1. These are the cross-appeals filed by the assessee and the Revenue against the order of CIT(A) dt. 10th Dec., 2007 for the asst. yr. 2002-03.
2. Facts in brief are that the assessee is engaged in exploration, development and production of hydrocarbons in overseas jurisdictions to augment the oil security of India mainly by way of acquiring participating interest in production sharing contracts. During the year under consideration, the assessee through an assignment agreement dt. 10th Feb., 2001 with consortium members and the Russian Government acquired a 20 per cent participating interest in Sakhalin Production Sharing Agreement ("Sakhalin PSA"). The project was implemented between the following parties:
Russian Federation represented by the Government of the Russian Federation and the administration of the Sakhalin Oblast;
Exxon Neftegas Ltd. ("Exxon"),
Sakhalin Oil Development Co-operation Ltd. ("Sodeco"),
Rosneft-Sakhalin ("Rosneft-S") and
The project relates to the Chayvo, Odoptu and Arkutun-Dagi oil, gas and condensate fields, which is offshore Sakhalin Island ("Sakhalin Block"). The PSA was entered into on 30th June, 1995 and was for a period of 25 years. Then the consortium members commenced hydrocarbons operations in the Sakhalin Block. Rosneft-S and SMNG-S held 40 per cent interest in the said Sakhalin PSA and in a joint operating agreement. Vide the assignment agreement dt. 10th Feb., 2001, Rosneft-S and SMNG-S (assignors) assigned 50 per cent of their share in the Sakhalin PSA and in a joint operating agreement to OVI for a consideration of Rs. 15,590.96 million. Consequent to the acquisition of such rights and licenses, the assessee became a consortium member and the assignors were relieved from obligation under the Sakhalin PSA to that extent. Thus, by acquiring 20 per cent participating interest, assessee has become the member of the consortium and acquired proportionate share in rights and licenses granted by the Russian State for Sakhalin Block. By acquiring these business rights and exploration and production licenses, the assessee became entitled to carry on hydrocarbon operations in the Sakhalin Block. The contention of assessee was that the rights and licenses, being intangible assets, were entitled to depreciation @ 25 per cent in view of the amended provisions of Section 32 of the Act.
3. The AO disallowed the claim of depreciation and
other expenses made by the assessee. The AO held that claim of depreciation under Section 32 of the Act and claim for other expenses are not allowable due to the following reasons:
1. The business or commercial rights, envisaged under Section 32 has close link to intangible assets which are in the nature of know-how, copyright, trademarks, franchises, which indicates that it is a right given from a licensor to a licensee in lieu of a payment which is in the nature of royalty, fees for technical services, or any such sum which is of a similar nature. The AO held that when one talks about acquiring an intangible asset, the payment made should be a consideration for the use of copyrights, industrial (sic-intellectual) property rights, equipment and experience or in short intellectual property rights.
2. If the claim of the appellant is accepted that participation rights are in the nature of business or commercial right, as defined in Section 32(1)(ii), it would amount to broadening the ambit of the section to a great extent. In such a situation, any partnership agreement between two entities or various entities would then fall within the purview of business rights and hence depreciation be claimed on any amount of a capital nature, which is in the nature of any investment made for the purpose of any partnership, joint venture agreement or any other agreement.
3. The commercial production did not start in year of acquisition of interest and, therefore, the expenditure is pre-commencement.
4. As per AO, what has been acquired is a participation right in the license to carry out hydrocarbon operations in Sakhalin Block. By the impugned order, the CIT(A) held that the said expenditure even though represents revenue expenditure, yet only 1/19th thereof had to be allowed, since the same represents deferred revenue expenditure. Accordingly, 1/19th of the expenditure so incurred by the assessee was directed to be allowed by the CIT(A) in his appellate order. Aggrieved by this order of CIT(A), both Revenue and assessee are in appeal before us. Revenue is aggrieved for CIT(A)'s direction to the AO for allowing 1/19th of the expenditure, whereas assessee is aggrieved for not allowing the entire expenditure or as an alternative for not allowing claim of depreciation under Section 32(1)(ii) of the IT Act.
5. Following grounds have been taken by the assessee:
1 That on the facts and in the circumstances of the case and in law, the learned CIT(A) erred in not allowing in full an amount of Rs. 1,559.10 crores as claimed by the appellant.
1.1 That the learned CIT(A) erred on the facts and in the circumstances of the case in not appreciating the business intricacies of the oil and gas sector and accordingly erred in not appreciating that the amount of Rs. 1,559.10 crores for getting the rights in exploration and prospecting of hydrocarbons was incurred in the regular course of the business and is a normal business activity.
1.2 That the learned CIT(A) erred in not allowing the claim of Rs. 1,559.10 crores under Section 42 of the IT Act, 1961 (Act) with production sharing contract and the agreement entered into by the appellant with the Central Government.
2. Without prejudice to the ground Nos. 1 to 1.2, and in the alternate the learned CIT(A) erred on facts and in law in not allowing the depreciation claim of Rs. 3,89,77,42,300 being 25 per cent of Rs. 1,559.10 crores claimed by the appellant under Section 32(1)(ii) of the Act.
2.1 That on the facts and circumstances of the case, the learned CIT(A) grossly erred in upholding the action of the learned AO that the acquisition of participating interest in the PSA only gives the appellant an access to the area in which exploration is done and is only a participating right and not a right eligible for depreciation under the Act.
2.2 That on the facts and circumstances of the case and in law, the learned CIT(A) gravely erred in law in upholding the contention of the AO that the payment made for acquiring an intangible asset should be a consideration for the use of copyrights, industrial (sic-intellectual) property rights, equipment and experience and hence must be in the nature of an IPR for being eligible for depreciation under Section 32(1)(ii) of the Act.
2.3 That without prejudice to the above and in the alternative, the AO and CIT(A) erred on the facts and circumstances of the case and in law in not allowing depreciation on tangible and intangible assets acquired by the appellant pursuant to acquisition of 20 per cent participating interest in Sakhalin Block.
3. That on the facts and circumstances of the case and in law, the CIT(A) grossly erred in confirming the action of AO in disallowing revenue expenses of Rs. 43,85,722 incurred on purchase and evaluation of seismic data treating the same as capital in nature.
3.1 That on the facts and circumstances of the case and in law, the AO and the CIT(A) grossly erred in not appreciating that this expenditure has been incurred in evaluating business opportunities for expansion of the existing business of exploration and production of hydrocarbons outside India for augmenting oil security of India.
3.2 That on the facts and circumstances of the case and in law, the CIT(A) grossly erred in holding that expenditure incurred by the appellant would bring enduring benefit to the business of the appellant.
3.3 That without prejudice to the above and in the alternative, the CIT(A) erred on the facts and circumstances of the case and in law in not allowing deduction of expenditure in accordance with the agreement entered into by the appellant with the Central Government under Section 42 of the Act.
4. That on the facts and circumstances of the case and in law, the learned CIT(A) grossly erred in disallowing revenue expenses relating to project pending final evaluation of Rs. 5,64,15,776 treating the same as capital in nature.
4.1 That without prejudice to the above and in the alternative, the CIT(A) erred on the facts and circumstances of the case and in law in not allowing deduction of expenditure in accordance with the agreement entered into by the appellant with the Central Government under Section 42 of the Act.
6. The ground taken by the Revenue reads as under:
The learned CIT(A) has erred in law and in facts and circumstances of the case in holding that deduction for the expenditure should be allowed over the period of production sharing agreement during which the benefit would accrue to the assessee and directed the AO to allow 1/19th of Rs. 1,550.10 crores.
7. It was contended by senior counsel that the assessee had acquired a business right in a form of a license equally qualified to be an intangible asset under Section 32(1)(ii) and eligible for depreciation allowance. Our attention was invited to the following terms of the PSA which read as under:
8. As per learned Authorised Representative, Section 32(1)(ii) of the Act specifically and separately recognizes "licenses" as an intangible asset, which is being completely ignored by AO. Since the term "license" was not defined, reference was made by learned Authorised Representative to other laws and judicial precedents where the term "license" has been defined and to the dictionaries meaning.
9. On the other hand, learned Departmental Representative relied on the order of AO and submitted that expenditure so incurred were capital in nature, the same were not allowable and CIT(A) was wrong in allowing 1/19th of these expenses. As per learned Departmental Representative, the assessee has not acquired any business rights, as the agreement so entered by assessee only gives it access to the area in which exploration and development of hydrocarbon is to be done and therefore it was only a participating right and not a business or a commercial right, as has been claimed to be by the assessee. As per learned Departmental Representative, the concept of business or commercial rights as has been envisaged in Section 32(1)(ii) is clearly distinguishable from the kind of agreement that the assessee has entered into for the exploration and development of hydrocarbon. The business or commercial right which is talked about in Section 32(1)(ii) has a close link to intangible assets which are in the nature of know-how, copyright, trademarks, franchises, which if studied closely, indicate that it is a right given from a licensor to a licensee in lieu of a payment which would be in the nature of either royalty, fees for technical services, or any such sum which is of a similar nature. Hence, the intangible asset i.e. to be considered for the purpose of claiming depreciation should be related to a product, skill or a technical know-how which is already in existence and on which payment is received for passing on its know-how or its patent or its copyright or its trademark or license to use or sublet it.
10. We have considered the rival contentions of both the parties and perused the material placed on record. From the record, we found that on 5th May, 1965 assessee company was registered as "Hydrocarbons India (P) Ltd." to take over the rights and interests of its parent company i.e., the erstwhile Oil & Natural Gas Commission to formalize the following agreements so as to explore and develop oil fields in Iran:
(a) the agreement made and entered into on 26th Aug., 1964, by and between A.G.I.P., S.p.A., an Italian Corporation, Phillips Petroleum Company, a Delaware USA Corporation and Oil & Natural Gas Commission, read with the agreement made and entered on the 30th July, 1964 by and between the said Phillips Petroleum Company and the A.G.I.P., S.p.A.; and
(b) the agreement made and entered into on the 17th Jan., 1965 by and between National Iranian Oil Co. of the one part and the said A.G.I.P., S.p.A. Phillips Petroleum Co. and the Oil & Natural Gas Commission of the other part.
11. In early 1970s, the assessee was also engaged in to carry out services and providing training in the international arena. In the year 1975, the assessee company also performed a service contract in Iraq, which due to lack of commercial viability, could not be pursued further after drilling a few wells in a field which still remains undeveloped. In the year 2000, this field was awarded by Iraq Government to the assessee through negotiations, for development and production of oil under new agreements. The assessee also had entered on 19th May, 1988 into a petroleum production sharing contract with Vietnam Oil & Gas Co. The production sharing contract entered on 19th May, 1988 envisages making available necessary manpower, technical skills and other inputs required for the execution of the production sharing contract in accordance with sound petroleum industry practices. The production sharing contract provided for exploration and exploitation of petroleum resources in the specified area in the Continental Shelf of Vietnam. The assessee carried out petroleum exploration in the area since 1988 and has the distinction of discovering the largest free gas field of Vietnam. The assessee partnered with British Petroleum and Vietnam Oil & Gas Co. in the block and finalized development plans for the development of natural gas discovery. The development plan for the discovery was finalized and necessary commercial arrangements entered into in December, 2000. The first phase of the development of Vietnam Project (Block 06.1) was completed in January, 2003. From the above, it is evident that the business of the assessee had already commenced which was set up in the year 1965.
12. From the record, we found that hydrocarbons in their natural habitat embedded in a particular territory are the property of the State Government, jurisdiction over such hydrocarbons does not lie with any private person other than State Government and a person cannot carry out hydrocarbons operations unless the person had entered into a production sharing agreement with the Government. In the instant case, by entering into an agreement called PCA, the Government owning the hydrocarbons, granted rights to the assessee company along with license for carrying on hydrocarbons operations. The business rights in the license are owned by the assessee entering into PCA and such right and license can be assigned and transferred to other parties subject to the terms and conditions of the PCA and approval of the Government. The assessee by virtue of acquisition of 20 per cent participating interest became the member of the consortium and acquired proportionate share in rights and licenses granted by the Russian State for Sakhalin Block. By acquiring these business rights and production licenses, the assessee became entitled to carry on hydrocarbon operations in the Sakhalin project. The statutory expression of the provision granting depreciation on intangible asset is that:
know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after 1st April, 1988.
13. A reading of the above statutory expression brings home the point that the law has specified items of intangible assets eligible for depreciation in the following categories:
(vii) Any other business or commercial rights of similar nature.
14. So far as claim of depreciation in case of intangible assets falling in the category of "any other business or commercial rights of similar nature" is concerned, as per our considered view, all the business or commercial rights are not by themselves assets eligible for depreciation, and that only those rights which are similar in nature with the know-how, patents, copyrights, trademarks, licences etc. are eligible for claim of depreciation. In view of principle of ejusdem generis, the expression "any other business or commercial rights" has to be read in the company of the preceding words. This rule of interpretation makes an attempt to reconcile incompatibility between the specific and general words. The first category of words like know-how, patents, copyright, etc., forms a distinct genesis or category in as much as all those items are specific and elucidated rights of business or commercial nature. In such circumstances, the expression 'any other business or commercial rights of similar nature' also must be in the same genesis or category with specific and elucidated identity of commercial or business nature. Therefore, in the light of the statutory provisions contained in Section 32(1)(ii), the commercial rights of exploration of mineral oils, as acquired by the assessee fall under the expression of any other business or commercial rights of the nature similar to one of the categories i.e., licenses as stipulated in Section 32(1)(ii). The commercial rights of exploration and licenses acquired by the assessee being in the nature of intangible assets are eligible for the claim of depreciation at the rate prescribed under Section 32(1)(ii) of the Act. The AO himself in his order had observed that as a result of entering into such an agreement i.e., PCA, the assessee company has been granted licenses by Russian Government to explore and produce hydrocarbons in the agreement area. There is no dispute to the fact that assessee has incurred expenditure of Rs. 1,559.09 crores for obtaining the right and license for exploration of oil. It is not possible to say that such expenditure was neither capital nor revenue in nature. If it is held to be capital, then it is obvious that what the assessee has acquired was a participating right which is in the nature of commercial right of carrying on of business of exploration and production of mineral oil. It also cannot be said that the right so acquired was not an asset. If it is an asset being the right then it is obvious that same is commercial right, therefore in the nature of asset in the form of license. This right had been granted to the assessee by way of license and the assessee became owner of such right i.e., license to have an access and to carry on of business of exploration and development of mineral oil. Accordingly, as per our considered view such an asset falls within the category of asset falling under Section 32(1)(ii) of the Act. Accordingly, we are inclined to agree with the learned senior counsel that the assessee had acquired business and commercial right and license by making payment of Rs. 1,559.10 crores, which is in the nature of intangible assets entitled to claim of depreciation under Section 32(1)(ii) of the IT Act.
14A. In view of the above discussion assessee's claim for allowing deduction of entire expenditure of Rs. 1,559.10 crores is declined. The stand of CIT(A) in treating the alleged expenditure as deferred revenue expenditure and directing the AO to allow 1/19th of the expenditure during the year is also declined, since there is no concept of deferred revenue expenditure under IT Act. As we have treated the expenditure as capital in nature the same is eligible for claim of depreciation at the rates prescribed for the assets falling under Section 32(1)(ii) of the Act. We direct accordingly.
15. With regard to disallowing claim of expenses of Rs. 43.85 lakhs incurred for purchase and evaluation of the seismic data of foreign blocks, on the plea of same being capital in nature, we found that assessee being engaged in the business of exploration and production of hydrocarbons in other countries to augment the oil resources of India, it was continuously evaluating various business opportunities before acquiring a particular field/block. Since all these opportunities have to be evaluated and studied before taking decision to invest and enter into a contract, the process of evaluation of the block started with submitting tender fee/data fee etc. and then the seismic data had to be evaluated in seismic processing centre. After evaluating the same, the assessee was to take decision as to whether investments are to be made in the project or not. There is no dispute to the fact that in all industries an activity of furtherance of its business or evaluation of better profit-earning process in one manner or other are undertaken. Efforts to evaluate the prospects of better earning profit is not a separate activity but is in the course of conduct of normal day to day business. These expenditure cannot be said to bring an enduring benefit to the business nor the same can be said as initial outlay for expansion of business. In the instant case, the expenditure so incurred by the assessee is for furtherance of activities undertaken by it in the normal course of its business. The same are incurred on continuous basis for evaluation of business activities. In view of the decision of Bombay High Court in the case of CIT v. Essar Oil Ltd. (2008) TIOL 530 (Bom), such expenditure is to be allowed as revenue expenditure. Hon'ble Calcutta High Court in the case of Kesoram Industries & Cotton Mills Ltd. v. CIT : (1992) 196 ITR 845 (Cal) held that where the setting up does not amount to starting of new business but expansion or extension of the business already being carried on by the assessee, expenses in connection with such expansion or extension of the business must be held to be deductible as revenue expenses. One has to consider purpose of the expenditure and its object and effect. Accordingly, it was held that expenses pertaining to exploring feasibility of expansion or extension of business are revenue expenditure and not capital expenditure. The expenditure so incurred by the assessee was in the normal course of business of exploration and production of oil, being revenue in nature is liable to be allowed as a deduction. Similar claim was also made by the assessee in the earlier year. We therefore direct the AO to allow the same as revenue expenditure. As we have allowed ground Nos. 3 to 3.2, the alternate ground No. 3.3 as taken by assessee becomes infructuous.
16. The expenditure of Rs. 5.64 crores incurred on projects pending final approval, even though the said expenditure was written off in the accounts over a period of five years the AO disallowed the same. We have considered rival contentions. The assessee in the instant case has incurred expenses relating to project pending final evaluation. The assessee had made distinction between contract projects for which agreement is entered into and the board approved projects i.e. projects for which no agreement/contract has been entered. The assessee used to capitalize expenditure incurred on projects for which no agreement/contract has been entered, however, the cost of such projects which are abundant (sic-abandoned) was written off over a period of five years in the books of account of the assessee. The assessee had claimed the expenses pertaining to abandoned project as revenue expenses. The expenditure incurred for this purpose was in the nature of travel cost, meeting and conference expenses, delegation, salaries and professional fees etc. These expenditure were claimed by the assessee in its return of income in the year of its incurrence. The issue under consideration is covered in favour of the assessee by the order of Bombay High Court in the case of CIT v. Essar Oil Ltd. (supra) wherein the High Court has observed that submitting tenders and bids in the field of oil exploration is a highly sophisticated technical task for which the assessee company had to incur substantial amount of expenditure before submitting its bid. If the assessee is not successful in obtaining bid, such expenditure is allowable as revenue expenditure. As the assessee was continuously in the business of exploration and production of oil, the expenditure so incurred was in the normal course of its business, such expenditure being revenue in nature incurred for the purpose of existing exploration and production business was required to be allowed under Section 37(1) of the IT Act. Similar claim was also made by the assessee in earlier years. Accordingly, we direct the AO to allow the same.
17. In the result, the appeals of the assessee and Revenue are allowed in part in terms indicated hereinabove.