Business expenditure – Deduction u/s 42(1)(a) of ITA, 1961 – Exploration and extraction of oil – Conditions precedent for deduction – Expenditure should be infructuous or abortive exploration expenses, and area should be surrendered prior to commencement of commercial production – Meaning of expression ‘surrender’ – Does not always connote voluntary surrender – Assessee entering into production sharing contract with Government of India and requesting for extension at end of contract period – Government refusing extension – Assessee entitled to deduction u/s 42(1)(a); A.Y. 2008-09

43. Principal CIT vs. Hindustan Oil Exploration Co. Ltd. [2020] 423 ITR 465 (Bom.) Date of order: 25^th March, 2019 A.Y.: 2008-09

Business expenditure – Deduction u/s 42(1)(a) of ITA, 1961 – Exploration and extraction of oil – Conditions precedent for deduction – Expenditure should be infructuous or abortive exploration expenses, and area should be surrendered prior to commencement of commercial production – Meaning of expression ‘surrender’ – Does not always connote voluntary surrender – Assessee entering into production sharing contract with Government of India and requesting for extension at end of contract period – Government refusing extension – Assessee entitled to deduction u/s 42(1)(a); A.Y. 2008-09

The assessee was engaged in the business of exploration and extraction of mineral oil. It entered into a production-sharing contract with the Government of India on 8^th October, 2001 for the purposes of oil exploration. According to the contract, a licence was issued to a consortium of three companies, which included the assessee, to carry out the exploration initially for a period of three years and the entire exploration was to be completed within a period of seven years in three phases. At the end of the period, extension was denied by the Government of India. In its Nil return of income filed for the A.Y. 2008-09, the assessee claimed deduction u/s 42(1)(a) of the Income-tax Act, 1961 on the expenditure on oil exploration on the ground that the block was surrendered on 15^th March, 2008. The A.O. was of the opinion that it had not surrendered the right to carry on oil exploration since the assessee was interested in extension of time which was denied by the Government of India and disallowed the claim.

The Commissioner (Appeals) allowed the appeal. The Tribunal found that according to article 14 of the contract, relinquishment and termination of agreement were two different concepts and that by a letter dated 28^th March, 2007 the assessee was informed that its contract stood relinquished. The Tribunal held that the assessee was covered by the deduction provision contained in section 42, that such expenditure was not amortised or was not being allowed partially year after year and it had to be allowed in full, and therefore there was no justification to deny the benefit of deduction to the assessee.

On appeal by the Revenue, the Bombay High Court upheld the decision of the Tribunal and held as under:

‘i) As long as the commercial production had not begun and the expenditure was abortive or infructuous exploration expenditure, the deduction would be allowed. The term “surrender” itself was a flexible one and did not always connote the meaning of voluntary surrender. The surrender could also take place under compulsion. The assessee had no choice but to surrender the oil blocks because the Government of India had refused to extend the validity period of the contract. Admittedly, commercial production of oil had not commenced. The act of the assessee to hand over the oil blocks before the commencement of commercial production was covered within the expression “any area surrendered prior to the beginning of commercial production by the assessee”.

ii)   The provisions of section 42 recognised the risks of the business of exploration which activity was capital-intensive and high in risk of the entire expenditure not yielding any fruitful result and provided for special deduction. The purpose of the enactment would be destroyed if interpreted rigidly. For applicability of section 42(1)(a) the elements vital were that the expenditure should be infructuous or abortive exploration expenses and that the area should be surrendered prior to the beginning of commercial production by the assessee. As long as these two requirements were satisfied, the expenditure in question would be recognised as a deduction. The term “surrender” had to be appreciated in the light of these essential requirements of the deduction clause. It was not the contention of the Department that the expenditure was infructuous or abortive exploration expenditure.

iii) The interpretation of section 42(1)(a) by the Tribunal and its order holding the assessee eligible for deduction thereunder were not erroneous.’