and production of mineral oil in India. The taxpayer entered into a Production Sharing Contract (PSC) with the Government of India to develop oilfields. The taxpayer developed clusters of wells in phases – first cluster of wells H1, consisting of five wells started commercial production prior to April 1, 1997; second and third cluster of wells H2 (consisting of two wells) and H3, began commercial production after April 1, 1997. The taxpayer, by appending a note in the return of income, reserved the right for claiming the deduction in respect of wells which began commercial production after April 1, 1997. The exact amount of deduction, however, was not quantified, in view of the likelihood of getting the claim of deduction under section 42 of the Income-tax Act, 1961 (“Act”). On disal lowance of deduction under section 42 of the Act on most of the expenditure, a tax holiday claim was made by the assessee under section 80IB of the Act. The Assessing Officer disallowed several claims made by the taxpayer including claim for tax holiday under section 80IB(9) of the Act for H2, inter alia, on the ground that the commercial production started before April 1, 1997. Claims of the assessee were partly allowed by the first appellate authority including the claim for tax holiday for H2 as a separate undertaking. On appeal, the following were some of the important conclusions of the Tribunal: · The term ‘mineral oil’ is not defined under section 80IB. However, the term is defined to include ‘natural gas’ in other sections of the Act (sections 42, 44BB and 293A). Based on the principle of harmonious construction for interpretation of statutes, when the same word is used in different parts of the same section or statute, there is a presumption that the word is used in the same sense throughout. Accordingly, based on the meaning provided in other sections of the Act, as corroborated by the meaning of the term given in other statutes, production of natural gas amounts to production of mineral oil and is therefore, eligible for deduction under section 80IB(9) of the Act. · Each well or a cluster of wells is a physically separate unit which can exist on its own and is capable of earning income independently. Since, in the instant case different clusters of wells (H1, H2, H3) produced measurable quantity of gas during the relevant financial year and separate books of accounts had been maintained by the assessee for each cluster, H1, H2 and H3 should be treated as three independent undertakings for the purpose of claiming tax holiday. · The allowances claimed by the taxpayer were not of the nature specified in the PSC, nor did the PSCs provide any manner for computation of such deduction. In the absence of explicit mention of allowable deductions in the PSC and also of the manner in which such deduction were to be computed, drilling and exploration expenses could not be allowed as deduction under section 42 of the Act. · A well is an apparatus used in the business of mineral oil production and hence ‘plant’ as per generic meaning. However, based on the meaning of ‘building’ as per the Income-tax Rules, 1962, oil wells would be treated as ‘building’ and thus shall be eligible to depreciation at the rate of 10 percent. (Refer, ACIT v Niko resources Ltd (123 TTJ 310)
- Expenditure covered by the PSC cannot be subjected to disallowance under Section 44C The taxpayer, a company incorporated in Cayman Islands, entered into a PSC with the Government of India for undertaking exploration and exploitation of mineral oil. In its return of income, the taxpayer had claimed deduction on the account of reimbursement of expenditure incurred by a third party. The Assessing Officer disallowed the claim of the taxpayer by invoking section 44C of the Act. Section 44C restricts the deduction of head office expenditure in the case of non-residents. On appeal, the first appellate authority allowed the taxpayer’s claim on the ground that section 44C is not applicable to a third party and further in the present case the taxpayer was entitled to concessional tax treatment provided in the PSC read with section 42(1) of the Act, hence section 44C is not applicable. On further appeal, Tribunal observed that section 44C speaks of expenditure in the nature of head office expenditure and not the expenditure incurred by the head office in relation to the operations of the taxpayer in India. Therefore, reimbursement of expenses to a third party is also caught within the mischief of head office expenses inadmissible under section 44C. However, following the decision of the Supreme Court in case of CIT vs Enron Oil and Gas India Ltd (305 ITR 75) (SC), the Tribunal held thatas the taxpayer is one of the parties to the PSC which represents an independent regime, such expenses are deductible under section 42 read with the PSC and section 44C is not applicable. (Refer, DDIT v BG Exploration and production India Ltd (29 SOT 79).
- In the case of Cairn Energy Pty Limited it was held that Expenditure with respect to business of prospecting, extraction or production of mineral oil is governed by special provision The taxpayer, a non-resident company incorporated in Australia, engaged in prospecting and exploration of mineral oils in India, carried out its business activities under the Production Sharing Contract (“PSC”). The taxpayer reimbursed certain expenses incurred by the parent company as per terms of PSC and claims it as deduction under section 42 of the Act, which is a special provision for computing income from the business of prospecting, extraction or production of mineral oil . The tax officer disallowed the expense as tax was not withheld from the payment. It was argued by the taxpayer that the payment was a reimbursement without any element of profit for which withholding provisions are not applicable and nevertheless, the disallowance cannot be made under section 40(a)(i) of the Act, which stands overridden by section 42 of the Act. The Tribunal noted that payments were in the nature of reimbursement of expenses by taking on record the Auditor’s certificate provided by the taxpayer from its parent and held that withholding tax provisions will not apply to reimbursements. Also, it relied on the decision of the Supreme Court in case of CIT v Enron Oil and Gas India Ltd 305 ITR 75 (SC), and held in favor of the taxpayer that section 40(a)(i) of the Act would not apply.