Chennai CESTAT: ONGC Exempted from Service Tax on Payment for Right to Use Natural Resources

The Chennai Bench of Customs, Excise, and Service Tax Appellate Tribunal (CESTAT) recently ruled that Oil and Natural Gas Corporation Ltd. (ONGC) is exempt from service tax liability concerning the payment for the right to utilize natural resources.

The bench, comprised of Sulekha Beevi C.S. (Judicial Member) and Vasa Seshagiri Rao (Technical Member), based its decision on the precedent set by the Supreme Court in Cements v. State of Tamil Nadu. The tribunal concurred with the Supreme Court’s perspective, asserting that royalty is a form of tax rather than compensation for services. Consequently, the demand for service tax on royalty was deemed untenable.

The appellant, engaged in the exploration and production of crude oil and natural gas across various oil fields in Nagapattinam, Cuddalore, Tiruvarur, Tanjore, and Ramnad Districts of Tamil Nadu, holds a service tax registration for fulfilling tax obligations related to various taxable services.

According to the department, the appellant failed to remit the requisite service tax on the consideration amount, represented by royalty payments to the Government of Tamil Nadu. This payment was made in exchange for the right to explore and produce crude oil and natural gas. An investigation was initiated by the officers of the Directorate General of Goods and Service Tax (GST), Zonal Unit, Bangalore, which involved the issuance of summonses for document submission and recording of statements.

The central question at hand was whether the Appellant is subject to Service Tax on the Royalty Payments made to the Government of Tamil Nadu for the utilization of oil fields.

The department argued that natural resources are state properties, which can either be employed by the state for public welfare or assigned to any individual for consideration. The valuation of the consideration for granting the right to use natural resources (through a license) involves factors such as contract terms, usage duration, benefits quantity, etc. Upon examining the Petroleum Mining Lease issued by the Government of Tamil Nadu, it was evident that the lease was granted for the extraction of crude oil and natural gas in allocated blocks, with the consideration being paid or payable by the appellant in the form of royalty, PEL/PML, dead rent, and surface rent.

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According to Section 65B (44) of the Finance Act, 1994, ‘service’ encompasses any activity carried out by one person for another for consideration, including declared services. In the negative list system, all services, except those specified in the negative list, are subject to service tax. Government-provided services fall under clause (a) of Section 66D, which designates services by the government or local authority as non-taxable.

The appellant argued that the Royalty paid is not a consideration for any service but rather an amount akin to a tax. Even if the Royalty is not considered a tax, the grant of a license by the State Government is not a service but an exercise of its regulatory functions. Additionally, the royalty payments under the Oilfields (Regulation and Development) Act, 1948 (ORD Act) are deemed regulatory fees, not consideration for a service.

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The court determined that as per the provisions outlined in the Oilfields (Regulation and Development) Act, 1948, along with the P & NG Rules, 1959, royalty is more appropriately characterized as a regulatory fee rather than compensatory. Despite periodic variations in the amount of royalty, the court viewed the payment as a regulatory measure aimed at preventing the over-exploitation of Earth’s resources. Given its predominant regulatory nature, royalty does not align with the definition of consideration for services under the service tax law.

Furthermore, the court established that the granting of a mining lease should be classified as a lease rather than an assignment, contrary to the Department’s contention. Rule 17 of the PNG Rules explicitly prohibits the transfer of assignments, reinforcing the court’s conclusion that the granting of a mining lease is akin to a lease agreement.