China: Energy Tax Regulations Updated

First published in Bloomberg BNA Tax Planning International Asia-Pacific Focus, April 2012

China has recently revised its tax policies to encourage energy conservation and the efficient exploration of natural resources. This article briefly describes and analyses the four major tax policy changes that will affect companies and investors engaged in the exploration, production and sale of oil and gas in China.

I. China implements new resource tax regulations

In September 2011, China's State Council announced new amendments to the Resource Tax Interim Regulations that would take effect from November 1, 2011. Shortly following this announcement, the Ministry of Finance (MOF) issued the revised Implementing Rules for the Resource Tax Interim Regulations on October 28, 2011 (together with the State Council's decision, the "New Resource Tax Regulations"). The State Council also promulgated at the end of September 2011 the new Regulations on Sino-Foreign Cooperative Exploitation of Offshore Petroleum Resources and the new Regulations on Sino-Foreign Cooperative Exploitation of Onshore Petroleum Resources (together, the "New Sino-Foreign Cooperative Exploration Regulations"), which change the tax payment obligations on foreign-invested onshore and offshore oil and gas fields by replacing the former royalty-based system with a resource tax system. The New Sino-Foreign Cooperative Exploration Regulations supersede and replace the prior versions of these regulations with effect from November 1, 2011.

Before the New Resource Tax Regulations took effect, resource taxes were levied on all domestically-produced crude oil and natural gas based on volumes produced with levies ranging between RMB 8 to RMB 30 per ton of crude oil and RMB 2 to RMB 15 per cubic meter of natural gas. Under the New Resource Tax Regulations, the Chinese government now levies a resource tax on all domestically-produced crude oil and natural gas based on the actual sales value of such crude oil and/or natural gas. The regulations provide that the resource tax is to be levied at rates ranging from 5–10 percent, to be set by the MOF from time to time. (Note that the new resource tax regime applies to oil and gas only; resource taxes for other natural resources such as coal and ores will continue to be levied based on the volume of such minerals produced.) The MOF has currently set the resource tax rate for crude oil and natural gas at 5 percent.

In accordance with the New Sino-Foreign Cooperative Exploration Regulations, the new resource tax regime applies to oil and gas produced from foreign-invested onshore and offshore oil and gas fields under petroleum contracts entered into or renewed after November 1, 2011; volume-based royalties are no longer levied on such oil and gas fields. See the table below.

We note that the New Sino-Foreign Cooperative Exploration Regulations do not specify whether the November 1, 2011 cut-off date refers to the signing date or the effective date (i.e. the approval date of the contracts by the Ministry of Commerce) of the relevant Petroleum Contract. No names inquiries with the relevant authorities on this question yielded inconsistent responses.

According to the Chinese government, this reform is an extension of a pilot scheme which has been in operation in a few provinces in the Northwest (e.g. Xinjiang) for a year, which is designed to raise regional government revenue while promoting resource conservation and reduction of environmental damage.

II. China extends compensation fees to foreign-invested energy projects

On March 31, 2012, the Ministry of Land and Resources issued a Notice regarding the Levy of Oil Resource Compensation Fees on Onshore and Offshore Oil and Gas Fields by Sino-foreign Cooperative Exploitation (the "Compensation Fee Notice"), which took effect from March 31, 2012 and will be effective until March 30, 2020. Shortly following the change of tax regime governing the foreign-invested onshore and offshore oil and gas fields in November 2011, China further extended the compensation fee levy on oil and gas production to cover oil and gas produced from foreign-invested onshore and offshore oil and gas fields. Previously, the levy on oil and gas production applied only to domestic energy projects.

According to the Compensation Fee Notice, the compensation fee applies to a wide range of natural resources, including not only the conventional oil and natural gas, but also the unconventional oil and gas, such as coal-bed methane and shale gas. However, oil and gas produced from foreign-invested onshore and offshore oil and gas fields under petroleum contracts entered into or renewed before November 1, 2011 will be exempt from the new levy; such oil and gas fields are required to continue to pay volume-based royalties.

The new compensation fees are to be levied in accordance with the Administrative Regulations re Collection of Mineral Resources Compensation Fees (the "Administrative Regulations"), which took effect from April 1, 1994 and were revised on July 3, 1997. According to the Administrative Regulations, the compensation fee rates of conventional oil and gas, as well as coal-bed methane, are set at 1 percent. As China has recently changed the legal status of shale from a "natural resource" to an "independent mining resource", it is uncertain whether the compensation fee rate of shale gas will remain at 1 percent. In addition, the benefits of tax reduction and exemption that apply under certain circumstances in accordance with the Administrative Regulations also extend to the foreign-invested onshore and offshore oil and gas fields.

III. China reduces crude oil windfall profit tax obligations

Since 2006, China has levied a windfall profit tax, known as the "special revenue charge" on oil producers — both foreign and domestic — selling crude oil produced in China. The windfall profit tax is calculated on a monthly basis and paid on a quarterly basis. Oil producers have to pay the windfall profit taxes on oil production based on a five-tiered rate system according to the sales price.

On December 29, 2011, the MOF issued a notice reducing the windfall profit tax obligations on crude oil production (the "Windfall Tax Notice"), effective retrospectively from November 1, 2011. The Windfall Tax Notice was released shortly after the State Council announced the national resource tax reform, as discussed in the section above, which increased the tax burdens of the oil and natural gas producers. At least to some extent, the purpose of the Windfall Tax Notice is designed to alleviate some of the increased tax burdens imposed by the new resource tax regime as energy and commodity prices continue to surge.

Without changing the other relevant rules, the Windfall Tax Notice raises the minimum threshold for the windfall profit tax payment obligation from USD$40/barrel to USD$55/barrel and all the other thresholds under the five-tiered progressive system as follows:

The amount of the windfall tax that is payable per barrel is calculated as follows: (i) (the monthly weighted average price per barrel of crude oil sold minus USD$55), multiplied by (ii) the applicable Rate, minus (iii) the "Quick Calculation Deduction." For example, if the crude oil price is 65, then the windfall tax is 10 x 25% = 2.50 - 0.25 = USD2.25 per barrel.

IV. China grants tax rebates for imported gas

In a move that reinforces China's increased emphasis on the use of natural gas in the country's energy mix, on August 1, 2011, the MOF, the General Administration of Customs, and the State Administration of Taxation jointly issued a notice regarding granting rebates for import value-added taxes (Import VAT) on rapidly growing imports of natural gas (the "Import VAT Notice"). This policy shift has been long-awaited by Chinese state energy companies who hope to reduce their losses on the import of natural gas as gas imports continue to increase.

The Import VAT rebates apply to state-mandated natural gas pipeline projects and LNG import terminals currently in use and those to be later approved by the state, including the central-Asia pipeline venture operated by PetroChina (the "Central-Asia Project"). These rebates apply when import costs are above the regulated domestic wholesale prices, and apply to all imports during the period from 2011–2020, as well as prior imports under the Central-Asia Project.

According to the news commentators, this tax rebate policy will buy some time for Beijing's policymakers to push for domestic energy pricing reform, including the liberalisation of natural gas pricing mechanisms. Following the introduction of this tax rebate policy, on December 26, 2011, China authorised a pilot gas-pricing program for wholesale and retail natural gas prices in Guangdong and Guangxi provinces to liberalise the natural gas prices and help local producers and importers of gas.

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