Sharing of Profit Petroleum and the Constitutional Bench decision on the nature of royalty

Just as with other minerals, oil & natural gas are owned by the Center when in the ocean, and largely owned by states within their boundaries. This sector has a global standard of using Production Sharing Contracts (PSCs), where after a certain level of cost recovery, a proportion of the profit petroleum is handed over to the government by the extractors. For onshore blocks, the extractor signs a lease with the state, which includes provisions to pay royalty, and the PSC with the center. The 12th Finance Commission examined the question of to whom this Profit Petroleum (the government share) would go to, and decided that it should be split 50:50. The state of Gujarat took the stance that since the oil & gas is the property of the state, it should receive the entire profit petroleum, even though they also receive royalty.

The Constitutional Bench of the Supreme Court recently decided on the question of whether royalty was a tax. By an 8:1 majority, they ruled that royalty was a contractual obligation, payable to the state under the mining lease. After examining various provisions of the State and Union Lists of the Seventh Schedule of the Constitution, they also decided that only states have the power to impose taxes on land, minerals or mineral rights. They also emphasized the public trust doctrine as well as the need for many mineral bearing states to find sources of funds.

The only alternative that the center receives a part of the profit petroleum as a result of signing the PSC seems absurd as they only have rights to regulate and develop and nothing more. Therefore, it would seem that the judgment of the Constitutional Bench has clarified that the stance of the state of Gujarat is the correct position, and this needs to be revisited.

This letter is a follow up to an earlier letter that can be read here.