Section 42 of the Act pertains to special provision for deduction in case of business for prospecting etc. for mineral oil. This section has been enacted to permit an assessee to claim an allowance which may on general principles be inadmissible, e.g., allowance in respect of expenditure which would be regarded as an accretion to capital on the ground that it brings into existence an asset of enduring benefit or to constitute initial expenditure incurred on the setting up of a profit – earning machinery in motion. It must further be noted that this concession can be availed of only in relation to contract or arrangements entered into by the Central Government for prospecting for, or the extraction or production of mineral oils.
42. Special provision for
deductions in the case of business for prospecting, etc., for mineral oil
[1][(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 [2][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 : [3][***]
[4][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.
[5][(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:
[6][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.
[7][Explanation
: For the purposes of this section, “mineral oil” includes petroleum and
natural gas.”
KEY NOTE
1. Section 42
renumbered as sub-section (1) thereof by the Finanace (No.
2) Act, 1998, with effect from 01.04.1999.
2.
Substituted for “the association or participation in such business of
the Central Government” by the Finance Act, 1981, with
effect from 01.04.1981.
3. The word “and” omitted by the Finance Act,
1981, with effect from 01.04.1981.
4. Inserted by the Finanace Act, 1981, with
effect from 01.04.1981.
5. Inserted by the Finanace (No. 2) Act,
1998, with effect from 01.04.1999.
6. Substituted by the Finanace Act, 1999,
with effect from 01.04.2000.
7. Inserted by the Finanace Act, 1981, with
effect from 01.04.1981
Section 42(1) provides for deductions in case of business for
prospecting or extraction or production of mineral oils. The deduction is
available to an assessee which has entered into an agreement with the Central
Government (tabled before each House of Parliament), whereby allowances
mentioned in clause (a)/(b)/(c) shall be made, to be computed in a manner
specified in the agreement.
On analysing section 42(1), it
becomes clear that the said section is a special provision for deductions in
the case of business of prospecting, extraction or production of mineral oils.
It, inter alia, provides for deduction of certain expenses.
Broadly speaking, section 42(1)
provides for admissibility in respect of three types of allowances, provided
they are specified in the PSC. They relate to expenditure incurred on account
of abortive exploration; expenditure incurred before or after the commencement
of commercial production, in respect of drilling or exploration activities; and
expenses incurred in relation to depletion of mineral oil in the mining area.
If one reads section 42(1)
carefully, it becomes clear that the above three allowances are admissible only
if they are so specified in the PSC. For example, in the PSC in question
expenses incurred on account of depletion of mineral oil was not provided for.
Therefore, to that extent, the assessee would not be entitled to claim
deduction under section 42(1)(c).
Under section 42(1), it is made
clear that for the purpose of computing the profits or gains of any business
consisting of prospecting, extraction or production of mineral oil, the
assessee would be entitled to claim deduction in respect of above-mentioned
three items of expenditure in lieu of or in addition to the allowances
admissible under the Act. Further, such allowances shall be computed and made
in the manner specified in the agreement. In short, an assessee is entitled to
allowances which are mentioned in the PSC. According to the department,
translation losses claimed by the assessee were not specified in the PSC and,
hence, they could not be claimed as deduction under section 42(1)
Clause (a) provides for expenditure of infructuous or
abortive exploration expenses [Section 42(1)(a)]
Clause (b) provides for expenditure
in respect of drilling or exploration activities or services
[Section 42(1)(b)]
Section 42(1)(b) provides for
deduction of expenditure incurred in respect of drilling or exploration
activities or services or in respect of physical assets used in that
connection, except for those assets on which allowance for depreciation is
admissible under section 32.
Clause (c) provides for expenditure in relation to the
depletion of mineral oil in the mining area [Section
42(1)(c)]
Section 42(1)(c) speaks of
allowances pertaining to the depletion of mineral oil in the mining area. In
order to be eligible to the deductions, certain conditions are stipulated in
this very section which have to be satisfied by the assessees. As is clear from
the reading of this section, these conditions are as under:
(a) it
grants such special allowances to those assessees who carry on business in
association with the Central Government or with any person authorized by it;
(b) business
should relate to prospecting for, extracting or producing mineral oils,
petroleum or natural gas;
(c) there
has to be an agreement in writing between the Central Government and the
assessees in this behalf;
(d) it is
also a requirement that such an agreement has been laid on the Table of each
House of Parliament;
(e) the
allowances which are claimed are to be necessarily specified in the agreement
entered into between the two contracting parties; and
(f) allowances
are to be computed and made in the manner specified in the agreement.
Allowable
expenses
The allowance
permissible under this section shall be in relation to
(i)
the expenditure by way of in fructuous or abortive
exploration expenses in respect of an area surrendered prior to the
beginning of commercial production by the assessee;
(ii)
after the beginning of commercial production,
the expenditure incurred by the assessee, whether before or after such
commercial production in respect of drilling or exploration activities
in services in respect of physical assets used in that connection (except
those assets which qualify for depreciation allowance under section 32);
and
(iii)
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 years as may
be specified in the agreement.
Amount of deduction
Following deductions shall be
allowed as deductions:
(a) Any infructuous exploration expenditure
(b) Expenditure on drilling or exploration
activities or services, etc.
(c) Allowance in relation to depletion of mineral
oil, etc.
§
The
sum of those allowance should be computed and deduction should be made in the
manner specified in the agreement entered into by the Central Government with
any person for the association or participation in the business of the Central
Government for the prospecting or exploration of mineral oil.
§
It
has been specifically provided that the other provisions of the Act are being
deemed, for the purpose of this allowance, to have been modified to the extent
necessary to give effect to the terms of the agreement.
§
It
may be noted that allowances in this regard are made in lieu of or in addition
to the other allowances permissible under the Act, depending upon the terms of
the agreement.
FAQs
Q. : 1 - Can
a business claim a deduction for expenses incurred before obtaining a license
or lease for prospecting, extraction, or production of mineral oil?
Answer : No,
a business can only claim a deduction for expenses incurred after obtaining a
valid license or lease for the above activities.
Q. : 2 - Can
a business claim a deduction for expenses incurred towards environmental
protection?
Answer : Yes,
businesses engaged in prospecting, extraction, or production of mineral oil can
claim a deduction for expenses incurred towards environmental protection.
Assessee oil exploration company
had no choice but to surrender oil blocks as Government of India refused to
extend contract period for oil exploration, act of assessee to hand over oil
blocks before commencement of commercial production would be treated as ‘surrender’
for claiming deduction of oil exploration expenditure under section 42(1)(a)
and, thus, and assessee would be eligible to deduction as claimed by it
Assessee company was awarded a
contract by Government of India for oil exploration in Kaveri basin. On account
of failure to complete project within time, Government of India refused to
extend contract period. Assessee under section 42(1)(a) claimed deduction in
respect of oil exploration expenditure. Since in instant case, assessee had no
choice but to surrender oil blocks as Government of India refused to extend
validity period of said contract, act of assessee company to hand over oil
blocks before commencement of commercial production would be treated as
surrender for claiming deduction under section 42(1)(a) and,
thus, and assessee would be eligible to deduction as claimed by it. [In
favour of assessee] (Related Assessment year : 2008-09) – [PCIT v. Hindustan
Oil Exploration Company Ltd. (2019) 264 Taxman 154 : 106 taxmann.com 117 (Bom.)]
Interprets Section 42(2)(b) on oil-exploration
income; DRP-route inapplicable absent income-variation, tax-rate change
irrelevant
Chennai ITAT allows assessee's (US Company
engaged in exploration/ processing of oil and natural gas) appeal for Assessment
year 2010-11, holds that consideration received on transfer of
participation rights/interests in oil banks and overriding royalty
interest (received as a part of sale consideration) is taxable as capital
gains and not business income under section 42(2)(b); Observes that
participation interests falls under the ambit of capital assets under section 2(14)
which includes property of any kind held by an assessee, whether or not
connected with business or profession”; On observing that provisions of
Sec. 42(2)(b) do not override Section 45 (dealing with capital gains) holds
that Section 42(2)(b) cannot have any bearing on deciding as to whether a
receipt is in the nature of capital receipt leading to capital
gains”; Opines that receipt on transfer of participation rights cannot be
taxed as business income since Section 42(2)(b) only seeks to reverse (under
certain circumstances), the deduction for prospecting expenses already granted
to the assessee in computation of business income whereas in assessee's case no
part of prospecting expenses (in respect of the participation interests sold)
was ever allowed as a deduction; However points out that such
capital gain could be taxed only in the year in which the asset is
transferred (i.e. Assessment year 2006-07) and not subject Assessment year
while adding that the fact that a part of the consideration was to be, and has
been, received later does not alter the year of taxability”; Further, rejects
assessee's stand that the said capital gains cannot be taxed in Assessment year
2006-07 as assessment for that year has achieved finality and time-limit for
reopening of assessment has also expired, holds that ITAT’s finding that
capital gains are taxable only in Assessment year 2006-07 prima facie
constitutes legally sustainable basis for bringing the capital gains to tax in
Assessment year 2006-07 in view of provisions of Section 153(6); Separately
upholds Assessing Officer’s action of directly issuing the assessment
order under section 143(3) without issuing a draft assessment order under
section 144C despite assessee being an 'eligible assessee' (i.e. a foreign
company) under section 144C as no variation vis-à-vis income
returned by the assessee was proposed by the Assessing Officer;
Distinguishes assessee's reliance on Vijay Television (P) Ltd. v. Dispute
Resolution Panal (2014) 46 taxmann.com 100 (Mad.), Jazzy Creations (P) Ltd. v. ITO (2016)
133 DTR 1 (ITAT Mumbai) and Capsugel Healthcare Ltd. v. ACIT (2015)
152 ITD 142 (ITAT Delhi) in this
regard; Rejecting Revenue's objection that the assessee itself had offered
the income as business income holds that the mere fact that the assessee
had made a mistake, by itself, cannot prejudice its legitimate interests
on merits of the claim, relies on Madras High Court ruling in Ramco Cements Ltd. v. DCIT (2015) 373 ITR
146 (Mad.) in this regard. [In favour of assessee] (Related Assessment year : 2010-11) – [Mosbacher
India LLC v. Additional Director of Income Tax (International Taxation) [TS-637-ITAT-2016(CHNY)] – Date of Judgement :
30.11.2016 (ITAT Chennai)]
Production Sharing Contract (PSC)s
entered into between assessee and Union of India through Ministry of Petroleum
and Natural Gas (MOPNG) relating to exploration of certain oil fields did not
include a clause pertaining to section 42, deduction under this section could
not be allowed to assessee
By virtue of section 42 it is Production Sharing Contract (PSC) which governs field
as without it deductions under section42 are not permissible. If PSC does not
contain any stipulation providing for such allowances, Assessing Officer would
be unable to give benefit of these deductions to assessee. Where PSCs entered
into between assessee and Union of India through Ministry of Petroleum and
Natural Gas (MOPNG) relating to exploration of certain oil fields did not
include a clause pertaining to section 42, such deduction could not be allowed
to assessee though assessee acted on understanding that such a benefit would be
given to it. [In favour of revenue] (Related Assessment years : 2001-02 to
2005-06) - [Joshi Technologies
International Inc. v. Union of India (2015) 374 ITR 322 : 277 CTR 409 : 232 Taxman 201 : 57 taxmann.com
290 (SC)]
Expenditure should fall under Section
42(1) clauses, mere Govt. contract not sufficient - For seeking exemption of
any expenditure under section 42(1), assessee has to enter into an agreement
with Central Government of nature mentioned in section 42(1) under which he has
been authorized to incur expenditures falling within either of clause (a) or
clause (b) or clause (c)
Sets-aside ITAT order allowing Section
42(1) deduction to assessee; To claim deduction under section 42, apart from
entering into agreement with Central Government, expenditure should also be
covered under one of the clauses under section 42; Assessee failed to establish
that expenditure incurred under agreement fell in any of the clauses of Section
42(1) of the Act; Rejects Tribunal's reliance on Supreme Court ruling in Enron
Oil and Gas India, Supreme Court did not make any observations contrary to what
has been provided in Section 42(1). Quoting Supreme Court ruling in Enron
Oil and Gas India Ltd. (2008) 305 ITR 77 (SC), High Court observed that ‘A
look on these observations would make it amply clear that the Hon’ble Supreme
Court was not making any observation contrary to what has been provided in
Section 42(1) of the Act.’
If an assessee seeks exemption of
any expenditure under section 42(1), he has to show that he has entered into an
agreement with Central Government of nature mentioned in section 42(1) and
that, under that agreement, he has been authorized to incur certain
expenditures and those expenditures fall within either clause (a) or clause (b)
or clause (c) of section 42(1).
In the instant case, no attempt has
been made by the assessee to establish before any of the Authorities that
expenditures incurred under the agreement entered into by the assessee with the
Central Government fell in any of the Clauses of Section 42(1) of the Act. We,
accordingly, interfere; set aside the judgment of the Tribunal as well as the
judgment of the Commissioner (Appeals) and remit back the matter to the
Commissioner (Appeals) with a direction upon him to ascertain, whether the
expenditure, being the subject matter of dispute, falls under Clause (a) or
Clause (b) or Clause (c) of Section 42(1) of the Act and, if so, to proceed in
accordance with the mandate contained in Section 42(1) of the Act and, if not,
to give an opportunity to the assessee to claim such expenses to be covered by
Section 44C of the Act. [Matter remanded] – [Director of Income-tax v. BG
Exploration & Production India Ltd. (2014) 221 Taxman 355 : 42 taxmann.com
173 (Uttarakhand)]
Foreign exchange losses on account of foreign currency translation, eligible for deduction under section 42
The issue in the instant case was whether foreign
currency translation loss is just a mere book entry and hence notional with no
actual loss to the assessee. The case relates to Production Sharing Contract
(PSC) in oil exploration and hence called for a combined interpretation of
Section 42 of Income Tax Act and PSC. The question before the Supreme Court was
whether translation losses are within the scope of Section 42. Section 42
provides for deduction for expenses, provided such expenses/allowances are
provided for in the PSC. The PSC provides for lost capital and revenue
expenditure. It also provides for a method in which the said expenses had to be
accounted for. PSC is an independent accounting regime. It prescribes a special
manner of accounting which was at variance with the normal accounting standards.
It obliterates the difference between capital and revenue expenditure. In view
of the special accounting procedure prescribed by the PSC, Accounting Standards
II had to be ruled out. Further Section 42 is inoperative by itself. It becomes
operative only when it is read with PSC. Expenses deductible under Section 42
had to be determined as per PSC. Therefore the short question is whether PSC
liable of translation and if so, whether translation losses could be claimed by
the assessee. In the special structure of the PSC, inherently there has to be a
frequent conversion from one currency to the other.
The capital contribution had to be converted under
the PSC at one rate, where the expenditure had to be converted at a different
rate. This exercise resulted into loss/profit on conversion. Under the PSC, the
assessee company had to convert revenues, costs, receipts and incomes.
Therefore currency gains and losses constituted an inextricable part of the
accounting mechanism for expenses incurred on the development and production of
oil. It is because of the specific provision in the PSC for currency translation
that loss/profit accrued to the assessee. It was inter alia provided in the
Appendix ‘C’ to the PSC that any realized or unrealized gains or losses from
the exchange of currency in respect of petroleum operations shall be credited
or charged to the Accounts. Therefore it would be wrong to say that currency
translation losses was only a notional loss/book entry.
Supreme Court held that losses on account of
foreign currency translations fell within the ambit of Section 42 of the Income
Tax Act, 1961. Supreme Court further held that the allowances provided for
under Article 15.2.1 of the Production Sharing Contract (PSC) were the same as
those in Section 42. Supreme Court observed that Clause 1.6.1 of Appendix
“C” to the PSC made a reference of currency exchange rates, which are to be
considered while making the accounts. Supreme Court also held that profits such as “profit
oil” and “cost oil” cannot be ascertained without taking into account
translation losses. [In
favour of assessee] (Related Assessment year : 1999-2000) – [CIT, Dehradun v.
Enron Oil & Gas India Ltd. (2008) 305 ITR 75 : 218 CTR 641 : 173 Taxman 346
: [TS-60-SC-2008] (SC)]
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