1. The questions posed for determination before the larger bench are the application of tax rate and payments to Government of Pakistan by Oil and Exploration Companies and the manner of calculation of depletion allowance to the E&P companies. During pendency of the instant appeals memorandum of understanding was executed on 26-3-2010 between the E&P Companies [Pakistan Petroleum Exploration and Production Companies Association (PPEPCA)] and F.B.R.
2. Through its member policy (direct taxes) on all matters including the aggregate of taxes on income and other payments to government and the depletion allowance which are the subject of dispute before the bench. On the issue of depletion allowance previously the full bench of the Appellate Tribunal Inland Revenue in the case of PIR KOH gas company had given its judgment.
3. Thereafter full bench was constituted to resolve the issue of tax rate and payments to GOP, subsequently it was converted into larger bench to decide the issue of manner of calculation of depletion allowance in addition to tax rate. In the earlier judgment of the full bench it is held that the transportation, gathering, processing and other charges specifically mentioned in Rule 2(K) of the 1986 Rules and the sales tax, Excise duty and Royalty the Government of Pakistan levies which are not specifically mentioned in Rule 2(k) are to be excluded from the gross receipts for the purpose of the depletion allowance.
4. Now the aforementioned judgment is sub-judice before the Hon'ble High Court. The MOU signed by the member F.B.R. And PPEPCA, which as per the counsels of the E&P Companies was to be implemented by the F.B.R. Whereas the DR stated that the MOU provide only a framework for understanding and it was never a binding agreement, hence its implications are not relevant to the instant appeals. The learned DR also referred the clause 10 of the MOU, which states that in case of any dispute over the MOU, parties are free to pursue their legal course.
5. We are persuaded to agree with the contention of the UDR, the matter relating to MOU has neither been raised through the grounds of appeals nor does it arise from the orders of the officers below which are subject of the present appeals, while also this Tribunal is not a proper forum to resolve the disputes arising out of MOU It has no legal status as it has neither been codified as law by the legislative body nor has been A notified by the subordinate legislation, rather it was a memo of understanding between the E&P Companies and member FBR, During course of hearing of appeals, it was pointed out on behalf of department that some of the E&P Companies have also filed writ petitions on the matter of implementation of MOU, in this way matter is also sub-judice before the Hon'ble High Court and yet is pending for adjudication.
6. Arguments tendered on behalf of the E& P companies: The dispute on account of calculation of tax rate has arisen because as per the contention of E&P Companies, the Petroleum Concession Agreement is binding on Government of Pakistan and has got sanctity under Rule-4 of Part-I of Fifth Schedule to the Ordinance, 1979. In majority of the taxation articles, it has been stated that 'payments' to Government shall be limited to 55 percent of profit and gains. Accordingly in case of almost all petroleum companies in Pakistan tax rate that is provided in the respective PCAs, has been applied on the profits and gains prior to deduction of payments to Govt. Tax department is misapplying the provisions and principles laid down in the PCAs. The gist of the misapplication is that taxation officers are reading the terms 'profit and gains' and 'profit and gains before deduction of royalty' as being synonymous, which is a fundamental error on the part of the department. The words "prior to deduction of payments to Government" are not contained in PCAs in the sentence 'containing the rate. The brief reasons of their incorrectness by tax department as per the view of L/ARs of E&P Companies are as follows:-- Clause 2 of the Schedule to the Mining Act specifies that the rate within the range of 50 to 55 per cent is to be applied on the `profits and gains prior to deduction of payments to Government'. This provision is not the rate of tax, it provides the ceiling and the floor within which, range of the rate can be fixed by the government.
7. This clause is being misconstrued since this clause also provides that the limit of payments to Government shall be fixed in the permit/license PCA.
8. Oil and Gas Development Corporation of Pakistan (OGDCL), Government Holdings Pakistan Limited
(GHPL) and Pakistan Petroleum Limited (PPL) are voluntarily paying to the Government at 55 percent.
9. This fact is not correct since OGDCL, which have several PCAs making payment to Government at 'average rates' (e.g. 52.0428 and 53.2564. This is not as per.Any law or PCA.
10. PPL has paid to the Government at 50 percent since past few years.] The tax department has contended that Circular No.2 of 1974 dated May 14, 1974 issued by the Federal Board of Revenue [F.B.R.] is no longer effective but this contention of the tax department is incorrect since F.B.R. Has not withdrawn this Circular.
11. The crux of the arguments of E&P Companies representatives was that:
(a) Each PCA contains a rate. Some PCA's state that this rate has to be either on: Profit and gains; or Profit and gains prior to deduction of payments to Government
(b) The amount payable to Government arrived at in the above manner needs to be compared with the following amount calculated under the Fifth Schedule to the Ordinance, 1979.
12. Profit and gains prior to deduction of payments to Government.
(c) Higher of A or B is payable to the Government.
13. There is nothing in the Mining Act, petroleum policy or any concession agreement that is different from the aforesaid principle and the same has been accepted by the FBR through circular of 1974.
14. Departmental Arguments: On behalf of the department it was stated that schedule to Mining Act, 1948 was inserted through amendment in 1976, which clearly set out an upper cap at 55% and floor at 50% of the profit or gains "before deduction of payments", to Govt. Of Pakistan The Ordinance, if allows for any limit to be set in PCA, the same limit can not be more or less than the limit provided in the Mining Act, 1948, but in each case it must be "before the deduction of payments" to the government. The PCA is dependent and is subject to section 4 of Mining Act, while the last Para of each PCA in its taxation clause also describe the same. No PCA can be in breach of mandatory law. Section 4 of Mining Act, 1948 provides "that any rule made under this Act and any order made under such rule shall have effect notwithstanding any thing inconsistent therewith contained in any enactment or any instrument having effect by virtue of enactment other than this Act". The E&P Companies from ambiguous wordings of PCA have tried to introduce a new category of rate which is 55% of profit and gains (after royalty) which is not envisaged in the Mining Act, 1948. Any basis if provided in PCA is against the mandate of law, the law of Mining Act shall prevail. If the arguments of ARs are accepted, then the "55% "after royalty" will always be lower than 50% (before. Royalty). Therefore there is no rationale in stating 55% (after royalty) in PCA. The PCA also provide the minimum rate of 50% of profit or gains, (before royalty). Mathematically 55% limit (after royalty) will always be lower than 50% limit (before deduction of royalty), unless the rate of royalty is reduced from 12.5% to a lower rate, which is legally not possible as the rate of royalty at 12.5% is fixed under the law. Rate of payments and taxes as per Mining Act, 1948 range from 50% to 55% but rate shall always be based on (profit and gains (before deduction' of royalty). If the PCA - impliedly provides the rate of 55% of Profit and gains and does not further expressly state (before deduction of royalty,) it does not mean that such rate will be applied on profit and gains (after deduction of royalty). On account of the PCAs of Tajal Adhi, Kandkat and Magarani, it was stated by the E&P companies that the rate of tax at 55% (before royalty) is stated to be applicable to the above PCAs, whereas in other PCAs no such sentence containing the rate has been recorded, therefore in all other cases rate of 55% of profits and gains (after royalty) will be applied. In its reply it was stated by the departmental representatives that if the above plea of the E&P companies is accepted then the rate will always be lower than 50% of profit and gains (before royalty) and then the statement regarding 55% limit (after deduction of royalty) becomes redundant, While the conflict under this special system of taxation is to be resolved as per the provisions of Mining Act under the arbitration clause of the PCA. It was also pointed out on behalf of the Revenue that there are different types of PCAs and in certain PCAs there are other are irrationalities too, therefore any interpretation to the wording of PCA would not be appropriate. Regarding the F.B.R. Circular No.2 of 1974, the L/DR stated that it is not applicable because of subsequent amendment in 1976 by virtue of which circular has become redundant, Mining Act of 1948 is the governing law which shall prevail over any other inconsistent provision contained in any PCA or circular. Before amendment in 1976 the Mining Act, 1948, was silent about the computation of limit, therefore F.B.R. As per its understanding of any particular PCA interpreted a manner of calculation which was applicable at that time in the absence of any provision in the statute. In 1976. "Regulation of Mines and Oil Fields and Mineral Development (Government Control) (Amendment) Ordinance was promulgated whereby schedule to the Mining Act was inserted along with other amendments. Para 2 of the schedule to the Mining Act clearly indicates that both 55% and 50% limit should be computed on profits and gains before royalty. The C.B.R. Circular No.2 of 1974 was issued on 14th May 1974, law was amended in 1976 and after the amendment in law, aforementioned circular has become redundant, as circular cannot stand in conflict with the law. As per amendment in 1985 depletion allowance is to be added back for computing the limit. The E & P companies are not applying the stipulation of Circular No.2 of 1974 by not adding back the depletion allowance towards profit or gain with the plea that after amendment in 1985 depletion allowance is not required to be added back, while on the other hand are applying the rate of tax deducting the royalty which is contrary to amendment in law. If the argument is taken by taxpayer that the law of adding back of depletion allowance was changed subsequently (in 1985), so the Circular to that extent is not applicable,.
15. Then there is also an argument that the Mining Act was also changed in 1976, therefore the Circular is also not applicable in respect of computing 55% limit (after deduction of royalty). It is also settled principle that FBR is not empowered to interpret the law. The instructions issued by FBR only in nature of administrative matters are binding on the tax officers. This concept has very well been explained by the Supreme Court of Pakistan in the case of Central Insurance. The Federal Government is entitled to prescribe the aggregate of payment of taxes on income and other payments to Government within provided limit only. The taxation officers were correct in applying the ceiling of 55% of profits and gains (before deduction of royalty), as this is the only. Basis envisaged in law for applying the rate. The Mining Act, 1948 does not allow providing any rate (50%, 52/5 & 55%) on profits (after deduction of royalty). All the rates are applicable on profit and gains (before deduction of royalty). The E&P Companies were required to pay tax as per PCA provided it is not in conflict with the Act. The Federal Government, no doubt is entitled to prescribe tax within the limit of.
16. 50% - 55% but whatever rate is prescribed within the provided limit, it should be before deduction of royalty. There exists no confusion and there is no miscalculation of tax payable. In fact E&P Companies are calculating tax payable by ignoring the fact that Act shall prevail over the PCA and after amendment in the Act, the circular and its calculation is not applicable. It was mandatory on E&P Companies to calculate tax as per schedule of Mining Act and not to calculate tax according to circular.
17. On account of "royalty" as an allowable expense for computing profits and gains there was no contrary provision to that effect in the law prior to 2001, E&P Companies' view is totally unreasonable and not based on correct interpretation of law. How payments and a levy to the Government is to be allowed as an expenditure, when it being part of 'payment to the Government' and it is adjustable as credit against the tax liability. Notwithstanding to that the amendment made through Finance Act, 2001 and FBR's Circular No.5 of 2001 has removed the doubt. As a result of the change in petroleum policy in 2001, whereby royalty is no more treated as 'payment to the Government', its deduction was consequently allowed as an expenditure. It is therefore clear that previously (for PCA singed before 2001 (which are under dispute), royalty was not an allowable expenditure for the purpose of computing 'profits and gains'. It was also stated by the L/DR that subsequent amendment or substitution of provision of law do not affect any provision of law, rather the amendment and substitution further clarify and supports the stance of the department that royalty is not an allowable expenditure and rate by the Govt. Of Pakistan is to be fixed between the range of 55% to 50% (before the deduction of royalty). The rate of 50% before the deduction is not disputed by the E&P companies.
18. We have heard the arguments of the rival parties, perused the relevant law and the PCAs on the subject. The issue of calculation of tax rate has arisen because of the broad types of Petroleum Concession Agreements by the E&P Companies with the Govt. Of Pakistan which as per the Authorized Representatives of E&P Companies have different implications, whereas departmental point of view was that the implications thereof should be the same in the light of the provision of Mines and Oil Field and Mineral Development Act, 1948 (Act of 1948) read with the amendments brought out in Act in 1976. In certain PCAs where the rate of 55% is not expressly stated to be applicable on profit & gains before royalty, E&P companies are contending that rate of 55% in such cases is applicable on profit and gains (after royalty).
19. The activities for exploration, prospecting, mining and production of petroleum are regulated by a Federal Statute viz. Regulation of Mines and Oil-Fields and Mineral Development (Government Control) Act, 1948 (Mining Act) and the Rules made pursuant thereto. The companies engaged in this line of business are assessable under special system as per the provision contained in Part-I of the 5th schedule to the Income Ordinance, 1979. Entities engaged in these activities enter into Petroleum Concession Agreements (PCAs) with the President of Pakistan. This is special system through which the sum of payments to government and taxes on income are determined, this system operates through combined reading of following:--
(1) Mining Act (read with the Rules)
(2) Petroleum Concession Agreement (PCA)
(3) Part I of Fifth Schedule to the 1979 Ordinance History and historical development of the above provisions is as follows:-- Through Finance Act, 1956 section 10(8) was inserted in the Income Tax Act, 1922, in consequence of which 2nd schedule was also inserted to provide separate basis for computing profits or gains and tax payable there on.
20. Rule 4(1) of the second schedule to the 1922 Act was inserted in 1956, which provides: "The sum of payments and taxes to the government on income in respect of profit or gains derived from their business to which the provisions of this schedule apply for any year of assessment shall equal to one-half of the profit and gains derived from the said business or part of business before deduction of payments to government and the additional allowance .Referred to in rule 3."
21. Through Finance Ordinance, 1969 Rule 4(1) was substituted as to provide that sum of payments and taxes on income shall be as provided for in the agreement with the government subject to condition that, such sum shall not be less than 50% of profit or gains before deduction of royalty and depletion allowance at that time called as additional allowance. (Now called as depletion allowance).
22. Circular-3 of income tax was issued after the finance Ordinance, 1969 to explain the amendments made in 1969 through these amendments three important changes were made in the 2nd Schedule under which the income of the companies engaged in the production of oil etc. Is computed.
23. Rule 4(1) as amended in 1969, now exists in similar form in the fifth schedule to the Income Ordinance, 1979, except for amendments in 1985 to the effect that 50% minimum limit was to be computed at that time on profit or gains before royalty and depletion allowance and now such minimum limit is computed at profit or gains before royalty, the and back of depletion allowance was deleted in 1985. In 1994 petroleum policy was introduced.
24. Before November 2nd 1976, there was no limit or rate provided in the Mining Act, 1948. Through amendment in Ordinance, 1976 sections 3A, 3B and Schedule was inserted in the Mining Act, 1948.
25. Till that time tax and payments made to the government by such companies taken together have not to exceed 50% of profits or gains derived before deduction of payments to the government and depletion allowance at time called as additional allowance. The law now provides that this percentage can be increased subject to an agreement between the government and oil producing companies.
26. From the above changes and development of law, it transpire that for the first time through Finance Act, 1969, the tax as provided in PCA were given legal sanction as prior to changes as granted in 1969, the income tax law of Pakistan did not recognize the sanctity of any rates given in the PCA.
27. The lower the limit of 50% of profit .And gains before the deduction of royalty in 1969 and there after through a proviso in Rule 4(1) to the schedule of Mining Act was in fact legislation by way of abundant caution for setting up a floor for taxation of E&P companies, so that if any PCA envisaged the rate below 50% before deduction of royalty then such rate should not prevail, this was in fact bringing it in harmony with section 3B of the Mining Act. After amendment in Mining Act, 1976, the legal status of PCA has been determined through section 2 of the regulations of Mines and Oil Fields and Mineral Development Act, 1948. This section empowers Government to make rules, which provide for the following:-- Section 2 of the Mining Act 1948 reads as under: It is hereby declared through the expediently in the public interest that (appropriate government) shall have power to make rules to provide, for all or any of the following matters namely:-
(i) (ii) (i.e) ........................... (iv) The determination of rate and conditions subject to which royalties, rent and taxes shall be paid by licensee, lessee and guarantees of mining concession. Section 2 (4) of Mining Act provided powers to the authorities for signing of PCA.
(v) ........................................ (vi) ........................................ (vii) ........................................ (viii).......................................... Further sections 3A and 3B were inserted in the Mining Act, 1948 vide Finance Act, 1976 in a manner to restrict the scope of powers provided under section 2(4) of the Mining Act to the extent of schedule inserted whereby method of computation of income, rate of royalty, basis of computing royalty on the well head value and taxes on income were provided with maximum and minimum limit together with the method of computing payments to the federal government including taxes on income Prior to 1976 there was no limit or rate provided in the Mining Act, 1948, through amendment in 1976, besides of sections 3A and 3B, schedule was also inserted in the Mining Act, 1948 the concessions provided as per section 3B and the schedule include;
(i) Freezing of tax law.
(ii) Rate of royalty.
28. (i.e) Limit of aggregate of payment to government.
(iv) Exemption of tax for foreign expenditure. .(v) ............................. (vi) ................... Rule-1 of schedule freezes the applicability of Income Tax Law on the date of signing of PCA. Thus any amendment in the income tax law after effective date of PCA is not applicable to taxation matters of that particular PCA. In all cases, which are subject of instant appeals, PCAs were executed prior to 1995, as per freezing clause of agreements Ordinance, 1979 is applicable, to which protection has also been given vide section 239(10) of Ordinance, 2001.
29. Rules 2 and 3 of the schedule to the Mining Act, 1948, relating to fixation of limit of aggregate since 1976 states as under:-- "Royalty shall be charged at a fixed rate of 12-1/2 percent of the well-head value and shall form part of the sum of payments to the Federal Government and taxes on income which shall neither be more than 55 percent nor less than 50 percent of the profits or gains before deduction of 'payments to the Government' referred to in clause (5) of rule 6 of part I of Fifth Schedule to the Ordinance, hereinafter referred to as the said Schedule".
30. Rule-4 of the 5th Schedule of Income Tax Ordinance, 1979 prescribes limitation payments to Government and taxes:
(1) "The aggregate of the taxes on income and other payments to the Government in respect the profits and gains derived from an undertaking to which this Part applies for any assessment year shall not exceed the limits provided for in the agreement: Provided that the said aggregate shall not be less than fifty percent of the profits or gains derived from the said undertaking before the deduction of the payment to the Government".
31. From bare reading of law, with Rule 4 of the fifth schedule to the Ordinance, 1979, point seems very much clear without any shadow of doubt:--
(1) Under section 4 of the Mining Act, 1948 no other Act or Rule can override the provision of Mining Act, 1948; therefore neither the Income Tax Ordinance nor a PCA or Rule can over ride provision of Mining Act; if there is conflict.
(2) The royalty is chargeable at the rate of 12.5% of the well-head value and it has to form the part of the payments to the government.
(3) The controlling law unambiguously prescribes the minimum and the maximum thresholds and states that payments to government including taxes on income shall neither be more than 55% or less than 50% of the profits and gains.
(4) Lastly and most importantly, the law prescribes that for the purpose of determination of aggregate sum of payments to the government and tax the profits and gains have to be taken "before the deduction of payments to government including royalty.
32. The 1948 Act set out upper limit 55% of the profits and gains before deduction of payments to the Government. The Income Tax Ordinance, 1979 provides only limit be that as provided in the PCA.
33. The 1979 Ordinance allows for any limit to be set in a PCA, the same can not be more or less than the limits provided in the Mining Act, 1948 i.e. 55% and 50% of profits or gains before deduction of royalty. For this purpose the 1948 Act also provides limit of profit and gains "before deduction of payments to the Government". In this way in the light of aforementioned provision of law contained in the Mining Act and 1979 Ordinance, Government is bound to execute an agreement accordingly, whereas no agreement can be in breach of a mandatory provision of law.
34. From the above it is evident that PCA provide a limit or an applicable rate of 55% of profits and gains, and a lower limit of 50% of profit and gains, which will be amount payable. The lower limit is well in accordance with the Act of 1948, in as much as the taxation article states that the said aggregate shall not be lower than 50% of profit and gains "before the deduction of payments" to the Government. Higher rate in the PCAs provides that the said aggregate shall not exceed the limit of 55% of profits and gains but fails to state whether payments to Government should be deducted from profits and gains. This has prompted the E&P Companies into claiming that since there is no expression of calculating the said "aggregate from profits and gains before deduction" it must mean that aggregate will be calculated after deduction of payments to Government from profits and gains. To this effect it would not be out of place to mention here that there are nine different types of agreements, which have been executed with different companies with slight difference of style but the implication, are alike in the substance. For the sake of convenience the categories of agreements are explained as under:-- S.No. Category Remarks Concession 1 A Fifty five per cent (55%) of the profits or gains before deduction of payments to the Government. Not less than 50% of the profits or gains1. ADHI (Pakistan Petroleum Limited)
(OGDC) (POL)
35. 2 B Fifty five per cent (55%) of the profits or gains before deduction of payments to the Government.1. KANDHKOT (Pakistan Petroleum Limited)
2. MAZARANI (Pakistan Petroleum Limited)
(PPL) (GHPL)
36. 3 C Fifty five per cent (55%) of net profits or gains before deduction of payments to the Government.1. TAJJAL PCA (ENI PAKISTAN LTD.) (PKP KADANWARI LIMITED and PKP S.No. Category Remarks Concession Government.
37. 4 D Fifty five per cent (55%) of profits or gains.1. QADIRPUR (Pakistan Petroleum Limited)
38. (KUFPEC) (OGDC)
39. 5 E Fifty five per cent (55%) of profits or gains.
40. No less than 50% of profits or gains before deduction of payments of Government1. DADU PCA (ENI PAKISTAN (M) LTD.)
41. (PKP EXPLORATION 2 LTD.)
2. MUBARAK (ENI)
42. PAKISTAN LTD.)
3. BLOCK-2567-2 WEST PHULJI (BHP PETROLEUM (Asia/Pacific) Inc.)
4. BADIN AND MEHRAN (BP PAKISTAN ' EXPLORATION AND PRODUCTION INC. OPPI AND OOGPL)
5. SAWAN (PAKISTAN PETROLEUM LTD.)
43. (ENI AEP.LTD) -
(MND) (GHPL)
44. (OMV)
6. MIANO (PAKISTAN PETROLEUM LTD)
45. (ENI AEP LTD)
46. (OGDC)
47. (OMV)
48. S.No. Category Remarks Concession 7. GAMBAT (PAKISTAN PETROLEUM LIMITED)
8. KANDHKOT EAST (PAKISTAN PETROLEUM LIMITED)
9. SOUHT WEST MIANO
10. MEHAR 11.
MUBARAK
12. MIRPUR KHAS
13. TANDO ALLAH YAR 14 NIM
15. KHIPRO 6 F (55% Zone III) (52.5 Zone II) or (50% zone 50% of profits or gains before the deduction of payments to the Government.1. BLOCK-22 (Hasan, Sadiq, Khanpur)
49. (Pakistan Petroleum Limited)
50. (PEL)
51. (PEII)
52. (GHPL)
53. 7 G Fifty two and a half percent (52.5%) of profits or gains.
54. Not less than 50% of profits or gains before deduction of payments to Government1. KIRTHAR PCA (ENI PAKISTAN LTD.)
55. (PKP KIRTHAR B . V . AND PKP KIRTAHAR 2. B.V.)
2. TAL (PAKISTAN PETROLEUM LIMITED)
56. (OGDC), (GHPL), (MOL)
3. KHUSHALGARH PCA (ATTOCK OIL COMPANY LIMITED
4. AHMADAL
5. MINWAL
6. BLAN S.No. Category Remarks Concession 8 H Fifty two and a half percent (52.5%) of profits or gains before deduction of payments to the Government.
1. SHAKARDARA 9 I Fifty two and a half percent (50%) of profits or gains Not les than Fifty percent (50%) ofBELA profit or gains before deduction of payments to the Government.
57. The PCA of Adhi (S. No.1) provides to compute 55% before deduction of payments to the government and 50% on profit or gain only. In such case 55% limit would always be higher and there is no rationale in stating 50% limit after royalty in the PCA of Adhi. Further the PCA of Qadir Pur does not specify lower limit of 50% provided in the ordinance would not apply. In case of Qadar Pur the question would also arise whether limit as per agreement would apply at first place, because the condition placed in law since 1979 does not allow any limit lower than 50% of profit or gains before royalty.
58. The PCA of Bela (S.No.9) is yet another example of irrational statement in PCAs. The rate of 50% (after royalty --- as per interpretation of E&P Companies) is stated in PCA subject to minimum rate of 50% (before royalty). At first place, the rate of 50% (after royalty) or even 55% or 52.5% (after royalty) is not in accordance with law as no rate (after royalty) is envisaged in law.
59. Notwithstanding to that there is no rationale of stating 55% after royalty and 50% before royalty in the same PCA, as the later amount will always be higher.
60. Examples of such taken from the PCAs reproduced supra: PCA Dated 196 April 1995.
61. "14.3 In accordance with the provisions of rule 4 of the said Fifth Schedule to the Ordinance, read with the Regulation of Mines and Oilfields and Mineral 1 Working Interest Owners and taxes on income, shall be limited to fifty five per cent (55%) of profits or gains derived from the operations or part of the operations, provided that the aggregate of the taxes on income and other payments shall not be less than fifty per cent payments as provided for in the Ordinance. '
62. Relevant Part of PCA at 12.5% (Tajj al Concession Agreement): For the purpose of Rule 4 in Part 1" of the 5th` Schedule to the Income Tax Ordinance, 1979 (No.XXXI) of 1979. The sum payments by each of the working interest owners to the Government and tax on income shall be equal to 55% of its net profits or gains derived from the operations or part of the operations to which the provision of the said schedule applied before the deduction of payments to the Government. Royalty shall be charged at a fixed rate of 12.5% of the "well head value" and shall form part of the sum of payments to the Federal Government and tax on income shall neither be more than 55% nor less than 50% of the profits or gains before deduction of. Payments to the Government "referred to in clause 5 of Rule 6 of Part 1st of the 5th Schedule to the Ordinance.
63. Royalty shall be charged. At a fixed rate of 12 1/2 percent. Similarly section 26 of 1979 Ordinance also provides for tax on income of E&P Companies and it is to be computed in accordance with Part I of the Fifth Schedule to the Income Tax Ordinance, 1979. Rule-4 of the said Schedule provides in general term for the PCA to set a limit to the aggregate sums and similar to the 1948 Act provides a minimum lower royalty) and 50% (before royalty) in the same PCA as the latter amount limit of the aggregate sum to be paid to the Government.
64. (Section-4 of 1948 Act) also provides that: "Any rule made under this Act, and any order mode under any such rule shall have effect notwithstanding anything inconsistent therewith contained in any enactment or in any instrument having effect by virtue of an enactment other than this Act"
65. Petroleum Concession Agreements taxation article in its clause also provides that: Schedule thereof, read with the Regulations as amended and in force on the effective date, the provisions of the latter (Ordinance, schedule thereon, and the regulations) shall prevail".
66. Furthermore, Rule 2 of the Schedule to the 1948 Act provides that the "limit of the sum of payments to the Federal Government and taxes on income shall be fixed at the time of grant of the permit or license in accordance with the Petroleum Policy of the Federal Government".
67. As per Petroleum Policy of 1994: "Under the Regulation of Mines and Oil Fields and Mineral (Government Control) Act, 1948, as amended in 1976 the Ministry of Petroleum and Natural Resources has the discretion to determine the aggregate of the taxes on income and other payments to the GOP in respect of the profits and, gains of E&P Companies within 50-55 per cent before deduction of payment to the GOP but after deduction of depletion allowance. Accordingly the respective rates of the three zones established under the Petroleum Policy are as follows: Zone-I 50 percent Zone-2 52 1/2 percent Zone-3 55 percent The above zones have been divided as per petroleum policy in 1994 which has divided Pakistan (one unit) into three on-shore zones and one of-shore zone: Zone 1 (High risk / High Cost)
68. Zone 2 (Medium risk / High Cost)
69. Zone 3 (Medium risk / lower to High Cost)
70. Zone 1 West Baluchistan, Pashin and Potowar Basins Zone 2 Kirthar, East Baluchistan, Punjab platform and Suleman Basins Zone 3 Lower Indus Basins From the above it reveals that as per policy the government in 1995 has defined the criteria to apply the rate of 55%, 52.5% or 50% the concessions on location to a particular area. Previously there were no specified criteria to allow the aforementioned rates. As per Mining Act government had discretion to fix rate between 55% and 50% on profit or gains before royalty, the policy not being a statute, it certainly states the scheme of the rates, regarding E&P Companies as per 1948 Act. The fact that the rates specified in the PCAs are intended to implement the 1994 Policy is also apparent from the 1994 Model PCA Clause 14.3:" the sum of payments by each of the Working Interest Owners and taxes on income, shall be limited to (50% for Zone I, 52.5% for Zone II and 55% for Zone III) of profits or gains derived..."
71. It is clear by the words used in the 1994 Policy that the above rates are to be calculated before deducting payments to Government. If the E&P Companies interpretation is taken, the above rates pertaining to different zones would be rendered ineffective and purposeless. In case the contention of companies is accepted then the lower limit will always be the applicable amount and consequently the rates of 55% or 52 1/2% will never be possible to be collected from the E& P Companies by the Government. This clearly shows that the taxation article as interpreted by the E&P companies is not only inconsistent with the 1948 Act on the face of it but its inconsistency is also deeply rooted. Furthermore, the fact that upon every calculation the higher rate results in an amount that is less than the result of the lower limit is an absurd result and cannot be taken as the intention of the legislature or the intention of the parties to the 'PCA. Such interpretation therefore renders the setting of any higher rate in a PCA redundant because there would be no scenario where the higher rate would come into play. Such situation will arise only if the royalty is less than 12.5%. Such circumstances cannot arise because the laws (including the rate of royalty) are frozen in, accordance with Rule 1 and the latter part of Rule 2 of the Schedule to the 1948 Act as reproduced supra. This freezing of the laws and the rate is also accepted by the E&P Companies.
72. The E&P Companies interpretation leads to inconsistency with the law and absurd results, the language of the statute can and should be accorded with the legislative intent. The E&P Companies interpretation is also against the appropriate meaning of 'Profits and Gains' and in this manner too such interpretation is inconsistent with the law. Profits and Gains include royalty, it only does not contain those allowable deductions as stated by Rule 2(5), Part I of the Fifth Schedule to the 1979 Ordinance. The fact that Profits and Gains include royalty is also evident from subsequent changes in legislation, which is vital in ascertaining whether Profits and Gains was meant to include royalty before such changes.
73. The Finance Ordinance, 2001 made an amendment to Rule 2(5) Part I of the 'Fifth Schedule to the Ordinance 1979 in the following manner:-- "(5) Any expenditure, [including royalty paid to the Government by an on shore petroleum exploration and production undertaking on, or after, the first day of July, 2001] (not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended after the commencement of commercial production wholly and exclusively for the purpose of the business of production and exploration of petroleum carried on by such undertaking shall be allowed as a deduction:...
74. Simultaneously, a corresponding change was made to Rule 4 of the Fifth Schedule to the Income Tax Ordinance, 1979 whereby royalties were excluded from being part of the aggregate sum paid to the government. This makes it evident that Royalty before 2001 was not an allowable expenditure and was therefore necessarily included in Profits and Gains. The appellate Tribunal Inland Revenue in the case of Attock Oil Company Ltd. MA (R) No.185/2007 vide its order dated 4th December 2007 has held; "the profits or gains derived from oil exploration business are liable to taxes before any deduction from such profits and gains. The department cannot and anything to such profits or gains and the taxpayer cannot subtract anything from this profit. The tax liability of such undertaking has to be worked out keeping in view the amount of profits and gains, "before payment to Government on account of any other liability".
75. Similarly in the other judgments the Appellate. Tribunal has held that the tax rate as fixed between the ranges of 55% to 50% as per the Mining Act must be "before the deduction of royalty".
76. The C.B.R's. Circular No.2 of 1974 is an executive order of C.B.R., whereas it is settled principle of law that executive F order, which is repugnant to the law are not to be applied or followed. The said Circular was issued in 1974, while Schedule to the 1948 Act was introduced in 1976, which is subsequent in time, the act will always prevail over the circulars, S.R.Os. And G notifications. The above discussion leads us to the conclusion, that in each case, whether tax rate is fixed at cap or floor, the payment and tax to the Govt. Must be before deduction of royalty, the department has done so therefore its action is approved.
77. Depletion Allowance: The issue relates to the calculation of depletion allowance as permissible under Rule 4 of Part I of the Fifth Schedule to the Income Tax Ordinance, 1979. Permissibility of depletion allowances at 15% of gross receipts representing the wellhead value is not disputed. Only the dispute between the oil companies and tax department is about the manner of calculation As per the oil companies such calculation has to be made on gross receipts from sale of oil. In their view calculation of 15% has to be calculated without the deduction of royalty. The L/AR stated that the depletion allowance is to be calculated on the gross receipts of the working interest owner from the sale of production, if it would have been made at well head. Accordingly while calculating the game the amount of costs incurred from the well head value to the sale point are deducted. The departmental assertion is leading to the fundamental error of understanding. It is assumed by the department that out of total of 100 barrels/mm of the production of working interest owner is only 87.5%. This is totally wrong assertion.
78. In the case of all concession agreements signed under 3B [unlike production sharing agreement singed under section 3A, the whole of the production is the ownership of the working interest owners. They are entitled to sell the same on their account as per the concessions agreements and are supposed to pay the royalty, however that has no relation with the right and sale of the production, Payment of royalty has no relation with the right to produce, on or sale of the production from that concession While reading the law, department is missing and not laying importance to the production. If the department contended that concession is limited to 87.5%. It would lead to many consequences, which will effectively lead to absfird result. In the concession agreement under section 3B whole of the production from the well belongs to the working interest owner unlike in the case of production sharing agreement where the role of the interest owner is that of contractor and he is entitled to share of production as agreed. In that case the contractor accounts for his share of production only. The L/AR Mr. Shabbar Zaidi, FCA further referred to the original concession agreement of ESSO and stated that from this agreement 2nd Schedule has been derived to understand why the word representing has been used. In the agreement mentioned above in relation to depletion allowance it is stated: "(0 In computing the income tax of Esso and additional deductible allowance shall be made in the amount of 15% of the portion of Esso's gross receipts representing the well head value of Esso's share of the production but such allowance shall not exceed to one half of Esso's net income from its share of the production of the joint operation computed before the deduction of such allowance on the basis that such portion of Esso's gross receipts constitutes gross income from such production.
79. It was further added that there is no ambiguity on the matter that depletion allowance is to be calculated on the gross receipts of the working interest owners from the sale of production, if it would have been made at the well head. Accordingly while calculating the same the amount of costs incurred from the well head to the sale point is to be deducted only.
80. On the part of MND, it was argued that it is crystal clear from a bare perusal of the 1986 Rules that well head value is market value of the petroleum less gathering, processing and transportation costs from the well head to the place at which market value is determined i.e. The point of sale. The perusal of the Petroleum Concession Agreement dated 19-4-1995 confirms that the well head value is to be calculated as defined in the 1986 Rules. Nowhere it is stated either in the 1986 Rules or in the PCA dated 19-4-1995 that the well head value i.e. The market value at point of sale is also to be reduced by the amount of royalty paid to Government before calculating the admissible depletion allowance. It is self-evident that it is for the above reason that FBR is conceding that from Tax Year, 2009 and onwards depletion allowance is to be calculated without deducting the amount of royalty from gross receipts representing the well head value of production. By conceding to the correct legal position from tax year 2009 onwards the FBR is also recommending to the judicial fora to follow the same for tax year 2009 and onwards, be followed in the previous years also. It was contented that royalty is to be calculated in the same manner as above.
81. The L/AR read out Para 2 of the Schedule to the Regulation of Mines and Oilfields and Mineral Development (Government Control) Act, 1948, as modified by (Amendment) Act, 1976 (LXXXIII of 1976) and clauses 9.1 and 9.5 of the agreement dated 19-4-1995 which are reproduced as under:- "Para 2. Royalty shall be charged, at a fixed rate of 12.5% of the well head value."
82. "9.1: The working interest owners shall pay to the Government a royalty equal to 12.5% of the well head value of gross production of petroleum produced and saved in each calendar year."
83. 9.5: For the purpose of determining the amount of royalty due, petroleum shall be valued in accordance with Article-VIII."
84. It was argued by the learned A.R. Of MND that it is settled law that there is no equity about a tax.
85. Where the taxpayer is burdened with double taxation the FBR is unforgiving with this argument viz. There is no equity about a tax. It is to be dealt with in accordance with the plain language of the law. For the same reason, the plain letter of the law has to be applied regardless of the specious argument of subordinate FBR functionaries that a double benefit is being conferred on the appellant/E&P Companies by calculating depletion allowance without first deducting royalty/payments from profits or gains. Reliance in this behalf has been placed on:-- 2007 PTD 67 - SC 2008 PTD 1563 2008 PTD 1494 2008 PTD 1693 2008 PTD 1973 2008 PTD 1420 2008 PTD 1227 2008 PTD 838 1994 SCMR 881 - SC PLD 1993 Lah 141 1993 CLC 1666 PLD 1994 Azad J&K 90 2008 PTD 202 - SC On behalf of department it was stated that it is not considering the 87.5 for depletion allowance.
86. The department is computing the value of 100 barrel at "well head value". Royalty is charged at 12.5% of WHV. Once the royalty is paid being a post head incidence on proceeds recovered by gas producer as a Government levy, the value net of royalty represent the receipts/market value of oil belonging to E&P. Companies. Inclusion of royalty in the gross receipt of WHV would amount double benefit, as the same is also adjustable towards payments and taxes to the government. Regarding binding force of Circular 1974, the LDR repeated the stance as taken on issue of rate of taxes and payments regarding the liberal construction of machinery provision reliance is placed on: 2010 PTD (Trib.) 635 2009 SCMR 1279 2002 PTD 441 1969 PTD 1281 AIR 1940 Privy Council 124 (CIT v. Mahaliram Ramjidas).
87. Arguments of the parties heard and the relevant law and material made available at the time of hearing taken into consideration Rule 6 (10) of Part I of the 5th Schedule to the 1979 Ordinance and Rule 2(K) of the Rules 1986 being relevant are reproduced as under:-- Rule 6(10), Part I of the Fifth Schedule to the 1979 Ordinance states.---"Well-head value" has the meaning assigned to it in the agreement, between the assessee and the Government and in the absence of any such definition in the agreement, the meaning assigned to it in the Pakistan Petroleum (Production) Rules, 1949 or the Pakistan Petroleum (Exploration and Production) Rules, 1986".
88. Mule 2 (K) of the Pakistan Petroleum (Exploration and Production) Rules 1986 (1986 Rules) states.--- "Well-head value means the market value of the Petroleum less gathering, processing, treatment and transportation costs from the wellhead to the place at which the market value is determined and in the case of natural gas shall also include compression, dehydration and liquefaction costs".
89. On the issue of dispute i.e. The manner of calculation of depletion allowance, the Appellate Tribunal Inland Revenue has given its adjudication in the cases of Attock Oil Company dated 16-6-2007, Govt. Holding Company dated 4-10-2000, Mari Gas Company dated 25-10-2008. BHP and ENI Exploration Companies and Pir Koh Gas Company. Relevant Para-15 of the judgment in the case of Mari Gas is as under: "It is also observed that depletion allowance like depreciation allowance is a sort of notional relief. It is to be allowed at 15% of the gross receipts representing the wellhead value of production. The payment of royalty is not includible in gross receipts because it is allowable as a deduction from liability. For the purpose of working out "payments to the government" the royalty is includible in total tax liability. In the case of petroleum companies, the assessments are made under provisions contained in section 26 read with Part I of 5th Schedule to the Income Tax Ordinance, 1979.
90. This is a "separate basket" assessme nt where certain provisions , of law are specifically applicable, which are not generally applicable to the other cases of taxpayer doing normal business. One of the special features of assessm ent of the petroleum companies is that all the "payment to the government" are included in the amount of tax whereas in the other cases royalty is allowed as a business expenditure. This is a very special concession because tax liability of petroleum companies is reduced by 12.5% of wellhead value of production in the shape of payment on account of royalty. In other words royalty is considered as part of "tax liability" and is includible in the "total amount of payments to the government" in the shape of tax. In this manner tax liability is reduced by the amount of royalty. If royalty is also included in gross receipts representing the "wellhead value" for working out depletion allowance, it will amount to double relief and probably is not the intention of the law. Therefore in light of Rule 3 of Part-I of 5th Schedule to the Tax Ordinance, 1979 the total value of royalty paid to the government is allowed as a relief in tax and it would again not be allowed as a relief for working out depletion allowance.
91. The above view is also appearing at Paras 7 and 8 of the judgment in the case of Pirkoh Gas Company. (Full bench)
(7) "As far as royalty is concerned, since it is an adjustment towards income tax on income, so its nature necessitates that it is not to be taken even as an expenditure and also, it is a payment which could not be made liable for deduction to arrive at the wellhead value.
(8) Further it is to be made clear that the royalty paid to the government is an adjustable payment towards the income tax liability of the assessee, so opposing its deduction would be availing double benefit, something which is not provided in law."
92. However Karachi Bench of Appellate Tribunal in case BHP Pakistan Exploration and Production Company has held that depletion allowance is to be allowed inclusive of royalty. The aforementioned judgment has been followed in the case of ENI Companies.
93. All the aforementioned judgments presently are sub-judice before the Hon'ble Islamabad and Karachi High Courts.
94. The issue relating to depletion allowance is now restricted to the resolution as to whether royalty should be deducted from. The gross receipts of production or not. The L/ARs during the ' course of hearing of appeals did not press the exclusion of sales tax, excise duty and other charges of gathering, processing transportation, treatment cost as embodied in Rule 2(k) of Pakistan Petroleum Exploration and Production Rules, 1986. In Rule 2(k) of 1986 (Rules) sales tax and federal excise duty through not specifically mentioned but as these are Govt. Levies and in the case of Pir Koh Gas Company and Attock Oil Company these for the purpose of depletion allowance have been excluded from the gross receipts representing the Well Head Value.
95. Before the larger bench the authorized representatives of the E&P Companies did not press the exclusion of sales tax and excise duty, but only the deduction of royalty was contested. The reasons for deducting royalty is clear from the meaning of "royalty" and "depletion allowance. Royalty in ordinary sense is defined; as a payment made by a producer of mineral, oil, or natural gas to the owner of the mineral rights over it; Black's Law Dictionary 8th Edition define it as; Royalty (oil and gas); A Share of the product or profit from the real property reserved for the grantor of mineral lease, in exchange for the lessee's right to mine or drill on land.
96. Royalty Interest (Oil and Gas): A share of production or the value or proceeds of production, free of cost of production when and there is production.
97. Mineral royalty: A right to share of income from mineral production.
98. It is well settled law that mineral property vests in the State, and now jointly and equally in the relevant Province and the Federal Government in accordance with Article 172(3) of the Constitution of Pakistan. The Petroleum Concession Agreements (PCAs) describe the E&P Companies' interest as a "working interest" defined as: "Working Interest" means all or any undivided interest in the entirety of the Petroleum concessions, rights and obligations and liabilities imposed by this agreement, including the enjoyment of the exclusive right to explore and prospect for, develop, produce, sell and otherwise dispose of Petroleum from the Area, which interest is chargeable with and currently obligated to bear and pay its proportionate share of all costs and expenditures (including royalties on production and rentals) incurred by Working Interest Owners, in exploring and prospecting for, drilling, developing, producing, selling and otherwise disposing of Petroleum from the Area "
99. Nowhere does the above definition mention a complete right of ownership in the petroleum/mineral itself. The concession and rights granted to them are similar in nature to usage rights granted to a book-publisher who pays royalties to the author for use of the original literary work, to publish it in the form of a book and profit from it.
100. "In determining the income of such undertaking for any year, ending after the date on Which commercial production has commenced, an allowance for depletion shall be made equal to fifteen percent of the gross receipts representing the well-head value of the production: An "allowance for depletion" or a depletion allowance in its ordinary sense is defined (by Oxford Dictionaries Online: http://oxforddictionaries.Com/) as: (Tax concession allowable to a company whose normal business activities (in particular oil extraction) reduce the value of its on assets."
101. Another definition (on imp://oilgasglossary.Com) is:
(b) Reduction in US taxes for owners of an economic interest in minerals in place to compensate for the exhaustion of an irreplaceable capital asset. This economic interest includes mineral interest, working interest in a lease, royalty, overriding royalty, production payment interest, and net profits interest."
(c) The relevant definitions in Black's Law Dictionary (8th Edition) are as follows: "Depletion economic interest: A mineral-land interest subject to depletion by the removal (by drilling or mining) of the mineral that is the subject of the interest.
102. Depletion: An emptying, exhausting, or wasting of an asset, esp. Of a finite natural resource such as oil.
103. Depletion Allowance/Allowance (3): A tax deduction for the owners of oil, gas,. Mineral, or timber resources corresponding to the reduced value of the property resulting from the removal of the resource."
104. It is clear then that a depletion allowance is given as a tax incentive on a taxpayer's depletable economic interest as a compensation for the gradual exhaustion/depletion of the mineral deposits.
105. A legal provision cannot exist in vacuum. Rule 3, Part I of the Fifth Schedule to the 1979 Ordinance significance is to cause a certain economic effect which is to compensate those economic interest holders who stand to lose in the future due to the exhaustible nature of the mineral deposits.
106. Therefore, in accordance with the meaning of the term depletion allowance, such an allowance can only be given to an interest holder on its actual interest, because it is that interest that the interest holder will lose, should the mineral, deposits become completely exhausted. The economic interest or royalty is not owned by the E&P Companies. From the above definitions and principles it could be inferred that an owner of an economic interest with intent to be compensated for depletion of the resources only to the extent of their actual right in those resources. The taxpayer i.e. The E&P Companies cannot receive the added benefit of a depletion allowance on that portion of the income/receipts which it does not on namely the portion representing royalties'. Therefore, royalties must be deducted from gross receipts ,because it represents that part of the receipts, which the E&P Companies do not have a right to.
107. It is worth noting that the Internal Revenue Service (IRS) under the Treasury Department of the US also provides for a similar treatment of depletion allowance by deducting royalties from gross receipts. In the IRS Publication 535 (http: //www . Irs , gov/pub/irs-pdf/p535 . Pdf), which gives guidance on business expenses in accordance with title 26 (Internal Revenue Code) of the US Code, Chapter 9 on page 33 provides.
108. Who Can Claim Depletion?
109. If you have an economic interest in mineral property or standing timber, you can take a deduction for depletion. More than one person can have an economic interest in the same mineral deposit or timber. ..."
110. The IRS Publication then goes on to state under the heading "Percentage Depletion" (this is the type of depletion provided for in Rule 3 of the Fifth Schedule) as under: "Percentage Depletion: To figure percentage depletion, you multiply a certain percentage, specified for each mineral, by your gross income from the property during the tax year...
111. Gross Income. When figuring your percentage depletion, subtract from your gross income from the property the following amounts.
112. Any rents or royalties you paid or incurred for the property.
113. The above is also reflected in S.613 of Title 26 (Internal Revenue Code) of the US Code: "S.163. Percentage depletion (a) General rifle <p.1)><p.m><p.m><p.m><p.m><p.m> <p.m>shall be the percentage, specified in subsection (b), of the gross income from the property excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50 percent (100 percent in the case of oil and gas properties) of the taxpayer's taxable income from the property..." </p.m></p.m></p.m></p.m></p.m></p.m></p.1)> Therefore, it is clear that deducting royalty from gross receipts when calculating depletion allowance is the correct treatment as reflected in the laws of a mature regime, (the extracts of which have reproduced supra). The definition of the terms used in the relevant provisions, and universal economic principles.
114. Further unlike sales tax and excise duty, royalty is not recovered on invoices from customer but by implication is recovered from gas and oil producer, who is bound to pay his share to the Government against the usage of property. In fact royalty is Govt. Levy but it is paid by the E&P Companies from its revenue as charges, while in its response the Govt. Allows E&P Companies to claim royalty as payment to Govt.
115. The nut shell of above discussion is that the royalty being the share of GOP in the mineral resources and levy just like sales tax and excise duty with only difference that sales tax and excise duty are recoverable from the end user and the royalty is recoverable at the time of production from the oil/gas producer. The exclusion of sales tax, excise duty from the gross receipts representing the well head value for the purpose of depletion allowance has not been disputed by the E&P Companies. The royalty being share of GOP in minerals and also a Govt. Levy for the purpose depletion allowance is liable to deduction from the gross receipts representing the well head value.
116. Further the royalty paid to the government is an adjustable payment towards the income tax liability so opposing its deduction would be availing double benefit, something which is not provided in law. The concept of depletion allowance is unique as it is percentage of gross income.
117. The true concept and proper comprehension of the situation demands that to allow the depletion allowance of such gross receipts, which have been arrived at after the legally prescribed deduction.
118. Muhammad Ashraf Abdul Rauf Nazir Ahmad Accountant Member Accountant Member Judicial Member Muhammad Jahandar Javid Iqbal Judicial Member Judicial Member After going through the order authored by my learned colleague, while I soncur with his findings on the issue of tax rate, I am unable to agree with his conclusion relating to Depletion Allowance. In this regard, there is hardly any need to recapitulate the arguments made by learned counsel of the parties for the same have been extensively mentioned in the proposed order.
119. The dispute as to the Depletion Allowance between the oil companies and tax department is regarding the manner of calculation of Depletion Allowance. As per oil companies, such calculation has to be on gross receipts while the department contends that the amount of royalty has to be deducted from the gross receipt before calculating the Depletion Allowance.
120. Rule 3 of Part I of Fifth Schedule to the Income Tax Ordinance, 1979 reads:- "In determining the income of such undertaking for any year ending after the date on which commercial production has commenced, an allowance for depletion shall be made equal to fifteen percent of the gross receipts representing the well-head value of the production. Provided that such allowance shall not exceed fifty percent of the profits or gains of such undertaking before the deduction of such allowance."
121. The expression well-head value has not been defined in the Ordinance and the same is contained in Rule 2(k) of the Pakistan (Petroleum Exploration and Production) Rules, 1986 which is as under:--- "Well-head value means the market value of the Petroleum less gathering, treatment and transportation costs from the well-head to the place at which the market value is determined, and in case of natural gas shall also include compression, dehydration and liquefaction costs."
122. Firstly, a bare perusal of the above mentioned rule shows that well-head value is the market value of the petroleum less gathering, treatment and transportation costs from the well-head to the sale point and the well-head value is not to be reduced by any other amount, like royalty, paid to the government before calculating the Depletion Allowance.
123. Secondly, it is worth mentioning that a memorandum of understanding was executed on 26-3- 2010 between Pakistan Petroleum Exploration and Production Companies Association (PPEPCA) and the Federal Board of Revenue regarding certain disputed issues including Depletion Allowance.
124. In para 3 (4) of part 2 of the MOU it was provided that from the tax year 2009 on words the oil companies will calculate depletion allowance on the well-head value as used for calculating royalty. It was clarified that royalty will not be deducted from "gross receipts representing the well- head value of production" while the sales 'tax and other levies will not be included and gathering and processing costs (where applicable under the relevant Petroleum Rules) shall be deducted accordingly. This shows that from the tax year 2009, the department accepted the contention of the oil companies about depletion allowance that royalty is not to be deducted from the gross receipts before calculating the Depletion Allowance.
125. However, the implementation of this MOU has been disputed by the department on the ground that the confirmation from PPECA was not done in time which made the MOU ineffective. Nevertheless, there is no dispute so far as the contents of the MOU are concerned, which inter-alia covers the Depletion Allowance. Assuming for sake 'of arguments that the oil companies did commit some default in not timely furnishing the acceptance of the MOU yet the fact remains, that the departmental interpretation on the Depletion Allowance from taxpayer 2009 onwards cannot be lost sight of. A question arises as to whether the acceptance of the claim of oil companies regarding Depletion allowance by FBR was within the letter of the law or permissible by the relevant provisions or the stand taken by the department before this Tribunal is the accordance with law.
126. Either of the two cannot be countenanced. If the contention taken by the department before this Tribunal is accepted how can it be reconciled with the position of the FBR in MOU. It seems that the very acceptance of the claim of the oil companies on Depletion Allowance in MOU weakens the case of the department before this Tribunal.
127. Thirdly, the meaning of the expression well-head value has favourably been interpreted quo the oil companies by the tax department for over a decade which practice cannot be ignored and carries weight. Now the oil companies can justifiably claim that royalty is not to be deducted from the well-head value in the computation of Depletion Allowance.
128. Fourthly, it seems that the Ministry of Petroleum, Government of Pakistan with whom exploration contracts were executed has never disputed the calculation of computation of Depletion Allowance from the gross receipts before deduction of royalty. In this regard, a letter by PPECA dated 21-4-2010 by Mazhar Farooq, Secretary General to Mr. M.Naeem Malik, Director General (PC)
129. Directorate General Petroleum Concessions, Ministry of Petroleum and Natural Resources, Government of Pakistan is worth quoting and the relevant part is reproduced:-- "Depletion Allowance is allowed to the E&P companies under the Tax Law @ 15% of the "gross receipts representing Well Head Value (WHV) of Production" and has been accepted as such by the tax authorities since it has been introduced in the law. However, the tax authorities for past few years have started to reassess the tax returns by interpreting that the depletion allowance should be calculated on WHV less Royalty paid to the Government of Pakistan.
130. We believe that the new practice adopted by the Tax authorities is contrary to the relevant Pakistan Petroleum Rules, Petroleum Concession Agreements (PCAs) and applicable laws and industry practice which had previously been accepted by Tax Authorities.
131. It is kindly requested that Ministry of Petroleum may endorse that the Depletion Allowances should be calculated' at 15% of the Well Head Value of Production as per the wordings of the law and prevailing Rules. This may also be noted that the same "WHV" be used for depletion allowance as is used for the purpose of calculation of Royalty."
132. "I am directed to refer to PPEPCA's letter No.PPEPCA/ 129(v)2010 dated 21-4-2010 on the subject cited above and to advise you to go ahead as per your agreement (MOU) of 26-3-2010 with FBR and plead tax cases by presenting the copy of MOU before competent statutory/judicial forums whereby FBR has set out a standard for computation of depletion allowance by withdrawing its stance taken in sub-jdice cases an agreed that for tax year 2009 Royalty will not be deducted from well head value for computation of depletion allowance."
133. "Another petroleum company calculated well head value (an amount lower than gross sales arrived at after deduction for certain expenses) and paid royalty on that basis. Letter No. BNA-8-29 dated June 1, 1998. The Director General Petroleum Concession (DGPC) through letter dated June 17, 1998 held that royalty @ 12% percent of the gross sales value is payable. The amount short para was recovered."
134. From the above it may thus be inferred that Ministry of Petroleum, Government of Pakistan, who is a party to the oil exploration contracts never disputed the royalty being deducted after the adjustment of Depletion Allowance from the gross receipts. As regards, the concern of the department that the oil companies shall be in receipt of double advantage, it may be said that it is the Ministry of Petroleum, Government of Pakistan which should worry about that and once a position has been taken by the Government of Pakistan which seems to be a kind of incentive to the oil companies engaged in business of oil exploration, tax department may not pick up the said issue.
135. Thus from the above discussion it may be concluded that Depletion Allowance is to be calculated on the well-head value without first deducting the royalty.