Stumbling block

Mumbai, July 9: A tax rejig in the recent budget could spell big trouble for Mukesh Ambani’s plan to build a network of pipelines across the country to carry the gas flowing out of its fields in the Krishna-Godavari basin.

Blame it on a new section — 35AD — introduced in the recent budget that appears to favour Mukesh Ambani by bringing back a tax break called investment allowance in a limited way.

But while handing out a big tax break to Mukesh Ambani-owned Reliance Gas Transportation Infrastructure Ltd (RGTIL) and the state-owned GAIL (India) Ltd with one hand, it has wrested more by denying them the benefit of a 10-year tax holiday extended to infrastructure projects.

Under section 35AD, the government has allowed companies to claim a 100 per cent deduction on the capital expenditure incurred for laying gas pipelines.

This section brings back the concept of investment allowance — a key demand of industry that pops up every year before the budget — after a gap of 19 years. Investment allowance was one of key elements in the tax code that helped a large number of companies, including Reliance Industries, to avoid having to pay corporate tax for a number of years until the minimum alternate tax came along in 1996. Investment allowance was on the statute books from 1976 till 1990.

However, the government has at the same time refused to allow Reliance Gas Transportation and GAIL to claim a tax holiday under section 80-IA. The amendment to this section reads: “Profit-linked deduction provided under section 80-IA to the business of laying and operating a cross-country natural gas distribution network will be discontinued. As a result, any person enjoying this incentive can take benefit under the proposed section 35AD.”

Experts say that the gas pipeline companies will be making huge investments in the first few years and will definitely benefit from section 35AD. But once they stop making those investments, they will be denied the tax break. Effectively, the tax holiday of 10 years could shrink to about three or four years.

Under 80 IA, these companies could claim a tax holiday for any block for 10 years.

In the case of section 35AD, the deduction will only be allowed on the capital expenditure and not on profits.

The new method of taxation will also hurt the cash flow of these companies.

“I am surprised that when we are all so focused on infrastructure development, the 10-year tax incentive in the field of cross-country pipelines, which is critical in the energy sector, is being withdrawn,” said Rahul Garg, head of the oil and gas practice at PricewaterhouseCoopers.

He reckoned that the full deduction of the capital expenditure would not compensate the company for the loss of cash flow because of the significantly higher tax burden in later years. “This will impact the ability of these enterprises to generate enough internal accruals to fund such capital-intensive projects.”

“I hope the tax incentive is restored, not only in respect of pipelines already entitled to such a tax holiday, but also in the case of new pipelines,” Garg added.

RIL refused to comment on the development. However, sources said that the company was studying the impact of section 35AD. GAIL is understood to be lobbying the government for a clarification on the issue.