2019 (4) TMI 62 - HC - Income Tax

Deduction u/s 42 - business of prospecting for or extraction or production of mineral oils - expenditure by way of infructuous or abortive-exploration expenses - non surrender of right to carry on oil exploration - assessee requested for an extension of project but DGHC rejected - HELD THAT - For the applicability of clause (a) of subsection (1), the elements vital are that the expenditure should be infructuous or abortive exploration expenses and that the area should be surrendered prior to beginning of the commercial production by the assessee. In other words, as long as these two requirements are satisfied, the expenditure in question would be recognized as a deduction. The emphasis of this provision is of infructuous or abortive exploration expenses and that there is surrender prior to the beginning of the commercial production. The term surrender in this clause, therefore, has to be appreciated in light of these essential requirements of the deduction clause. The revenue in our opinion has put unnecessary stress on the term surrender while the main focus of the clause is on infructuous or abortive exploration expenditure in respect of area surrendered prior to the beginning of the commercial production. As long as the commercial production has not begun and the expenditure is abortive or infructuous exploration expenditure, the deduction would be allowed. The term surrender itself is flexible one and does not always connote the meaning of voluntarily surrender. As in the present case, the surrender can also take place under compulsion. The assessee had no choice but to surrender the oil blocks, because the Government of India refused to extend the validity period of the contract. Nevertheless, the act of the assessee to hand over the oil blocks before the commencement of commercial production would as well be covered within the expression; any area surrendered prior to the beginning of commercial production by the assessee. The revenue does not dispute that the expenditure was infructuous or abortive exploration expenditure - Appeal of revenue dismissed

Summary

Issues:
1. Interpretation of Section 42(1)(a) for deduction eligibility.
2. Application of the surrender concept in the context of oil exploration contracts.

Issue 1: Interpretation of Section 42(1)(a) for deduction eligibility:
The case involved an appeal by the revenue challenging the judgment of the Income Tax Appellate Tribunal regarding the eligibility of a company for deduction under Section 42(1)(a) of the Income Tax Act. The tribunal held that the company was entitled to the deduction, emphasizing the purpose of Section 42 to encourage oil exploration. The tribunal's decision was based on a purposive interpretation of the provision, highlighting that the Act did not differentiate between voluntary or forced surrender in the context of exploration expenses. The tribunal noted that the company's contract was relinquished, not terminated, as per the terms of the Production Sharing Contract (PSC). The tribunal concluded that the company's claim fell within the deduction provision of Section 42(1)(a) due to the nature of the exploration expenses and the relinquishment of the contract.

Issue 2: Application of the surrender concept in the context of oil exploration contracts:
The facts of the case revealed that the company, engaged in oil exploration, had to surrender the exploration block to the Government of India after being denied an extension for exploration beyond the initial contract period. The critical question was whether the surrender of the block prior to the commencement of commercial production qualified for deduction under Section 42(1)(a). The court analyzed the provisions of Section 42, emphasizing that the deduction was applicable to infructuous or abortive exploration expenses related to an area surrendered before commercial production. The court highlighted that the term "surrender" should be understood in light of the essential requirements of the deduction clause, focusing on the nature of exploration expenses and the timing of surrender before commercial production. The court determined that the company's situation, where surrender was compelled due to the denial of an extension, still met the criteria for deduction under Section 42(1)(a. The court emphasized that a flexible interpretation of the surrender concept was necessary to uphold the purpose of encouraging oil exploration and to acknowledge the risks associated with the capital-intensive nature of the industry.

In conclusion, the High Court upheld the tribunal's decision, dismissing the Income Tax Appeal and affirming the eligibility of the company for the deduction under Section 42(1)(a) of the Income Tax Act. The judgment underscored the importance of a purposive interpretation of tax provisions to align with the legislative intent and policy objectives, particularly in specialized sectors like oil exploration.