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ROYALTY PAYMENT TO GOVERNMENT - UN-DESIRABLE LITIGATION EVEN BEFORE THE SUPREME COURT IN FACT AO SHOULD NOT HAVE DISALLOWED

Income Tax - By: - CADEV KUMAR KOTHARI - Dated:- 6-1-2017 - Relevant PROVISIONS AND LINKS: Sections 37 and of the Income-tax Act, 1961 Section 92(F)(ii) was also considered by honourable High Court, as an aid to find out reasonableness based on árms length pricing. Section 6A(4) of the Oilfield (Exploration and Development Act), 1948, Commissioner of Income Tax Versus Oil And Natural Gas Corporation Ltd. 2016 (12) TMI 252 - SUPREME COURT Commissioner of Income Tax, Dehradun Versus Oil An .....

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ibunal for correction of facts. Relevant question was as follows: Whether the ITAT has erred in law by holding that payment made on account of royalty to State Govt. calculated on international price instead of discounted sale price in the nature of allowable business expenditure? From this question it is clear that facts found by Tribunal were not challenged. The amount was allowed by CIT(A) and revenue preferred appeal before Tribunal. Tribunal confirmed finding of CIT(A). Therefore , here was .....

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ould not be litigation. The assessee- Oil & Natural Gas Corporation Ltd (ONGC): The assessee ONGC, in the cited cases is a well-known Central Government Public Sector Enterprise - in fact it is one of nav-ratna PSU. The promoters, at present hold 68.93% of equity shares, as per information obtained from the website of BSE on 29.12.16. Besides, Government Insurance Companies also hold substantial stake. During the years to which litigation relates to Government held much higher stake. ONGC ha .....

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e and found that payment made on account of royalty to State Government was in in excess of 20% . The AO took view that the payment was in excess of limits and was therefore hit by Explanation to S.37 as violation of law was involved. Therefore, the AO disallowed excess payment, as per his computation. As per related notification of government and communication, the payment was made on the basis of international price instead of discounted sale price. This was with a view to avoid loss of revenu .....

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ration of related provisions, notification and communication of Central Government. The relevant substantial question of law in appeal before the High court was as follows: 2. Whether the ITAT has erred in law by holding that payment made on account of royalty to State Govt calculated on international price instead of discounted sale price in the nature of allowable business expenditure? From the question, it is clear that the payment is on account of Royalty and was paid to State Government. Th .....

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ad, we must also view it in the context of the notification read with resolution read with communication. Certainly, we cannot liken it to hafta or extortion money, which appears to have been the intention. It is very fairly conceded by the learned counsel for the Revenue, there is no question of any offence being committed. In fact, the respondents were only faithfully abiding by the decision of the Government of India. In the circumstances of this case, we are therefore of the view that the am .....

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nal, cannot be faulted. In such circumstances, we are of the view that the question of law raised has to be answered against the Revenue. We do so and, consequently, the appeals fail and are dismissed. No order as to costs. Appeal before the Supreme Court: Revenue preferred appeal before the Supreme Court. For the Petitioner/ revenue the following seven senior counsels appeared: Mr. P.S. Patwalia, ASG Mr. Ashok K. Srivastava, Adv. Mr. S.K. Pathak, Adv. Mr. R.K. Rathore, Adv. Mr. Subhash Acharya, .....

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The Special Leave Petitions are dismissed. From reading of the above, we notice that the appeal was filed late with petition for condonation of delay. This shows that the appellant revenue and its officers and counsels were not serious enough. This shows that appeal might have been filed just for filing an appeal, fully knowing that there is no merit in appeal. Is it not wastage of human resources of our country? Does this not amount to wasteful expenditure on undesirable and un-necessary litig .....

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horities. A businessman will not pay a sum unless he is required to pay under a law, contract or as per commercial expediency. The tax authorities must have some respect and regard to the wisdom of businessman. An expenditure which is incurred for the purpose of business in normal course of business, must be allowed taking into account point of view of businessman. In this case it is not clear, whether there was any dispute on amount of royalty fixed. Even if there was a dispute, and suppose som .....

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to earn money. In this case as noted earlier seven counsels appeared before the Supreme Court on behalf of revenue. Can one dare to ask- whether it was necessary to have a team of seven senior counsels to appear in this case? Was it not a case fit for withdrawing the appeal by revenue? Is it not a case in which an assessee had to fact un-necessary litigation and incur costs to safeguard against wrong doing of the AO in disallowing the Expenditure. A fit case for awarding costs: As discussed abov .....

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olous or un-necessary appeals. However, unfortunately despite policy decision to avoid un-necessary appeals, the revenue authorities are preferring appeal, even when tax effect is low and even when over a period of time there is no tax effect at all. In case of matters related with PSU like ONGC filing of appeal also involves scrutiny and approvals by various authorities and counsels. Therefore, in such a situation, filing of appeal, on an issue which is devoid of merit must have been avoided. H .....

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oach adopted by government authorities with primary target to deny a legal benefit and to burden public with monetary costs, lot of wastage of human resources of highly qualified people take place. Unproductive and un-necessary work has to be done. This causes brain drain and wastage of human resources. Expenditure incurred on such unproductive work cause higher cost to public that is recovered by higher taxes. If un-necessary work be eliminated, then only there will be proper credit to producti .....

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nt of royalty to State Govt. and Expenditure incurred on Dry Docking expenditure - Held that:- We do not find any legal and valid ground for interference. The Special Leave Petitions are dismissed. Judgment / Order Ranjan Gogoi And L. Nageswara Rao, JJ. For the Petitioner : Mr. P.S. Patwalia, ASG Mr. Ashok K. Srivastava, Adv. Mr. S.K. Pathak, Adv. Mr. R.K. Rathore, Adv. Mr. Subhash Acharya, Adv. Mr. D.L. Chidananda, Adv. Mrs. Anil Katiyar, Adv. For the Respondent : Mr. Arvind P. Datar, Sr. Adv. .....

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Order K. M. Joseph, CJ And V. K. Bist,JJ. For the Appellant : Mr Hari Mohan Bhatia, Adv For the Respondents : Mr Rupesh Jain & Mr Udhoyg Shukla, Advs JUDGMENT K M Joseph,CJ (Oral) The appeals, two in number, are related to the assessment year 2006-2007. Following are the substantial questions of law, which have been raised: 1. 2. Whether the ITAT has erred in law by holding that payment made on account of royalty to State Govt. calculated on international price instead of discounted sale pr .....

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ssessment year in question, namely, 2006-2007, noticing the reports in the Economic Times that royalty is being paid at the rate of 29% to the State Governments by the assessee, the Assessing Officer issued notice calling upon the appellant to explain how despite the injunction contained in Section 6A of the Oilfield (Regulation and Development) Act, 1948, the assessee could have paid 9% extra. The reply of the assessee is as follows: Payment of Royalty In response to this, the assessee submitte .....

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advised by new scheme of royalty on crude oil effective from Apr 98, vide MoP&NG s resolution dated 17 Mar 03, which was notified vide Gazette Notification dated 16 Dec 04 (copy enclosed as Annexure-VII). MoP&NG, vide letter no. P-20012/2897-PP dated 30 Oct 03 conveyed the decision of the Government that the revenue of State Governments in terms of royalty on crude oil will not be affected by discount on ONGC s crude oil (copy enclosed at Annexure-VIII). As replied in point 2(i) of our l .....

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ayable is allowable. In our view payment of the entire amount of royalty is, an expenditure incurred by ONGC wholly and exclusively for the purposes of its business, the same having been made to secure a valuable business right viz., the right to receive its share of production from various fields and is entirely as per direction of Government of India (refer letter No. P-20012/2897-PP dated 30-10-2003 enclosed at Annexure-VIII). The entire amount of royalty paid by ONGC is, therefore, fully ded .....

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otal 3958.74 661.11 4619.85 (ii) Onshore Royalty (Provisional) on Pre Discount Prices as well as on Post Discount Prices: (Rs. in crore) Particulars Royalty based on pre disc. Price Royalty based on post disc. Price (provisional) NG-IOCL 1005.52 562.83 SG-IOCL 639.42 399.08 Eastern Region-IOCL 80.38 49.77 Eastern Region Other Refineries 268.76 268.76 RJY-HPCL-Onshore 68.89 34.66 Cauvery-CPCL 118.99 118.99 Total 2181.96 1434.09 The assessee further contended that the amount of royalty was payable .....

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er was not inclined to accept the explanation offered by the assessee and the Assessing Officer disallowed the royalty paid in excess of 20%. The Assessing Officer actually taxed the difference in royalty paid between the pre-discount and post-discount price. The Appellate Authority in appeal, however, accepted the contention of the assessee and found that all the ingredients for allowing royalty as revenue expenditure were present and it could not be said to be hit by the explanation given in S .....

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y of crude oil to various Government oil companies such as HPCL, BPL etc. As per new scheme of royalty on crude oil effective from April, 1998 notified by the Government as per Gazette notification dated 16-12-2004, it was decided that the revenue of State Governments in terms of royalty on crude oil will not be affected by discount on ONGC s crude oil. ONGC has paid royalty on Onshore production to State governments as per these instructions of the Central Government. The AO has noted in the sa .....

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since royalty is payable at maximum rate of 20% of the sale price at wellhead, any payment in excess thereof is infraction of law and hence, not allowable. On this basis, he made disallowance of ₹ 747.87 crores, being the difference in the royalty amount paid on pre discount price and payable based on post discount price. One more reason is given by the AO. This reason given is that when reduced price is taken into account for sales, royalty paid on extra price is not allowable. Being agg .....

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order. 19. We have considered the rival submissions. We find that the reasons for making payment of royalty to State Governments for onshore productions based on pre discount price has been explained by the assessee before the AO and it has been submitted that the said payment is as per the guidelines and instructions of Central Government. In view of this factual position, we are of the considered opinion that the AO is not justified in holding that such payment of royalty to State Governments .....

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d since such extra sale revenue has not been taken to the credit of profit and loss account of the assessee, payment of royalty thereupon cannot be allowed as expenditure. We find that this objection of the AO is also without any basis because it is a Government policy to make the sales at reduced price but royalty payable to State Government is on pre discount price. We are of the considered opinion that for this reason also, the payment of royalty cannot be disallowed. Considering all these fa .....

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e Income Tax Act (hereinafter referred to as the Act ), inasmuch as, the said provision expressly prohibits claiming of any expenditure as revenue expenditure if inter alia the item is one which amounts to commission of offence or one which is prohibited by law. He does not have a case that the payment of the excess royalty, which is involved in this case, amounts to an offence, but he would firmly contend that the excess royalty paid by the respondent assessee is prohibited by Section 6A of the .....

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ibits the payment of royalty in excess of 20% of the Well Head Price and admittedly, as in this case, royalty has been paid by the respondent assessee by taking into consideration the international price and not the post-discount price, at which latter price, crude oil has been sold to the OMCs (Oil Marketing Companies), clearly, there is violation of Section 6A. Therefore, the explanation of the assessee should not be accepted. 8. Per contra, the learned counsel for the respondent assessee woul .....

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d as follows: MINISTRY OF PETROLEUM AND NATURAL GAS RESOLUTION NEW DELHI, the 17th March, 2003 No. O-22013/1/2001-ONG-III- The Government vide its Resolution No. 224 dated 21-11-1997 decided the phased dismantling of Administered pricing Mechanism (APM). In the aforesaid resolution, it was envisaged that the prices payable to the indigenous crude oil producers will be linked to the increasing percentage of international prices Free on Board (FOB) in place of cost plus based prices prevalent till .....

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te of Public Finance & Policy (NIPFP), an eminent autonomous body supported by the Ministry of Finance. After considering the recommendations of the Committee and subsequent views of some of the State Governments, the Government has decided to introduce new Scheme of Royalty on crude oil w.e.f. 01-04-1998. The salient features of the new Scheme are as follows:- (i) The revised royalty dispensation will be applicable to the areas granted to National Oil Companies on nomination basis, the expl .....

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ctively will be made in order to determine the wellhead price. (vi) For the period 1-4-1998 to 31-3-2002: (a) Royalty will be paid on the wellhead price derived as at sub para (v) above and calculated on the basis of notified percentages of weighted average FOB price of actual import of crude oil stipulated in the Government Resolution on dismantling of the APM. (b) Royalty on crude oil production from onland and shallow water offshore areas (upto 400 mts water depth) will be paid @ 20% of the w .....

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With effect from 01-04-2002: (a) The wellhead price of crude oil as derived from the market driven price obtained/obtainable by the producers based on arm s length transactions will be considered for royalty calculations. (b) For crude oil productions from onland areas, royalty will be paid @ 20% of the Wellhead price as derived from the price determined as at sub sub para (a) above till the year 2006-07.The convergence process may commence w.e.f. 2007-08 with tapering rates of royalty @ 1.5% e .....

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een made very clear by the communication dated 30th October, 2003 issued by the Government of India to the Chairman & M.D. of the respondent assessee among others and, therein, it is stated in clause (vi) as follows: The revenue of State Governments in terms of royalty on crude oil will not be affected by the discount on ONGC s crude oil. 10. He would further submit that the expression prohibited by law must be understood in the context of the object which is sought to be achieved. In this r .....

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rotection money, extortion, hafta, bribes etc. as business expenditure. This amendment will take effect from 1st April, 1962 and will accordingly apply in relation to the assessment year 1962-1963 and subsequent years. 11. Therefore, he would submit that it is inconceivable that the payment made by the respondent assessee, a Government of India undertaking, of the royalty to the State Government in terms of the Government of India s policy and directions could amount to protection money, extorti .....

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ate Governments, it could not be said that there is any violation of the explanation. Lastly, he would submit that the Revenue has impugned the decision in respect of this matter in regard to the year 2006-07 in these appeals, but he reminds us that in regard to the other assessment years, where similar question arose and the Appellate Authority took the similar view as was taken in this case, it has not been subjected to appeals and therefore, on principles analogous to res-judicata, the presen .....

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Section 11 of the C.P.C. and his attempt would appear to be that had it been for the previous year that the assessee had not challenged the order, there might have been some merit. On the other hand, the assessment year, where the assessment had became final at the hands of the appellate authority or at the higher level, relates to 2007-08 and therefore, we would not think that in the facts of this case, we should throw out the Revenue s case on the basis of res judicata. 13. The respondent asse .....

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969, shall, notwithstanding anything contained in the instrument of lease or in any law in force at such commencement, pay royalty in respect of any mineral oil mined, quarried, excavated, or collected by him from the leased area after such commencement, at the rate for the time being specified in the Schedule in respect of the mineral oil. (2) The holder of a mining lease granted on or after the commencement of the Oilfields (Regulation and Development) Amendment Act, 1969, shall pay royalty in .....

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or natural gas, or both. (4) The Central Government may, by notification in the official Gazette, amend the Schedule so as to enhance or reduce the rate at which royalty shall be payable in respect of any mineral oil with effect from such date as may be specified in the notification and different rates may be notified in respect of same mineral oil mined, quarried, excavated or collected from the areas covered by different classes of mining leases; Provided that the Central Government shall not .....

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oil produced from such areas from the whole or any part of the royalty leviable thereon. 14. Undoubtedly, under Section 6A(4) of the Oilfield (Exploration and Development Act), 1948, the Government can issue a notification fixing the rate of royalty. The proviso is a limitation on the maximum rate of royalty that can be fixed. It expressly provides that royalty cannot be in excess of 20% of the Well Head Price. It is necessary at this juncture to notice the facts. The respondent assessee produce .....

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at is to say, there will be rise in the price. Apparently, the Government of India had a policy, under which the price was to be controlled. The result was that the oil companies like the respondent assessee were asked to sell the oil, which they drilled at a discount to OMC s. This is what is the post-discount price. If the amount of royalty, which the appellant paid to the State Government, is calculated with reference to the post-discount price, then there would be a violation of Section 6A, .....

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ed 30.12.2003, which we have already adverted to and extracted. In other words, the royalty to the State Governments is to be paid on the pre-discount price. Now the central issue, which we are called upon to resolve, is that arising from Section 37 of the Income Tax Act, inasmuch as, under the explanation that which is prohibited cannot be allowed as a revenue expenditure. At this juncture, we must notice the case of the respondent assessee with reference to Notification dated 16.12.2004, which .....

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l Head Price in terms of the aforesaid formula in Clause (a). The effect of a conjoint reading of Clauses (a) and (b) would be that the Government of India decided that for the purpose of calculation of royalty, the Well Head Price will be the market driven price on the basis of the arm s length transactions. Therefore, the contention is that the price, which is a controlled price or rather the post-discount price or in other words, the price at which the respondent assessee had to sell to the O .....

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ction between persons other than associated enterprises, in uncontrolled conditions; 15. No doubt, the said definition is actually meant for the sections, which are mentioned therein; but generally, as a concept, price at arm s length would appear to mean the description of an agreement made by two parties freely and independently of each other. In other words, Well Head Price for the purpose of calculating the royalty has been understood to mean by the Government of India, which is the Authorit .....

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e, at which the respondent assessee has sold the crude oil to the OMCs, which is the discounted price. If we were to look at the situation in the context of the notification read with the resolution read with the communication, which we have adverted to, the Government of India intended as we have already found, on the one hand, that the oil should be sold by the oil producers to the oil marketing companies at a discount, which is intended to pass on to the consumers and, at the same time, prese .....

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