The Finance Bill (No 2) 2010 was published on 1st October 2010. In addition HMRC have recently released draft legislation dealing with proposed changes to certain oil industry provisions to be included in the Finance Bill 2011. This newsbrief sets out details of the measures included within these two sets of documents which will be most relevant to our clients.
- Licence Disposals
1.1. Changes to reinvestment relief rules
There are two changes to the reinvestment rules contained in sections 198A to 198G TCGA 1992.
The first is contained in clause 198H, to be inserted by Finance (No.2) Bill 2010, and relates to group reinvestment. The second is contained in the draft clauses which will be in Finance Bill 2011 (to be published in draft late November / early December) and relates to the expansion of categories of qualifying expenditure for reinvestment relief.
1.2. Group reinvestment
The current Finance Bill includes provisions to expand the scope of reinvestment relief to reinvestment by any other company in the group. The rules will treat the company which makes the disposal and the company making the acquisition as if they were the same person, so that reinvestment relief can be claimed by means of a joint election.
These provisions bring the applicability of the reinvestment relief in line with the rollover relief provisions. Helpfully they are backdated to 22nd April 2009 emphasising that it was always the intention that this wider form of the relief would be available to groups of companies. Like the group rollover provisions there is no requirement that the selling company and the reinvesting company are part of the group at the same time. The requirement is simply that the seller was a member of the relevant group at the time of the disposal and the company reinvesting is a member of that same group when the expenditure is incurred.
1.3. Extension of scope of reinvestment expenditure
The draft clauses for Finance Bill 2011 propose to expand the scope of reinvestment relief to include “exploration or development expenditure”. The new rules will apply for disposals taking place on or after 24th March 2010, although the reinvestment can take place before that date, subject to the usual 12 month time limit.
To ensure that these costs can qualify for reinvestment relief, there are a series of deeming provisions in the draft legislation to ensure that the costs qualify for rollover relief, which is one of the preconditions for reinvestment relief. In particular the costs are deemed to be within the classes of qualifying assets for rollover relief (thereby avoiding the need to decide whether they are land or fixed plant and machinery).
When the reinvestment rules were initially under discussion relief for drilling costs was promised but when the legislation was published these costs were excluded. It is welcome that HMRC have listened to industry and agreed to include such costs within the scope of costs eligible for reinvestment.
The legislation does not specifically talk about drilling costs but instead deems “exploration or development expenditure” to be qualifying expenditure for the purposes of the reinvestment relief. The scope of the rules would therefore seem to be wider than drilling and could include for example engineering studies, feasibility studies, seismic and geological studies etc. There is no definition of “exploration or development expenditure” although the legislation provides that the Treasury can issue regulations to say what is, and is not, such expenditure. Given the other definitions available in the legislation this seems odd, particularly when the qualifying cost does not appear to include “appraisal”. We do not believe that it is intended that appraisal costs are excluded and this aspect will therefore need to be clarified. Leaving the definition open in this way creates unacceptable uncertainty for taxpayers and we believe representations should be made for a clear definition to be included in the legislation.
Qualifying costs also exclude consideration for the purchase of an asset. It is unclear why this restriction is included. For example, is this intended to prevent consideration allocated to exploration or development costs for capital allowance purposes in an SPA from qualifying for reinvestment relief, given that an allocation to the licence element would qualify under the existing provisions of section 198A?
1.4. Swap rules
Provisions were introduced in FA 2009 to limit the taxable consideration for CGT purposes on swaps of licence interests, where at least one licence related to a developed field. The limit was to the non-licence consideration, if any, payable in respect of any difference in value. The rules only applied to transactions where non-licence consideration was given by only one party. As drafted it was likely that the requirements to fall within the provision could not be met for many typical North Sea disposals, as one needed to look at the position at completion, when it is common for non-licence consideration to be payable by both parties. Government has acknowledged that this was not the intent of the provision and has revised the requirements such that the tests have to be applied at the commercial “effective date” of the deal. All “interim period” adjustments to the consideration, apart from any time value of money adjustment on the initial cash amount, are effectively ignored for CGT purposes, such that any CGT (before reinvestment relief) is limited to the amount by which the cash differential, plus any time value of money adjustment to that number, exceeds the basis the company had in the licence they have disposed of.
While more development licence swaps may now fall within the provision the rules would appear to have little practical significance as the reinvestment rules which, as noted above are being extended to include exploration and development costs, are likely to mean that no capital gain will in any event arise if the transaction does not fall within these swap rules. Indeed in many cases companies might well prefer to fall exclusively in the reinvestment relief rules rather than in these swap rules, although the swap rules, if they apply, take priority.
2. Other measures
2.1. Extension of Definition of New Field
Draft legislation has been published for consultation, as previously announced, in order to extend the definition of a “new field” for the purposes of field allowances against SCT, to include certain previously decommissioned fields.
A new field is now to be defined as an oil field whose development is first “authorised” on or after April 22, 2009, i.e. essentially a field which received its first development consent after this date. For a field which has previously been developed the draft legislation states that any earlier development consent is to be ignored in identifying whether the development of a field can be treated as first authorised after April 22, 2009 provided any assets which have been used for the purposes of winning oil from the field under that previous development consent have been “decommissioned”. The definition of decommissioned follows that introduced in Finance Act 2009 in connection with the cessation of oil fields due to licence expiry.
The extended definition is to be backdated to April 22, 2009, the date of introduction of the first field allowance rules.
Arguably the existing legislation could be interpreted to include fields which had previously received development consent but the new legislation will in most cases remove the uncertainty, which is welcome. In order to fall within the redrafted legislation it will be necessary to establish that any asset which has been used for the purposes of winning oil from the relevant field has been decommissioned. If a field has previously been produced across another field and that field has not been fully decommissioned this could prevent any redevelopment qualifying for the field allowance.
2.2. PRT compliance
As previously announced the rules relating to interest in respect of over or under payment of PRT , penalties for failing to make returns, penalties for failing to pay tax, and recovery of overpaid PRT, are being brought into line with the same rules applying to other taxes. The changes in respect of the first three areas are to be effective from a date to be set out in a Statutory Instrument, while the change in respect of claims in respect of overpayments will be effective for claims made after April 1, 2011.
It is not thought that these new rules will have any significant effect in practice.
2.3. Venture Capital Schemes
In the past various oil and gas start- up operations have looked at whether they could raise equity funding through the venture capital trust (VCT) , enterprise investment scheme (EIS), and corporate venturing schemes (CVS). There are many hurdles to overcome before the qualifying requirements of such schemes can be met, but for oil and gas companies there was one clear hurdle that couldn’t typically be met, , and that was that the investee company had to carry on a trade wholly of mainly in the UK. HMRC confirmed many years ago that activities in the UK sector of the Continental Shelf beyond the Territorial Sea limit did not meet this requirement. Companies other than those investing in “onshore” projects were therefore excluded.
The corporate venturing scheme has now lapsed, but in order to comply with EU requirements the above test within the VCT and EIS schemes is being changed such that the requirement will be that the investee has a permanent establishment in the UK through which the business of the company is wholly or partly carried on.
It is thought that most UK E&P companies should satisfy the new permanent establishment test and while there are still a lot of other requirements to be met, not least the limited amount of funding that can be raised, this may be an area which smaller start-up operations may want to revisit.
2.4. Consortium Relief
There are two changes to the group relief rules included in the current Finance Bill that have been previously announced.
The group relief rules are to be amended to allow EU and EEA-resident companies who are members of a consortium to be able to act as link companies. The current statutory rules only enable companies which are within the charge to UK tax to “pass on” relief for losses of consortia to UK-resident group companies. These provisions were shown to be in contrary to EU law in the first tier Tribunal decision in the Phillips case earlier this year and the law is now to be changed.
At the same time, the consortium relief rules are to be amended to modify the ownership test for consortia. Group relief claims and surrenders are restricted to the relevant ownership proportion. This is currently based on the lowest of the beneficial ownership, profits available for distribution, and assets available on a winding up. The legislation will now also include a test based on voting power.
Both these changes will have effect from October 1, 2010, the date of publication of the Bill.
The first change is welcome but companies entering into joint venture arrangements will now need to take account of the new “voting” test when planning which consortium member groups can use any available losses.
2.5. Capital Distributions
Draft clauses, which were initially published as part of the Emergency Budget package, concerning the treatment of distributions following capital reductions, are included in the current Finance Bill.
Finance Act 2009 introduced an exemption from tax for UK companies on the receipt of most forms of distributions. However, “capital” distributions were excluded from this exemption.
HMRC practice has been to treat all UK distributions as income in nature (subject to certain specific exemptions). Considerable uncertainty had been created following a change of practice by HMRC which emerged last year.
The dividend exemption introduced in Finance Act 2009 is therefore to be amended with retrospective effect to remove the exclusion from the exemption for capital distributions.
The new law is also to include changes to make it clear that distributions made out of reserves arising from a reduction in capital (whether under the Companies Act or under corresponding overseas provisions) are not to be regarded as repayments of share capital, and therefore they will not be excluded from being treated as income distributions.
Distributions which would otherwise fall to be treated as giving rise to a deemed disposal for capital gains tax, for example the amount which does not represent the repayment of capital on a redemption of shares, are also to be excluded from capital gains tax treatment where they fall within the amended dividend exemption. However the fact that an actual disposal of shares, for example as a result of a purchase of own shares, gives rise to a distribution, which would be exempt from corporation tax on income under the 2009 dividend exemption, will not prevent that distribution from being brought within the charge to capital gains tax. Similarly distributions made in a winding up will continue to fall within the capital gains tax rules.
These changes are effective for corporation tax purposes for distributions made on or after July 1, 2009 but are applied to distributions made out of reserves created by capital reductions whenever the reduction occurred, with an option to elect out of this change for any distribution made before June 22, 2010.
These proposals remove the threat of dividends following capital reductions from being brought within the charge to capital gains tax. Capital repaid directly is still however likely to be treated as within the capital gains tax rules. We understand that the value shifting rules are currently being reviewed and it is possible that they will be amended to prevent capital reductions followed by a distribution being used to strip down the value of companies prior to a sale or liquidation.