Profit petroleum is in the nature of non-tax revenue receivable by the central government out of the profit generated on account of production of crude oil and natural gas from the fields awarded by the government under a production sharing contract (PSC). Central government becomes entitled to a share in profit if, in the event of commercial production, a project generates profit. The formula for sharing of the profit is specified in the relevant PSC.

In terms of articles 294-296 of the Constitution, the ownership rights on all land and mineral resources located within the territory of the state, rest with the state. It is in recognition of this constitutional right that the The Petroleum and Natural Gas Rules, 1959 (P&NGR) provide that a license or lease in respect of any land vested in a state government shall be granted by the state government, albeit with the previous approval of the central government. In addition, section 6A of the Oilfields (Regulation and Development) Act, 1948 (ORDA) specifically creates a liability on the holder of a mining lease for payment of royalty in respect of any mineral oil mined, quarried, excavated or collected by the holder from the leased area at the rate specified in the Schedule in respect of that mineral oil.

It is, clear that the royalty is payable to the state for on-shore areas and to the centre, for off-shore areas. But, under the ORDA, the central government has the authority to enhance or reduce the rates of royalty.Keeping in view the ownership rights of the states over the land within their territory, the exploration blocks in the onland areas are offered to national oil companies or to others by the central government after obtaining the concurrence of the respective state governments.The Ministry of Petroleum and Natural Gas (MOP&NG) has informed Finance Commission that there are five different regimes in the matter of mining lease/ licenses for exploration of oil and gas, namely :

a) Petroleum Exploration License (PEL) and Petroleum Mining Lease (PML) granted to national oil companies [Oil and Natural Gas Commission (ONGC) and Oil India Ltd. (OIL)],

b) Mining Licences granted under small size discovered field PSCs,

c) Mining Licences granted under medium size discovered field PSCs,

d) Petroleum Exploration License and Petroleum Mining Lease granted under pre-NELP PSCs, and

e) Exploration Licences granted under the New Exploration Licensing Policy (NELP).

Under the first regime, exploration blocks were offered to national oil companies on nomination basis. These companies are required to pay full statutory levies viz. royalty to the state government/ central government for on-land/off-shore areas and cess to the central government. National oil companies pay customs duties in the nomination fields, in case of petroleum mining licenses granted prior to 1.4.1999.

Some of the small and marginal fields discovered by ONGC and OIL were offered to other parties for rapid development under two rounds of bidding in the year 1992 and 1993. In the PSCs relating to those fields, the rates of royalty and cess were frozen with a view to providing fiscal stability i.e. a stable tax regime to the contractors. In order to ensure that the states get royalty from onland blocks at full rates i.e. 20 per cent, the difference is paid to the states through Oil Industry Development Board. The central government has exempted the imports from customs duties and has frozen the cess for the life of the contract at the rate of Rs 900 per metric tonne as against the normal rate of Rs 1800 per metric tonne effective from 1st March, 2002.

Prior to 1997, in the pre-NELP exploration blocks, the two national oil companies as licensees, were required to bear all the liability of statutory levies, namely royalty and cess, but the exploration blocks were offered to various companies in order to attract private investments in exploration and production of oil. The private companies were selected through a bidding process. As per the PSCs under this regime, the share of the national oil companies could be up to a maximum of 40 per cent and the parties to the contract are to share profit oil and profit gas separately from each field on the basis of post-tax returns. Royalty is paid to the state for onland areas at the same rate as applicable in the nomination blocks/fields i.e. at the rate of 20 per cent. Further, central government forgoes its revenues by granting customs duty exemption on imports required for exploration, development and production.

The system of offering exploration blocks to various parties was modified in 1997 with the introduction of the NELP, under which the national oil companies and private players are treated at par and are required to compete with each other for acquiring exploration acreages under uniform contractual and fiscal framework.As regards PSCs entered into under NELP, the policy was announced by the government in 1997 and it became effective in 1999, after completion of relevant requirements, including concurrence from state governments. Under NELP, the net revenue remaining after deduction of royalty and costs (i.e. pre-tax profit) is to be shared between the contractor and the government of India on the basis of an investment multiple system. The contractor is allowed full cost recovery on all costs incurred in an exploration block.

All companies are required to pay royalty at the rate of 12.5 per cent on crude oil to the state governments for on-land areas and at 10 per cent to central government for shallow water areas. Royalty is payable at half the rate i.e., at 5 per cent, to the central government for deep water areas for the initial seven years of commercial production. Half the royalty from off-shore areas is credited to a hydrocarbon development fund to promote and fund exploration related activities.Under NELP, government has exempted companies from payment of cess on crude oil. Further, imports have been exempted from custom duties and a seven year tax holiday is available from the date of commencement of commercial production. In forgoing the revenues, the objective of the central government is to encourage exploration of oil and gas and find more reserves to meet economic growth and strategic requirements of the country.