Commr.Of Income Tax, Dehradun & Anr vs M/S Enron Oil & Gas India Ltd

5. During the year, EOGIL debited its P&L account by exchange loss of Rs. 38,63,38,980. The A.O. disallowed this loss on the ground that it was a mere book entry and actually no loss stood incurred by the assessee.

13. The above analysis of the PSC indicates that both the Government and the Contractor are entitled to their "take" in oil and not in money. That is why the contract is called as Production Sharing Contract and for that purpose it becomes necessary to translate costs into oil barrels. This is done by dividing the monetary value of costs by the agreed price of oil. The price of oil generally is bench-marked - x% above Brent Crude quotation, or it may depend on oil market price.

28. To sum up, the simple question which arises for determination in this civil appeal is whether translation losses are illusory or real losses? According to the Department, they are illusory losses.

30. There are two main systems around the world: royalty/tax systems or production sharing systems. PSCs have become the fiscal system of choice for most countries. Taxes are embedded in the Government share of profit oil. PSC is a complex system. In it, the foreign company provides the capital investment in exploration, drilling and construction of infrastructure. The first proportion of oil extracted is allocated to the company, which uses oil sales to recoup its costs and capital investment. The oil used for this purpose, namely, to recoup capital investment and cost is termed as "cost oil". Once costs have been recovered, the remaining "profit oil" is divided between the State and the company in agreed proportions. The company is taxed on its profit oil. Sometimes, the State participates either itself or 21 through its nominee as a commercial partner in the contract, operating in joint venture with foreign oil companies. In such cases, the State provides its percentage share of capital investment, and directly receives the percentage share of cost oil and profit oil.

31. As stated above, in PSC, the foreign company provides the capital investment and cost and the first proportion of oil extracted is generally allocated to the company which uses oil sales to recoup its costs and capital investment. The oil used for that purpose is termed as "cost oil". Often a company obtains profit not just from the "profit oil", but also from "cost oil". Such profits cannot be ascertained without taking into account translation losses. Moreover, as stated above, taxes are embedded in the profit oil. If these concepts are kept in mind then it cannot be said that "translation losses" under the PSC are illusory losses.

32. Before concluding, we may point out that on behalf of the Department, great emphasis was placed on clause 3.2 of Appendix `C' annexed to the PSC which inter alia referred to costs not recoverable and not allowable under the Contract (PSC). In the said clause it was stated that exchange losses on loans or other financing would not be admissible for deduction. We find no merit in this argument advanced on behalf of the 22 Department. As stated above, "Cash Call" is not a loan. It is a contribution made into the Account of the Operator by each co-venturer in USD. Clause 3.2 of Appendix `C' refers to loans borrowed by an assessee or loans which are financed on which the assessee has to pay interest. Interest costs incurred by the assessee on such loans is not allowable under clause 3.2 of Appendix `C' to the PSC. That clause is not applicable for cash call/contribution. It may be noted that PSC is a special regime. It does not come under Accounting Standard 11. Note 12 annexed to the Accounts for the year ending 31.3.1999 refers to carrying costs of fixed assets financed through loans. This Note refers to the P&L account of EOGIL. It is a comment regarding the 2nd tier whereas clause 1.6.1 of Appendix `C' to the PSC refers to tier 1. If one keeps in mind the concept of PSC being a separate regime and if one keeps in mind the concept of cash call being an investment and not a loan then the entire controversy stands resolved. In this case, we are concerned with foreign currency transaction under which all monetary balances were required to be translated at the exchange rates prevailing as on the last date of the accounting year (balance sheet date) and accordingly the resultant translation gains/losses were required to be recognized which is referred to in Note 1(d) to Schedule R, annexed to the Accounts for the year ending 31.3.1999.

33. For the aforestated reasons, we find no merit in this civil appeal and the same is dismissed with no order as to costs.

September 2, 2008.