ABCD
KEY INDIRECT TAX
ISSUES IMPACTING THE
INDIAN NATURAL GAS
SECTOR
KPMG
February 2015
This report contains 16 pages
© 2015 KPMG, an Indian Partnership and a member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss
entity. All rights reserved.
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KEY INDIRECT TAX ISSUES IMPACTING THE
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© 2015 KPMG. All rights reserved.
TABLE OF CONTENTS
I Purpose of this report 2
II Summary 2
III Indirect Tax challenges under Current Regime 2
A. Service tax on cash calls and reimbursements 2 B. Blockage of Service tax paid on Services consumed in E&P Activities 4
C. Customs exemption on import of Liquefied Natural Gas (LNG) 5 D. Setting up of infrastructure – CENVAT Credit denial 5
E. Value Added Tax and service tax on Sale and Transport of Gas 7 F. Inter-state supplies to customers – Liable to VAT or CST 8 G. Concessional CST against Form C on goods required for laying of
pipeline network 9
IV Proposed GST Regime 10
A. Included under GST 11
B. GST Exempted 12 C. GST Zero Rated 12 D. Way forward 13
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I Purpose of this report
Natural gas has emerged as the most benign fuel and it plays an important role in driving
the economic growth of a country. Being cleanest of all fossil fuels, efficient, and
relatively economical, it fulfils the requirements for fuel in today’s industrial society.
The sector has however, been facing enormous challenges over the last few years in
India on the indirect tax fronts in terms of levy of multiple taxes, interpretation issues,
unfavourable credit structure adding to the overall tax cost.
This document encapsulates the key indirect tax issues including the possible issues
that are likely to arise under the proposed GST regime.
II Summary
At present many challenges such as blockage of credit of taxes paid on inputs and input
services, disputes in relation to applicability of various taxes on output activities,
disparity in tax structure, high tax cost etc. are being faced by the industry.
In view of the same where natural gas is brought under the purview of the proposed
GST regime the issues are likely to be largely addressed providing relief to the industry
in terms of fair and stable tax regime.
III Indirect Tax challenges under Current Regime
A. Service tax on cash calls and reimbursements
Exploration & Production (E&P) activities are generally carried on by Unincorporated
Joint Ventures (UJVs), on behalf of all members because of the high stakes involved.
Working of UJVs for E&P activities under the Production Sharing Contracts (‘PSC’)
requires designation of one of the participants as operator. Such operator is responsible
for carrying out the operations and incurring expenses based on the approved work
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plans. He shall then collect/ mobilize funds (referred to as cash calls) from the other
members, according to their participating interest in the UJV. The amount so
contributed by members towards cash calls is in the nature of financial/capital
contribution.
The above transaction may be depicted as follows:
As per the Finance Act, 1994, service tax is levied on all services performed in India
unless specifically exempted under a notification or covered under the negative list of
services.
Sub-section 44 of section 65B of the Finance Act, 1994, defines ‘service’ as any activity
carried out by a person for another for consideration. Further, Explanation 3 to Section
65B (44), provides that an unincorporated association or a body of persons, as the case
may be, and a member thereof shall be treated as distinct persons.
Thus, in light of the above provisions, view is adopted by the tax authorities that
payment or contribution made by the members of the UJV to the operator is a
consideration for the activities being undertaken by the operator. Hence, they seek to
levy service tax on such transactions.
Further, Education Guide released by the Finance Ministry in relation to Service tax
law, clarified certain aspects pertaining to Association of person (AOP) and its
members. In paragraph 2.4.3, it has been clarified that:
Cash
Calls
Cash
Calls
PSC block
expenses
PSC contractor ‘B’
(Operator)
PSC
Contractor ‘C’
PSC
Contractor
‘A’
Unincorporated JV (UJV)
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“The services provided, both by the so constituted JV or profit sharing association
of persons (AOP), as well as by each of the individual persons constituting the
JV/AOP will be liable to be taxed separately, subject of course to the availability of
the credit of the tax paid by independent persons to the JV/AOP and as otherwise
admissible under Cenvat Rules.”
The industry is of the view that Service tax should not be applicable on the aforesaid
transactions, as each member including operator is providing service to oneself.
Recently a clarification1 was also issued on the above matter giving partial relief
wherein it was clarified that if cash calls are merely a transaction in money, they are to
be excluded from the definition of service provided in section 65B(44) of the Finance
Act, 1994. Whether a 'cash call' is merely a ‘transaction in money' [in terms of section
65B(44) of the Finance Act. 1994] and hence not in the nature of consideration for
taxable service, would depend on the terms of the Joint Venture Agreement, which may
vary from case to case. The final treatment is left to be determined by the tax authorities.
As there is no intention to provide services by the members among themselves but to
pool their expertise, a clarification should be issued that there is no service involved
amongst the UJV members for execution of works under E&P activities.
B. Blockage of Service tax paid on Services consumed in E&P
Activities
In order to boost the natural gas sector in India, the Government of India has provided
for exemptions from customs/ excise duty to specified goods, used for E&P activities,
when imported or purchased from indigenous manufacturers. However, services
consumed by such E&P entities are subjected to service tax.
Production of natural gas is not liable to Excise duty under the Central Excise Act,
1944. Thus, service tax paid on services consumed by E&P entities is not allowed to be
1 179/5/2014-ST, dated September 24, 2014
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claimed as credit/ refund. Hence, tax so paid becomes a cost adding to the overall tax
cost.
Introduction of a refund mechanism in respect of such taxes can bring parity and make
the E&P tax chain neutral.
C. Customs exemption on import of Liquefied Natural Gas (LNG)
NG is a clean fuel used in many sectors other than power such as fertilizer, city gas
distribution (for transport and domestic use), petrochemical, LPG, steel industry etc.
Recognizing the shortage of natural gas, the Government has encouraged the import of
LNG.
In terms of the notification no. 12/ 2012 dated 17th March 2012, customs duty on import
of LNG is exempt if the same is supplied to power generating companies.
Generally, at the time of importation of LNG, end use of the gas so imported is not
known by the importers and thus, availing exemption under the aforesaid notification
basis end use becomes a difficulty.
Instead an unconditional and a blanket exemption from customs duty on import of LNG
would remove the anomaly in availing the exemption. Further, it would benefit various
sectors including the fundamental ones such as fertilizer and steel.
D. Setting up of infrastructure – CENVAT Credit denial
Infrastructural set up i.e. construction of storage tanks, laying of pipelines, etc. is vital
for the companies engaged in regasification or transportation of gas. Taxes paid on such
construction activities form significant part of project costs.
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As per CENVAT Credit Rules, 2004 (rules prescribing the credit/ setoff of central taxes
paid), credit of inputs and input services used for the construction or execution of works
contract of a building or a civil structure; or laying of foundation for support of capital
goods is not available2.
Further, credit of taxes paid on construction expenses is not allowed to the service
providers (e.g. those engaged in regasification/ transportation) contending that such
storage tanks/ buildings/ pipelines qualify as civil structures/ immovable property. This
leads to substantial increase in already exorbitant cost of operating such business.
Further, in certain cases doubts have been raised on the pipe etc contending the goods
were used as an immovable property hence, no credit of taxes paid in relation to such
goods should be allowed.
The founding principle of CENVAT Credit laws is to provide set off of taxes paid by
the manufacturers/ service providers on inputs and capital goods against the taxes
payable on output reducing the cascading effect of taxes and taxing the value additions.
As storage tanks, pipelines etc. are essentially required to provide services, the non-
availability of set offs in respect of duty paid on goods and services used for
construction of such structures renders such activities tax inefficient.
2 The relevant portion of the definition of ‘inputs’ and ‘input services’ as defined under the CENVAT Credit Rules, 2004 as
follows:
“(k) “input” means -
(iv) .....
but excludes -
(A) ....
(B) any goods used for-
(a) construction or execution of works contract of a building or a civil structure or a part thereof; or
(b) laying of foundation or making of structures for support of capital goods,”
“(l) “input service” means any service, -
(ii) ...excludes,-
(A) service portion in the execution of a works contract and construction services including service listed under clause (b) of
section 66E of the Finance Act] (herein referred as specified services) in so far as they are used for –
(a) construction or execution of works contract of a building or a civil structure or a part thereof; or
(b) laying of foundation or making of structures for support of capital goods, except for the provision of one or more of the
specified services; or”
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To avoid ambiguities around interpretation of law resulting into disputes and following
the underlying principles of CENVAT Credit, a clarification should be issued allowing
credit of the taxes paid on goods and services used for setting up the infrastructure.
E. Value Added Tax and service tax on Sale and Transport of Gas
Transmission charges are collected separately for transmission of gas by the suppliers
in addition to sale price of gas.
Such suppliers selling and transmitting natural gas to the customers’ premises consider
the entire transaction as 'sale' transaction and pay sales tax/VAT3 on the 'total price'
including transmission charges.
Service Tax was made applicable on the category of 'transportation of goods through
pipeline' with effect from 16.06.2005. Thus, disputes by tax authorities have arisen on
the applicability of service tax on such transmission charges recovered from the
customer along with the sale price of gas.
Payment of VAT and service tax on transmission charges results in double taxation and
thus, it has invited huge tax disputes.
In this regard, Hon’ble Gujarat High Court4 held that the manner of raising sale bill
(whether the transportation charges are embedded in the cost of gas or shown
separately) does not alter the basic nature of such contract which remains essentially a
'contract for sale'. This ruling further substantiates that such transactions do not involve
any element of service and are purely sale transactions not liable to service tax.
However, due to overlapping tax provisions under sales tax/VAT and service tax, this
issue continues to be a grey area.
3 Value added tax (VAT) is levied by the State governments on sale of goods within the state. 4 CIT (TDS) v/s Krishak Bharati Cooperative Limited
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A clarification issued by the service tax authorities that such transactions do not involve
any service element and hence not liable to service tax would help to resolve the issue.
F. Inter-state supplies to customers – Liable to VAT or CST
The Central Sales Tax Act, 1956 (CST Act) seeks to levy tax on sale of goods taking
place ‘inter-state’. As per section 3 of CST Act, 1956, sale or purchase of goods is
deemed to be in the course of inter-state trade or commerce if the sale or purchase
occasions the movement of goods from one state to another5. Here, movement of goods
is understood as physical movement of goods. Where the supplies qualify as ‘inter-state’
supply (purchase from outside the state), goods can be purchased at 2% (by resellers
and manufactures) as against VAT applicable on local purchases (purchase from within
the state) at 5% to 26%6.
To illustrate, where gas is supplied from Gujarat to a customer in Uttar Pradesh:
The transaction qualifying as inter-state sale, would attract CST at the rate of
2% payable to the Gujarat tax authorities
Where the gas is stock transferred (gas is transported in Uttar Pradesh) and then
sold to customer in Uttar Pradesh, VAT at the rate of 26% would be applicable
in the state of Uttar Pradesh.
This transaction may be depicted as follows:
5 Section 3 of the CST Act reads as under:
“A sale or purchase of goods shall be deemed to take place in the course of inter-State trade or commerce if the sale or
purchase -
(a) occasions the movement of goods from one State to another; or
(b) is effected by a transfer of documents of title to the goods during their movement from one State to another.
............”
6 Depending upon the State
Inter-state Supply Supplier
Option 1: CST @ 2% in
Gujarat
Customer
UTTAR PRADESH GUJARAT
Option 2: VAT @ 26% in
UP
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As the availability of natural gas in the country is not enough to cater to the needs of
the various industries, the same is also imported from outside India. Gas available from
different sources (domestic as well as imported) is co-mingled/ pooled and supplied
through common pipeline network to fulfil the requirements of gas on pan India basis.
As it is not possible to have separate pipeline infrastructure for each source, different
suppliers from different states commonly access the pipeline network. Due to above
trends of co-mingling and pooling, it has become difficult to demonstrate physical
movement of gas originating from each source corresponding to its final delivery/sale
to consumers. Since tax treatment under existing VAT/CST laws is largely dependent
on physical movement of goods, it is very challenging to ascertain real tax liability
under the circumstances where gas originating from different sources is co-mingled.
Where suitable amendments are made in the existing provisions of the CST Act so as
to facilitate trading of goods through pipeline network, the above could be resolved.
G. Concessional CST against Form C on goods required for laying of
pipeline network
Under the CST Act, concessional rate of tax at 2% is applicable on inter-state sale of
goods used for certain specified purposes (resale, use in manufacture/processing or for use
in mining, generation of electricity or any other form of power) against issuance of Form C.
As the goods required for use in natural gas pipeline network are not covered above,
natural gas transmission companies are not able to issue Form C for purchase of goods
for construction of pipeline network at concessional tax of 2%.
Laying of cross country pipelines including connecting gas source to ultimate
consumers is a priority for achieving the energy security of the country. Amendment of
the existing CST provisions so as to make the pipeline transmission projects eligible
for inter-state procurement of goods against Form C will reduce the project cost and
will ultimately benefit the consumers.
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IV Proposed GST Regime
GST was first announced to be introduced with effect from 2010, way back in 2006.
GST is set to replace the plethora of indirect taxes both at the Central (excise duty, CST,
etc.) as well as State Government’s level (VAT, entry tax, etc.), reducing the cascading
effect of taxes, simplifying the tax compliances and administration and creating a
common market.
Extensive discussions over last several years have taken place on the issue of inclusion
of petroleum products (diesel, petrol, ATF) including Natural gas in the ambit of GST.
While Centre wanted petroleum products (including natural gas) to be part of GST,
some States were averse due to revenue considerations (as States generally levy VAT
at a rate higher than the standard rate).
The recent Constitutional Bill tabled in the Parliament seeks to keep both the options
open. Natural gas has neither been specifically excluded from GST ambit nor the power
of the Central and State Government to levy Excise duty and VAT on the same has
been withdrawn. Further, the GST Council has been empowered to recommend a date
from which GST shall be levied on natural gas. The Constitutional Amendment Bill is
likely to be taken up for voting in the upcoming budget session around March 2015.
In the above backdrop, there are three possible scenarios regarding the treatment of
natural gas under the GST ambit:
It is included within GST ambit
Its exempted from GST
It is zero rated under the GST regime
In the following sections, we have discussed the possible implications on the overall
gas value chain under the above scenarios.
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A. Included under GST
This would entail treatment of natural gas like any other products. Existing taxes would
be discontinued.
There would be free flow of credits for suppliers of natural gas and other products under
the proposed GST regime. A typical value chain for a supplier engaged in activities of
trading and transmission of natural gas under the scenario is depicted below:
Under this scenario, input GST paid on goods and services (transaction 1 and 2) would
be available as credit against the output GST liability on sale and transmission of natural
gas (transaction 3 and 4). Thus, there will be no denial of GST paid in the chain resulting
in efficiency across the chain.
Currently, as excise duty (tax on manufacture of goods in India) is exempt and CST at
2% is applicable on inter-state supplies, assuming natural gas is taxed at standard rates
(say at 20% to 22%) like any other product, it is likely to result in increase in tax cost
for customers with no ability to claim credit (e.g. power plants). This would require
levy of GST at concessional rate, for users who do not have ability to claim credit of
GST paid on natural gas (such as power plants) to maintain parity of overall tax burden
with current regime.
NG Supplier
Customer Trader/ Transporter
Other Suppliers Customer
Purchase of NG – GST
(credit available against
output GST)
CAPEX/ OPEX – GST
(credit against output GST)
Transportation Service-GST
Sale of natural gas-
GST
1
2
3
4
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B. GST Exempted
If natural gas is exempted from GST and existing taxes such as VAT is continued to be
levied, suppliers engaged in trading (exempt) and transportation (taxable) activities
would end up with hybrid regime i.e. subjected to current taxes as well as GST regime.
The value chain of such supplier is depicted below:
Sale of natural gas would be an exempt activity (transaction 3) with levy of VAT (as
under the current regime). Transmission of gas (transaction 4) would be subject to GST
levy. The suppliers would face the following challenges:
It is not clear whether GST paid on opex (transmission charges) and capex (GST
paid on pipelines), which would be used both for GST activity (such as re-
gasification, transportation) and non GST activity (sale of gas) would be
allowed as full credit against the GST (say output GST liability on
transportation of gas). As the States would be losing revenue, full credit may
not be allowed. Where full credit is not allowed, this would lead to additional
tax cost;
The suppliers would be subject to tax administration by both GST (on
transportation of gas) and VAT (on sale of gas) authorities requiring compliance
for both regimes such as tax returns, assessments, complying with invoicing
requirements, etc.
C. GST Zero Rated
NG Supplier
Customer Trader/ Transporter
Other Suppliers Customer
Purchase of NG
GST Exempt
VAT
CAPEX/ OPEX - GST
(credit?)
Transportation
Service
GST
Sale of natural gas-
GST Exempt
VAT
1
2
3
4
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In view of the challenges under the above two scenarios, natural gas may subjected to
zero rate GST regime i.e. while VAT may be levied on sale of gas (as under the current
regime) however, GST paid on capex and opex should be refunded.
The value chain of the supplier under such scenario is depicted below:
In the above flow of transactions, where trader/ transporter is not able to claim credit
of taxes paid on capital goods and services (1 and 2), it should be entitled to claim
refund of such taxes.
While the refund of input taxes may result in cash flow implications a robust time bound
refund mechanism would help to minimize the adverse impact.
The final treatment of petroleum products including natural gas is under discussion
however, owing to revenue considerations raised by the states, it may be accorded GST
exempted treatment (with existing tax regime continue to apply).
D. Way forward
Even after extensive discussions over the issue, no final consensus has been reached
yet. The final decision regarding inclusion under the GST net is left on the GST
Council. The importance of inclusion under the GST regime would need to be conveyed
to the stakeholders on the following lines:
NG Supplier
Customer Trader/ Transporter
Other Suppliers Customer
Purchase of NG
No GST
VAT
CAPEX/ OPEX - GST
Credit against output
GST/ refund
Transportation Service - GST
Sale of natural gas- No
GST
VAT
1
2
3
4
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Natural gas, unlike other petroleum products, is used primarily as an industrial
input (and not as fuel in vehicles, etc. akin to HSD, Petrol in scale) by power/
fertilizer units, which are all thrust sectors for the economy. As natural gas is
predominantly used in industrial sector and is an environmental friendly fuel, it
should be considered for inclusion even without including other petroleum
goods
Natural gas does not generate any negative externalities and hence, should not
be treated as a demerit product
Share of contribution of natural gas to state revenue in comparison to
contribution of other petroleum goods (such as diesel, petrol, ATF) is not
substantial. Some states have already accorded a concessional VAT rate at least
for certain users (e.g. domestic supplies). Thus, inclusion of natural gas in the
ambit of GST may not have significant effect on the exchequer of the states
Internationally natural gas is generally accorded similar treatment as other
goods under GST. For the treatment under key economies refer Annexure 1
Even if it is finally decided to exclude natural gas from GST, it should at least
be zero-rated with time bound refund mechanism and not exempted.
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Annexure I:
Illustrative treatment of natural gas in global economies
S.
No. Particulars European Union Australia Malaysia Canada
1 Applicability of GST/
VAT Yes Yes Yes Yes
2 Standard/
Concessional rate Standard rate Standard rate Standard rate Standard rate
3 Availability of credit/
set off of GST paid by
business consumers or
traders of natural gas
Available Available Available Available
4 Any other tax
applicable Not applicable Not applicable Not applicable Excise duty
