Reliance Industries has served a notice for suspension of gas supplies to four fertiliser plants in Uttar Pradesh from Thursday unless they enhance their financial guarantees to cover for state sales tax.

RIL on October 1 served a notice for suspension of supplies to plants of Indo Gulf Fertiliser, IFFCO, KRIBHCO, Shyam Fertilisers and Tata Chemicals from 0600 hours on Thursday, sources privy to the development said.

The fertiliser firms, which produce about 2 million tonnes of urea from gas sourced from RIL, are opposed to providing financial guarantees in the form of letters of credit (LC) to cover for liabilities arising out of the levy of local sales tax on gas sales, as it would increase the cost of production and subsidy payouts.

RIL supplies some 4 million standard cubic metres per day of natural gas from its eastern offshore KG-D6 fields to these plants. Like elsewhere in the country, it has been charging central sales tax of 2 per cent from users in Uttar Pradesh.

However, the state government has refused to accept these transactions as inter-state sales and have demanded that local sales tax of 21 per cent should be paid. Tax as the liability of consumers has been clearly enshrined in the Gas Sales and Purchase Agreements (GSPAs) RIL signed with fertiliser and other users.

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Naturally, users should have contested the demand for higher sales tax, but strangely, RIL went to the Allahabad high court challenging the demand.

The high court on July 26, 2010, stayed the Uttar Pradesh government demand. The state government has appealed against the stay in Supreme Court.

Sources said RIL is demanding that users in Uttar Pradesh enhance the value of their Letters of Credit, which were previously submitted as guarantees against default, to cover for payments in case the state sales tax liability was to materalise.

So far, state power utility NTPC is the only firm that has enhanced its LC, while fertiliser firms have not complied with RIL's demand so far, leading to the notice for suspension of supplies.

While the fertiliser firms refused comments, the Fertiliser Association of India (FAI) has shot off letters to the oil and fertiliser ministry protesting against the RIL move.

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In an October 3 letter, FAI director General Satish Chander said there was no need to enhance the LCs as the Supreme Court has not vacated the stay given by the Allahabad high court.

"Any increase in the limit of LC will increase the cost of domestic urea production and has a direct bearing on the subsidy payable by the government. The demand of RIL for a higher LC is totally unjustified," he wrote.

RIL had last year, too, threatened to suspend supply to the fertiliser plants with effect from July 15, 2010, if the value of their LCs were not raised.

While the threat was executed, RIL has again issued the notice because the tax liability, in case the Uttar Pradesh government's demand is upheld, amounts to a whopping Rs 750 crore (Rs 7.50 billion).

While Chander asked for the intervention of oil secretary G C Chaturvedi and fertiliser secretary Sutanu Behuria in the matter, sources said RIL has also informed the oil ministry of the notice for suspension of supplies.

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Chander said any disruption in RIL gas supply will affect production of urea, whose demand has been "very good" because of heightened agricultural activity on the back of the good monsoon.

"Any loss in production of urea will have to be met through higher imports. We will be substituting low cost urea production in the country by a very high cost of imported urea. The country will end up paying heavily through the exchequer," he wrote.

Fertiliser companies would also be liable to pay a penalty under the 'ship or pay' clause of their Gas Transportation Agreements with Reliance Gas Transportation Infrastructure Ltd (RGTIL) and state-owned GAIL India Ltd.

"The Empowered Group of Ministers (EGoM) has allocated the gas to fertiliser units on a priority basis for full capacity utilisation of urea plants in view of fertiliser being an essential input for agriculture. RIL's decision to unilaterally decide to stop the supply of gas to fertiliser plants in Uttar Pradesh is unjustified and also violative of the decision of the EGoM," he added.