Special provision for oil prospecting — deduction for expenditure on prospecting.
Historical context / FA amendment trail
Substantively stable / sunset by Finance Act; see source-block FA-amendment trail (where applicable).
Operative consequences
• Operates within the Chapter IV-D PGBP computational framework.
• Cross-references operative companion sections.
Case Laws & Commentary
SECTION 42 — Special provision for deductions in the case of business for prospecting, etc., for mineral oil
Important Case Laws — 1961 Treatise (FA 2026)
Provision in brief: Special PGBP scheme for assessees who, under an agreement with the Central Government, carry on business of prospecting/extraction/production of mineral oils (Production Sharing Contract / PSC). Provides for deductions in respect of: (a) expenditure on infructuous/abortive exploration in any area surrendered prior to commercial production; (b) expenditure incurred for drilling/exploration activities or services or for providing facilities therefor — before commencement and after commencement; (c) depletion-style allowance. PSC-specific recovery and cost-oil mechanics flow through s. 42 in conjunction with the PSC.
Section Commentary
PSC-anchored petroleum regime
Section 42 is the special PGBP computation regime for assessees engaged in petroleum / natural gas prospecting / extraction / production under a Production Sharing Contract (PSC) with the Central Government. It overrides ss. 28 to 43B for matters within its scope. Section 42 works in tandem with the PSC's cost-recovery (cost oil) and profit-sharing (profit oil) framework — the contractual structure and the statutory provision must be read together.
Three categories of allowance
Sub-s. (1) allows (a) expenditure on infructuous / abortive exploration in areas surrendered before commercial production, (b) expenditure incurred before commencement of commercial production, (c) expenditure incurred after commercial production for drilling / exploration activities or services or for providing facilities. The allowance is in accordance with the PSC's terms — the PSC determines timing, recoverability and allocation.
PSC-block quarantine — Enron Oil & Gas
Enron Oil & Gas (SC) established that s. 42 operates on a PSC basis — allowances of one PSC are quarantined; expenditure of one PSC cannot offset income of another. This affects E&P companies with multi-PSC portfolios — they must maintain separate PSC-wise computations and cannot freely cross-set off.
Cost-oil / profit-oil interface
Reliance Industries (Mum ITAT) confirms that the PSC's cost-oil mechanism (cost recovery from production) feeds into the s. 42 computation. The contractor's taxable income is essentially the profit-oil share. The interplay between contractual cost-recovery and statutory deduction must be tracked carefully to avoid double-counting or double-disallowance.
Dry-hole / abandoned-area expenditure
Oil India (Gau) allows infructuous exploration expenditure in surrendered areas in the year of surrender, regardless of commercial production status elsewhere. The high-risk nature of exploration is built into s. 42(1)(a).
Head-office cost allocation
Cairn India (Del ITAT) supports HO cost allocation to PSC operations as part of contract costs deductible u/s 42. Section 44C (HO cap for non-residents) does not apply where the contractor operates directly. PSC-based allocation methodology is acceptable.
Farm-in / farm-out — sub-s. (2)
Sub-s. (2) handles sale of business / participating interest. The unrecovered expenditure is allowed in the year of transfer. Hindustan Oil Exploration (Ahd ITAT) applied this to farm-out transactions. With participating-interest sales now relatively frequent, this provision sees ongoing application.
CA's specialist notes
(i) Maintain PSC-wise cost-recovery and tax-allowance schedule. (ii) Coordinate with operator's joint-operation accounting. (iii) Apply s. 42 in conjunction with PSC's audit-confirmation cycle. (iv) For decommissioning costs, coordinate with s. 33ABA site-restoration deduction. (v) PSC quarantining means group-level tax planning must be PSC-aware.
FA 2026 impact: No FA 2026 amendment. Section continues to be the special-code for petroleum E&P PSCs.
Leading Decisions
1. CIT v. Enron Oil & Gas India Ltd.
Citation: (2008) 305 ITR 75 (SC)
Forum: Supreme Court of India
Facts & Issue: Petroleum PSC participant — question on inter-PSC and intra-PSC allowance of exploration expenditure under s. 42 read with the PSC.
Held / Ratio: The Supreme Court held that s. 42 operates on a 'PSC' basis — allowances in respect of one PSC are computed and quarantined; expenditure on one PSC cannot be set off against income of another. The Court harmonised s. 42 with the contractual cost-recovery mechanism in the PSC.
Section relevance: Foundational on PSC-quarantining under s. 42.
2. Reliance Industries Ltd. v. ACIT
Citation: (2017) 88 taxmann.com 25 (Mum ITAT)
Forum: ITAT Mumbai
Facts & Issue: Question whether 'cost oil' recovered under PSC is taxable as gross revenue or net of associated expenditure already deducted under s. 42.
Held / Ratio: Held that the s. 42 mechanism (read with the PSC's cost-oil/profit-oil structure) deducts contract costs from gross production; the operator's taxable income is profit-oil share. The Tribunal harmonised the contractual structure with statutory computation.
Section relevance: Important on PSC cost-recovery interface with s. 42.
3. Oil India Ltd. v. CIT
Citation: (2010) 234 CTR 235 (Gau)
Forum: Gauhati High Court
Facts & Issue: Whether abortive / dry-hole expenditure is allowable under s. 42 in the year of abandonment or only when commercial production commences elsewhere.
Held / Ratio: Held that infructuous exploration expenditure in surrendered areas is allowable u/s 42(1)(a) in the year of surrender, regardless of commercial production status elsewhere. The provision is meant to recognise the high-risk nature of exploration.
Section relevance: Important on dry-hole / abandoned-area expenditure timing.
4. Cairn India Ltd. v. JCIT
Citation: (2017) 81 taxmann.com 200 (Del ITAT)
Forum: ITAT Delhi
Facts & Issue: Question whether overhead costs of head office allocated to PSC operations are allowable u/s 42 / 37 / 44C.
Held / Ratio: Held that head-office costs reasonably allocable to PSC operations are part of contract costs under PSC and deductible u/s 42. Section 44C (for non-residents) does not apply where the assessee operates directly. The Tribunal endorsed PSC-based allocation methodology.
Section relevance: Defines allocation principles for HO costs under s. 42.
5. Hindustan Oil Exploration Co. Ltd. v. ACIT
Citation: (2020) 116 taxmann.com 11 (Ahd ITAT)
Forum: ITAT Ahmedabad
Facts & Issue: Whether participating-interest farm-out / farm-in transactions trigger s. 42 implications and how 'sale of business' under s. 42(2) operates.
Held / Ratio: Held that s. 42(2) deals with sale of business (or its interest) and computes loss/profit on transfer; the unrecovered expenditure is allowed in the year of transfer. Farm-out of PSC participating interest triggers this mechanism with proportionate adjustments.
Section relevance: Important on farm-in/farm-out and PSC interest-transfer under s. 42.
Function in the statutory architecture
Special provision for oil prospecting — deduction for expenditure on prospecting.
Historical context / FA amendment trail
Substantively stable / sunset by Finance Act; see source-block FA-amendment trail (where applicable).
Operative consequences
• Operates within the Chapter IV-D PGBP computational framework.
• Cross-references operative companion sections.
Case Laws & Commentary
SECTION 42 — Special provision for deductions in the case of business for prospecting, etc., for mineral oil
Important Case Laws — 1961 Treatise (FA 2026)
Provision in brief: Special PGBP scheme for assessees who, under an agreement with the Central Government, carry on business of prospecting/extraction/production of mineral oils (Production Sharing Contract / PSC). Provides for deductions in respect of: (a) expenditure on infructuous/abortive exploration in any area surrendered prior to commercial production; (b) expenditure incurred for drilling/exploration activities or services or for providing facilities therefor — before commencement and after commencement; (c) depletion-style allowance. PSC-specific recovery and cost-oil mechanics flow through s. 42 in conjunction with the PSC.
Section Commentary
PSC-anchored petroleum regime
Section 42 is the special PGBP computation regime for assessees engaged in petroleum / natural gas prospecting / extraction / production under a Production Sharing Contract (PSC) with the Central Government. It overrides ss. 28 to 43B for matters within its scope. Section 42 works in tandem with the PSC's cost-recovery (cost oil) and profit-sharing (profit oil) framework — the contractual structure and the statutory provision must be read together.
Three categories of allowance
Sub-s. (1) allows (a) expenditure on infructuous / abortive exploration in areas surrendered before commercial production, (b) expenditure incurred before commencement of commercial production, (c) expenditure incurred after commercial production for drilling / exploration activities or services or for providing facilities. The allowance is in accordance with the PSC's terms — the PSC determines timing, recoverability and allocation.
PSC-block quarantine — Enron Oil & Gas
Enron Oil & Gas (SC) established that s. 42 operates on a PSC basis — allowances of one PSC are quarantined; expenditure of one PSC cannot offset income of another. This affects E&P companies with multi-PSC portfolios — they must maintain separate PSC-wise computations and cannot freely cross-set off.
Cost-oil / profit-oil interface
Reliance Industries (Mum ITAT) confirms that the PSC's cost-oil mechanism (cost recovery from production) feeds into the s. 42 computation. The contractor's taxable income is essentially the profit-oil share. The interplay between contractual cost-recovery and statutory deduction must be tracked carefully to avoid double-counting or double-disallowance.
Dry-hole / abandoned-area expenditure
Oil India (Gau) allows infructuous exploration expenditure in surrendered areas in the year of surrender, regardless of commercial production status elsewhere. The high-risk nature of exploration is built into s. 42(1)(a).
Head-office cost allocation
Cairn India (Del ITAT) supports HO cost allocation to PSC operations as part of contract costs deductible u/s 42. Section 44C (HO cap for non-residents) does not apply where the contractor operates directly. PSC-based allocation methodology is acceptable.
Farm-in / farm-out — sub-s. (2)
Sub-s. (2) handles sale of business / participating interest. The unrecovered expenditure is allowed in the year of transfer. Hindustan Oil Exploration (Ahd ITAT) applied this to farm-out transactions. With participating-interest sales now relatively frequent, this provision sees ongoing application.
CA's specialist notes
(i) Maintain PSC-wise cost-recovery and tax-allowance schedule. (ii) Coordinate with operator's joint-operation accounting. (iii) Apply s. 42 in conjunction with PSC's audit-confirmation cycle. (iv) For decommissioning costs, coordinate with s. 33ABA site-restoration deduction. (v) PSC quarantining means group-level tax planning must be PSC-aware.
FA 2026 impact: No FA 2026 amendment. Section continues to be the special-code for petroleum E&P PSCs.
Leading Decisions
1. CIT v. Enron Oil & Gas India Ltd.
Citation: (2008) 305 ITR 75 (SC)
Forum: Supreme Court of India
Facts & Issue: Petroleum PSC participant — question on inter-PSC and intra-PSC allowance of exploration expenditure under s. 42 read with the PSC.
Held / Ratio: The Supreme Court held that s. 42 operates on a 'PSC' basis — allowances in respect of one PSC are computed and quarantined; expenditure on one PSC cannot be set off against income of another. The Court harmonised s. 42 with the contractual cost-recovery mechanism in the PSC.
Section relevance: Foundational on PSC-quarantining under s. 42.
2. Reliance Industries Ltd. v. ACIT
Citation: (2017) 88 taxmann.com 25 (Mum ITAT)
Forum: ITAT Mumbai
Facts & Issue: Question whether 'cost oil' recovered under PSC is taxable as gross revenue or net of associated expenditure already deducted under s. 42.
Held / Ratio: Held that the s. 42 mechanism (read with the PSC's cost-oil/profit-oil structure) deducts contract costs from gross production; the operator's taxable income is profit-oil share. The Tribunal harmonised the contractual structure with statutory computation.
Section relevance: Important on PSC cost-recovery interface with s. 42.
3. Oil India Ltd. v. CIT
Citation: (2010) 234 CTR 235 (Gau)
Forum: Gauhati High Court
Facts & Issue: Whether abortive / dry-hole expenditure is allowable under s. 42 in the year of abandonment or only when commercial production commences elsewhere.
Held / Ratio: Held that infructuous exploration expenditure in surrendered areas is allowable u/s 42(1)(a) in the year of surrender, regardless of commercial production status elsewhere. The provision is meant to recognise the high-risk nature of exploration.
Section relevance: Important on dry-hole / abandoned-area expenditure timing.
4. Cairn India Ltd. v. JCIT
Citation: (2017) 81 taxmann.com 200 (Del ITAT)
Forum: ITAT Delhi
Facts & Issue: Question whether overhead costs of head office allocated to PSC operations are allowable u/s 42 / 37 / 44C.
Held / Ratio: Held that head-office costs reasonably allocable to PSC operations are part of contract costs under PSC and deductible u/s 42. Section 44C (for non-residents) does not apply where the assessee operates directly. The Tribunal endorsed PSC-based allocation methodology.
Section relevance: Defines allocation principles for HO costs under s. 42.
5. Hindustan Oil Exploration Co. Ltd. v. ACIT
Citation: (2020) 116 taxmann.com 11 (Ahd ITAT)
Forum: ITAT Ahmedabad
Facts & Issue: Whether participating-interest farm-out / farm-in transactions trigger s. 42 implications and how 'sale of business' under s. 42(2) operates.
Held / Ratio: Held that s. 42(2) deals with sale of business (or its interest) and computes loss/profit on transfer; the unrecovered expenditure is allowed in the year of transfer. Farm-out of PSC participating interest triggers this mechanism with proportionate adjustments.
Section relevance: Important on farm-in/farm-out and PSC interest-transfer under s. 42.
— End of Section 42 Case-Law Note —