Budget fails to cheer oil drilling sector

Budget provisions

The following announcements have been proposed in the Union budget 2008-09:

• The Assam Gas Cracker Project sanctioned in April 2006 is being executed at a cost of Rs.5,461 crore. The capital subsidy of Rs 2,138 crore (Rs 21.38 billion) for the project is to be provided by the Central Government. The outlay for this project is being stepped up suitably.
• Minimum Alternate Tax (MAT) to be increased to 15% of book profits from 10%. The period allowed to carry forward the tax credit under MAT to be extended from seven years to ten years.
• Tax holiday under section 80-IB(9) of the Income Tax Act, which was hitherto available in respect of profits arising from the commercial production or refining of mineral oil, to be extended to natural gas. This tax benefit to be available to undertakings in respect of profits derived from the commercial production of mineral oil and natural gas from oil and gas blocks which are awarded under the NELP-VIII round of bidding. The section to be retrospectively amended to provide that "undertaking" for the purposes of section 80-IB(9) will mean all blocks awarded in any single contract.
• Fringe Benefit Tax (FBT) on the value of certain fringe benefits provided by employers to their employees to be abolished.
• Introduction of the Goods and Services Tax (GST) with effect from 1st April, 2010.

Industry expectations

• Withdrawl of service tax on oil and exploration production
• 100% tax holiday for a period of any 10 consecutive years out of 15 years beginning with the year in which the undertaking starts commercial production or refining of mineral oil
• Weighted deduction of 150% of the actual expenses incurred by the assessee in respect of drilling and exploration activities
• Deduction for expenditure incurred on drilling and exploration activities by an Indian company with overseas production block
• Exemption of oil and gas profits from minimum alternate tax-Not fulfilled. Contrary MAT tax rate has been increased to 15% of book profits from 10%.

Budget impact

Union Budget 2009-10 provided for extension of tax benefits to Natural gas under section 80-IB(9) of the Income Tax Act. This tax benefit to be available to undertakings in respect of profits derived from the commercial production of mineral oil and natural gas from oil and gas blocks which are awarded under the NELP-VIII round of bidding.

The hike in Minimum Alternate Tax (MAT) from 10% to 15% is an irritant for the corporate sector.  On the positive side, this hike has come with a benefit of extending the period allowed to carry forward the tax credit under MAT from seven years to ten years.

Also, the hike in MAT will not be earnings dilative but will only be cash flow dilative.  The increase in liability towards MAT will be matched by an incremental deferred tax credit.

Hence, the net profit or EPS of a company will not change due to hike in MAT from 10% to 15%.  But it will mean increase in cash outflow, and if the company is not returning to profits as per Income tax act within ten years, then it may have to forego them.

So, from a current year(s) point of view, increase in MAT from 10% to 15% is not earnings dilative but cash flow dilative. On the other hand, the removal of Fringe Benefit Tax (FBT) is a major positive for Corporate India.

Increase in MAT rates from 10% to 15% is negative for the oil and gas sector as these companies normally earn higher book profits in the initial years after commercial production begins, since the tax deductions in respect of exploration and drilling expenditure is granted on an accelerated basis.

Stocks to watch

ONGC, RIL, Cairn India

Outlook

No major industry specific announcement was made in the Union budget 2009-10 besides providing clarity to extension of tax holiday to natural gas from earlier available only to exploration of crude oil.

However this tax benefit to be available to undertakings in respect of profits derived from the commercial production of mineral oil and natural gas from oil and gas blocks which are awarded under the NELP-VIII round of bidding. Overall the budget is neutral to the sector.