The Chancellor delivered his Autumn Statement this afternoon.

There were no new measures announced targeted at the UK upstream oil and gas industry.

The reduction in the mainstream CT rate to 21%, with effect from April 2014, will have no impact on the ring fence CT rate which will remain at 30% (together with SCT at 32%).

We await publication on 11 December 2012 of the draft Finance Bill, which is expected to include a number of provisions affecting the oil and gas sector, particularly with respect to decommissioning, together with the draft Decommissioning Relief Deed and a summary of the responses on the decommissioning relief consultation measures. We will be issuing a further newsletter once we have had a chance to properly consider those documents.

5 December 2012

Finance Act 2012 provided for the introduction of a Brown Field Allowance (BFA) by Statutory Instrument.  The government have now announced the parameters for the BFA which will be available to set against SCT profits.  The BFA is to apply to the development of new, previously un-accessed, reserves in an existing field that is approved by DECC on or after 7 September 2012 (“additionally developed oil fields”).

A maximum allowance of £250m (or £500m in a PRT paying field) is to be given, based on the expected capital cost per tonne of developing the additional reserves, representing a total potential tax saving of £80m (or £160m for PRT fields).  For these purposes PRT paying fields are those that are paying or are expected to pay PRT at any time during the life of the incremental project, as determined by HMRC.

For relief to be available the expected capital cost per tonne of the incremental development must be more than £60.  The maximum relief is available at the rate of £50 per tonne (tax value of £16 per tonne) if the expected cost is £80 per tonne or more, with a straight-line taper to zero at £60 per tonne.  Thus, if the cost per tonne was £80 and the incremental reserves were 5m tonnes the maximum allowance for a non PRT field would be obtained whereas, if the cost per tonne was £70 for a non PRT paying field, incremental reserves of 10m tonnes or more would be needed to obtain the maximum allowance.

A pre-requisite for relief is a revised development consent (a “development consent addendum”).  The expected reserves, which is thought to mean the P50 reserves, and expected capital cost figures of the incremental project have to be included in a draft development plan which must be approved by DECC.  The cost estimates, which can include contingencies of up to 20%, must then be verified by a suitable independent third party, and a final development plan, containing the cost and reserve estimates must then be approved by DECC.

As with other field allowances a maximum of 20% of the allowance can be activated each year.  The first year in which a BFA can be activated is the year of expected first production from the incremental reserves project, although the quantum which can be activated is based on income from the existing reserves as well as from the incremental reserves.  If the field already qualified for a different field allowance, income from the field is first used to activate the original allowance before it can activate a BFA.

The cost of the measure has been estimated by HM Treasury to be £100m per annum, but the government expects this to be far outweighed by taxes from the incremental production stimulated by this measure.

CW Energy LLP

September 2012

Purchasers of oil and gas licences after 1st April 2012 need to be aware of new provisions in the Finance Act 2012 relating to “fixtures”.

There is now a requirement for a buyer of plant or machinery which is classified as a fixture to make a joint election with the seller within two years of the date of acquisition to fix the allocation of the consideration to that plant or machinery (or alternatively either party can make an application to the Tax Tribunal within two years of acquisition, for a ruling on the level of consideration which should be allocated to plant).

In the absence of a timely election or ruling plant and machinery allowances will not be available for that element of the consideration (although this would not prevent a seller from having to recognise an appropriate level of disposal proceeds).

This measure is applicable to all types of industry including oil and gas companies. In particular where a company acquires an interest in an oil or gas licence it will now be important that the nature of the assets being acquired is carefully reviewed and the fixtures element of any plant identified.

It is worth remembering that the term “fixture” is wider in scope than constituting just something which is attached to a building; the definition in section 173 CAA 2001 includes any plant or machinery  installed or otherwise fixed in or to land which becomes in law part of that land

In the case of plant and machinery fixed in buildings on land, such as terminals, the position should be clear. Whereas in the past seller and purchaser would typically agree an overall allocation of consideration to plant and machinery on a just and reasonable basis such that a fixtures election under s198 CAA 2001 was rare, it will generally now be necessary for such an election to be made as a matter of course. It is important to note that such an election can include an allocation which differs from the just and reasonable amount as the buyer and seller jointly fix the amount so allocated (although the allocation is still restricted by the cost to the seller).

The position with regard to plant or machinery situated offshore such as platforms and pipelines is less clear. We understand HMRC take the view that structures such as platforms which are fixed to the seabed within the 12 mile limit constitute fixtures for these purposes such that an appropriate election should be made where the acquisition includes such items. For plant located outside the 12 mile limit we understand that HMRC’s view is that such structures do not become part of the land, as a matter of law, such that the fixtures rules have no application.

The position with regard to offshore pipelines is unclear, but it is questionable as to whether these would properly represent a fixture for the purposes of these provisions.

Given the majority of UK oil and gas licence transactions would not include a significant element of plant and machinery situated onshore or within the 12 mile limit these rules will not be relevant for many licence transactions, but for those where such plant is in place it will be crucial for the purchaser to ensure that the sale and purchase agreement includes appropriate wording to enable them to make a relevant timely election with the seller and thereby to secure the allowances they expect.

CW Energy LLP
August 2012

On Monday 9^th July the Government published its long awaited consultative paper (the “Condoc”) on the proposed implementation of a contractual arrangement between oil and gas companies operating in the UK and UKCS and their affiliates, and the Government, to provide a level of certainty as to the tax relief that will be available on decommissioning expenditure. 

There have been discussions between Government and Industry on how to deal with the uncertainties over tax relief for decommissioning for many years.  This uncertainty has had three main effects on Industry over the years. 

• First, it has acted as a barrier to changes in licence interests, as typically a seller has requested security against default in respect of decommissioning  liabilities to be provided on a gross of tax basis, which has the impact of tying up the purchaser’s borrowing base
• Second, the uncertainty acts as a disincentive to new investors buying in to fields, particularly where tax relief on projected abandonment costs are a material element of any valuation    
• Third, existing owners are dis-incentivised from investing to prolong the life of existing fields because of the risk that existing  decommissioning relief would be lost as a result of  possible law changes.   

The increase in the supplementary charge (SCT) and the introduction of a cap on the rate of SCT relief for certain decommissioning costs has led to an intensification of these discussions.  This culminated with an announcement in Budget 2012 that the Government would introduce “a contractual approach to offer long term certainty on decommissioning relief”.  This will take the form of the issue of Decommissioning Relief Deeds (the “Deed”) to all past and future licensees and their affiliates.

The wording in the Condoc is naturally not as precise as will be contained any actual Deeds, if and when they are introduced, so the commentary below is necessarily based on our interpretation as to what the current intent behind the proposals in the Condoc is.

Main Proposals

Industry had asked that this contractual approach guarantee tax relief at the current restricted rate of 50% for ring fence CT and SCT, without the need to have reference to the particular taxpayer’s tax capacity, whilst accepting that any mechanism for PRT would need to take into account the field history.

The proposals in the Condoc are less generous than requested.

The proposed regime has two separate methodologies for providing assurance depending on whether the company is meeting its own decommissioning costs, or is picking up another party’s costs in the case of a default.

In the case of default the Government proposes to “switch off” the subsidy rules but only in the case where security has been provided on a post-tax basis.  It is not however clear how receipts in other circumstances are to be treated.

The proposals do not commit Government to the current tax regime for CT or SCT, or indeed the current rates of tax for CT, SCT or PRT, except in the case of relief in respect of expenditure incurred by a company in connection with another company’s default, where relief is to be fixed at current rates of 30% for CT and 20% for SCT.

For PRT, in a default situation, assurance is to be provided with reference to the defaulting party’s PRT field profile.  There is also some protection in the case of PRT abolition.  If the PRT rate is reduced however the guarantee would appear to work with reference to the prevailing rate in both the default and no default cases.

As currently drafted the proposals are likely to enable companies to provide security on a post CT and SCT basis.  The position with regard to PRT is more difficult as this will turn on the profile of the field and the history of the ownership of the interest.

The proposals do not, however, put new entrants on a level playing field with existing field owners as guarantees will, except in the case of default, work with reference to a company’s tax profile.  A new owner may not have sufficient tax capacity to utilise relief in which case the guarantee will not apply to make up the shortfall.  

Further, while it appears that a company without a ring fence trade which picks up decommissioning liabilities of a defaulting affiliate can benefit from the Deed; this will not be the case if the relief under the Deed would be better than could be obtained if the defaulting affiliate had been adequately funded.

The Condoc is open for discussion for 12 weeks, meaning that responses should be made by 1^st October 2012.  Given the revolutionary nature of these proposals it is to be hoped that as many companies and industry bodies as possible respond to its proposals.  As part of the consultation process the Government is setting up four work groups to discuss the details of the proposals, and invites interested parties to apply to join these.  The working groups cover the commercial aspects, legal design, reference amounts and technical and anti-avoidance issues.

The Condoc states that the Deed should be a mechanism of last resort; thus the Government is not expecting many claims to be made where relief is otherwise available through the prevailing tax system.

In all situations there are to be anti-avoidance provisions which disapply the provisions of the Deed if the decommissioning work is undertaken by an affiliate of the Deed holder, or if relief under the Deed has been engineered to give a better result than would otherwise be available.

Comment

The affiliate restriction would seem to mean it is very unlikely that any contractor groups will be able to obtain protection under a Deed which may mean that these groups could be at a competitive disadvantage.

Details of the proposals:

The guarantee works by comparing tax relief available to the company in respect of specified categories of decommissioning expenditure to a “reference amount”.  Should there be a shortfall then the Government will make a payment under the Deed to the taxpayer.

1. Where there is a default:

Where a company pays for a defaulter’s share of decommissioning costs the reference amount is fixed at 30% in the case of CT, and is capped at 20% in the case of SCT.  The Deed holder can claim the shortfall between the actual amount repaid and this reference amount under the Deed from the Government.  In this case the capacity of the company to actually obtain effective relief for these costs (i.e. its past CT and SCT paying history and profits) is not relevant in determining the reference amount. 

A slightly different approach is to be adopted in the case of PRT.  Here the Deed will only provide relief on the decommissioning costs being borne as a result of default if the Deed holder has insufficient PRT history for the field to achieve the same level of PRT relief that the defaulting party would have achieved had they borne the decommissioning expenditure.  In this case, and subject to certain other conditions, the reference amount is the amount of relief that the defaulter would have achieved under the tax code in place as at the time the expenditures are incurred, such that the Deed holder can claim the difference between the actual PRT repayment it has received and that provided under the Deed.

Importantly, if PRT is abolished the reference amount will be the level of relief that the defaulting part would have achieved as of the last period of account where PRT was in place.

Comment:

In the case of CT and SCT, where there is default, the guarantee of a fixed rate of relief without reference to the tax capacity of the company coupled with the switching off of the subsidy rules means that a company (whether they be an existing partner selling out of a field or a continuing joint venturer) should be comfortable in accepting a post CT and SCT guarantee.  However there doesn’t appear to be any protection for relief for losses resulting from costs other than decommissioning if a company’s tax capacity is used up by meeting other parties’ liabilities.

In the case of PRT it is unlikely that linking the reference amount to the PRT profile of the defaulting party will be of any practical benefit where a field has changed hands late in life as in practice the defaulter may have been looking to use a previous owner’s tax profile to obtain relief for costs.  There is nothing in the document that suggests that this profile can be factored into the reference amount.   

The inclusion of a specific provision to cover the abolition of PRT is welcome.  Further clarification on this aspect is required but on the face of it this would suggest that PRT will not be abolished at any time.  This does not however represent a guarantee that relief will be available at the current 50% rate.  Rather it would appear that absent abolition of PRT, protection will be based on the prevailing PRT rate at which the profits which are subsequently sheltered by losses generated by decommissioning spend were taxed. 

2. No default:

The proposal is that for CT and SCT losses resulting from decommissioning set against current or previous years’ profits will attract relief at the rate those profits were taxed, subject in the case of SCT to the 20% cap.  This calculation will take into account the tax capacity of the company.  However if that capacity has been wholly or partly utilised as a result of the company having to pick up defaulters’ costs then the reference amount will be calculated as if that capacity had not been used.  

Comment:

Apart from in the case of the extension of the tax capacity to reflect default expenditure, this proposal  appears to reflect the current situation, so that if the rate of tax falls the rate of decommissioning relief would also fall for that element of the cost which is set against profits taxed at the lower rate.  The only protection being offered is against a change in the deductibility of decommissioning costs.

The stated rationale for not guaranteeing the rate is that Government believes that any company investing in a project will expect to make profits and hence have sufficient capacity to fully absorb decommissioning costs, and it wants to retain the flexibility to reduce tax rates if that is in the overall interest of the economy.  Capacity would not be available if a company wanted to take on an asset where decommissioning costs were already predicted to be in excess of future net revenues (such that a reverse premium would be paid).  This feature will therefore restrict when a company is able to dispose of a mature field interest.   

Whilst the use of the prevailing rate may be reasonable, what is unhelpful is that there is no suggestion in the document that the Government are guaranteeing that the scheme for providing relief for decommissioning costs will not be restricted in the future.  For example, under the current proposal, in the case of a non-default situation, it is not clear if the law were changed to restrict the periods for which a loss carry back could be made, whether this would restrict the reference amount and no claim could be made under the Deed for any shortfall in relief as result of such a restriction.    

For PRT the relief available will reflect the PRT history of the Deed holder.

If PRT is abolished, as with the default situation, the relief will reflect the situation in the last chargeable period when PRT was in place.

Again where a company’s PRT tax capacity has been reduced as a result of it bearing defaulters’ costs, the reference amount in respect of the non-defaulter amount will be based on the relief available ignoring any defaulter cost amounts claimed.

The PRT solution is complicated by the fact that PRT losses are relieved against profits of all previous owners of the field interest, and it is not clear how assurance is to be provided in this case.

Whilst most companies now take care of the PRT loss carry back as part of the Sale and Purchase agreement for an asset, this is not the case in all situations and there will be cases where a company will not be able to obtain effective PRT relief because the relief will be given to a previous owner of the interest, which may not exist at the time of decommissioning.

However even if a Purchaser has adequately protected itself it is unclear whether the current proposals offer any assurance to a purchaser in respect of repayments which it expected to receive by means of loss carry back to a previous owner. 

The Condoc proposes that all companies with interests in PRT fields will have their PRT history certified by HMRC.  Presumably this will be a case of companies listing their PRT history and HMRC checking it, which may not be a simple process in practice, particularly where there have been claims for non-field relief.

There are still a number of unanswered questions, (and we suspect more will emerge as the provisions are considered further), such as when will payments under the Deed become due, if these are not made before the expenditure is incurred how will that expenditure be funded, how will receipts under the Deed in a non-default situation be dealt with in the tax regime, and what relief is available if the SCT rate were to be increased above 32%?

3. Taxation of decommissioning security trusts

The Condoc is also proposing to look again at the taxation of monies held in decommissioning security trusts, in particular the issue of the application of Inheritance Tax to such trusts.  However it suggests there is little Government support for dealing with the other tax issues that have been identified in the past.

Comment:

Companies and industry bodies have long lobbied that IHT is inappropriate for such trusts and it is to be hoped that this will now be removed.  The application of other taxes to such trusts is also anomalous but it seems it is up to respondents to prove a case for change.

There is no mention in the Condoc of a number of other issues that have arisen in connection with the taxation of decommissioning trusts such as FX capital gains, and double counting if the funds in the trust were treated as a loan relationship.

4. Other Technical changes

Currently decommissioning losses would displace field allowances such that the level of effective relief for SCT purposes would be restricted.  The Government is to look at possible changes to the operation of the field allowance rules where there are losses carried back.

The Condoc also highlights areas where it is believed that tax relief is uncertain, being:

• Decommissioning studies
• Setting cement plugs when wells are abandoned
• Removal of drill cuttings
• Onshore decommissioning
• Associate company obligations

It is intended that the tax relief for the above items will be discussed in the technical working group as part of the consultation process.

Comment:

It was originally hoped that when changes were made to the scope of decommissioning relief in 1991 and other years that these would cover all the costs of decommissioning.  This view was confirmed by HMRC at the time but latterly HMRC seem to have moved away from these assurances.  A review of areas where there are doubts with a view to correcting this in legislation is therefore to be welcomed.

CW Energy LLP

July 2012

HMRC have recently written to industry to set out their views on the tax treatment of the costs of decommissioning certain assets.  The announcement that a “cap” on the amount of relief for decommissioning costs for the purposes of the Supplementary Charge is to be introduced has led to a discussion as to the scope of the cap and this in turn has led to a more fundamental review of the rules under which relief is given.

One area where HMRC have set out their views is the costs associated with plugging and abandoning a well.  They have agreed that the cost of pulling the production string and cutting away the well head at the mud line qualify as decommissioning of plant and machinery.  However, they have not agreed that the cost incurred in setting cement plugs is the demolition of plant and machinery or of any other asset.

HMRC’s view that capping a well is not demolition seems strange; for example the Oxford English Dictionary (OED) defines demolition as:

“To destroy (a building or other structure) by violent disintegration of its fabric; to pull or throw down, pull to pieces, reduce to ruin”

This view contrasts with previous HMRC guidance which clearly stated that they believed the cost constituted demolition; for example, the very first Oil Taxation Office manual stated:

“Meaning of Abandonment

5.3       …….  Thus, for example, the cost of plugging wells on a field abandonment is accepted as expenditure on the demolition of plant within CAA90s62 (now s.26 CAA 2001)……..

5.3.1   ………………..  The killing of wells is done by plugging the well with cement and the dismantling of the platform may take place years later.  It has been accepted that all the series of actions that make up abandonment are incidental to this and, subject to other conditions being met, may be relieved under CAA90s62, CAA90s62A or CAA90s62B (now s26 and ss163 to 165 CAA 2001).”

If this revised view that capping the well was not demolition were correct this would suggest that no relief would be available for this cost under the “general decommissioning” of plant and machinery rules in S163/164 CAA 2001 or under S433 CAA 2001 of the MEA rules, costs of demolishing an asset representing qualifying MEA expenditure.  There is however a suggestion that specific legislation may be introduced to deal with the issue.

Further, HMRC have recently indicated that they believe that the costs of abandoning a well could fall within s403 CAA 2001, which provides tax relief for the expenditure on acquiring a mineral asset.  This is on the basis that the obligation to abandon is effectively taken on when the licence is granted and in this sense the cost is part of the cost of acquisition.  We think this argument is flawed in the context of wells except perhaps those exploration wells which are commitments under the terms of the issue of the original licence (although in our view the plugging of these wells is likely to qualify for RDAs).

If relief did fall to be available under S403 then it would be restricted to a 10% WDA.  There is also S410 to worry about, which restricts qualifying costs under S403 in respect of UK oil and gas licences to the original amount paid to the Secretary of State. Although HMRC have indicated that they don’t believe the restriction is relevant in the context of well costs the rationale for this statement is unclear.

If HMRC are correct that the act of capping a well is not demolition we believe that there may nevertheless be arguments to support a 100% claim for relief without the cap as currently worded applying.

The other unhelpful view which has been set out in the HMRC correspondence is the view that the costs of removing drill cuttings is not expenditure on the restoration of land.  It is unclear why they have come to this view, but again there is the suggestion that there might be legislative change to deal with the issue. 

It is our belief that the sea bed is land for these purposes (The Interpretation Act clearly provides that land includes land covered by water).

Restoration is defined in the OED as…  “to bring back to the original state…”

It seems therefore that the costs of removing cuttings, which has the effect of clearing the seabed to leave it in the condition which it was in before the drilling operation occurred, should fall to be treated as restoration of that sea bed, but HMRC do not agree.

The Treasury have now published the long awaited consultative document of Decommissioning Relief Deeds and this notes that there is uncertainty as to the relief which is available under current law for the above areas, as well as in connection with decommissioning studies and onshore costs and that discussions will continue. It is likely that there could be further legislative changes in Finance Act 2013 in this area.

HMRC seem to be using the pretext of the discussions with industry to lock in a certain level of relief for decommissioning costs under the “contractual” approach as an opportunity to “clarify” the workings of the legislation in this area.  In does seem that there may be a trade-off here in that part of the cost of obtaining certainty is that there are new restrictions enforced in the scope of that relief.   

In the meantime taxpayers will have to take a view when filing their 2011 returns as to what relief can be claimed under current law.  These views could also have an effect on the calculation of tax provisions, particularly when looking at 2012 and future years and in considering the extent to which the cap applies.

We are delighted to announce that Ian Hack joined the CW Energy team on 28 May as a tax consultant.  Ian has been with HMRC for nearly 20 years spending the last 12 years as an Inspector at LBS Oil & Gas.  Ian’s  area of expertise include all aspects of upstream corporation tax with particular emphasis on capital allowances, capital gains for companies, and the Supplementary Charge.  

Ian’s expertise and experience will further strengthen our team and will be invaluable in ensuring that CW Energy can continue to provide up to date and accurate support and advice to all our clients. 

If you would like to speak to Ian he can be contacted on +44 (0) 20 7936 8306 or via e-mail on  Ian.Hack@cwenergy.co.uk

Farm-ins

Readers will be pleased to learn that after over two years of discussions, HMRC has finally accepted that the tax treatment of farm-ins that had been in operation for the last 20 years is in fact in accordance with the law.

HMRC have said that they will amend their manuals to make the position absolutely clear and will give industry a chance to comment on these amendments before the manuals are reissued.

Although HMRC had given industry comfort that while the discussions were continuing they would not seek to impose their new view (apart from in respect of abusive transactions), this had still left companies planning a farm-in at a later date with an element of uncertainty.

The issue that originally triggered the HMRC review of how the rules worked was an intra-group transaction in respect of a non-UK licence where relief was being obtained againstUKtax with no prospect of anyUKtax being collected from subsequent profits from the licence, presumably as a result of double tax relief.  HMRC have commented that if they see companies using the farm-in rules in a way they believe is abusive they will not feel constrained in recommending to Ministers a change in law, and in the current climate there is no reason to believe that any such change would not be made with retrospective effect.

Comment

CWE has been actively involved in the discussions between HMRC and industry in which industry has consistently set out why they believed the interpretation put forward by HMRC in early 2010 was incorrect and it is pleasing to see that our views have finally prevailed.  The change of heart by HMRC will also provide some much needed assurance for industry on the way this type of transaction is taxed.

Decommissioning Relief

Readers will be aware of the on-going discussions between industry and Government to provide for a “contract of assurance”, to effectively guarantee decommissioning tax relief in accordance with the current tax rules.  Part of this process will be to agree a definition of “decommissioning expenditure” for these purposes. 

Readers will also be aware of the restriction of relief for decommissioning costs for SCT purposes to 20%, which was announced in Budget 2011, and is being enacted in FB 2012.  Government is keen to align  the definitions of decommissioning expenditure used for the purposes of the contract of assurance and the cap on relief (and indeed the costs which when creating or enhancing a loss for corporation tax and supplementary charge purposes can be carried back to 2002).

We reported in our Budget newsletter (at Point 6) that we understood that the cap on decommissioning relief was to apply only to end of field life decommissioning.  This comment was based on the comments made to industry as part of the debate on the draft Finance Bill clauses published in December 2011.  It has however now become clear that Government intend that the cap should apply to not only end of field life decommissioning but midlife decommissioning and also exploration and appraisal wells. This is because Government believes there would be an incentive to decommission early given there is a possibility (albeit it currently looks very unlikely) that the tax rate will reduce in the future, and they don’t want companies’ commercial decisions affected by tax. Although the scope of the cap set out in the Finance Bill remains unchanged the draft legislation now includes a provision to enable Government to extend the scope of the cap by Regulation.

Comment

We continue to believe that it is fundamentally unfair for a tax system to tax profits at one rate and give relief for expenditures at another.  If this feature was not present there would be no incentive for companies to advance decommissioning.  We believe the extension of the cap to exploration and appraisal wells to be particularly unwelcome as it will clearly increase the cost of, and therefore deter companies from, drilling such wells, which is completely at odds with the other changes to the tax system that Government is making and indeed the stated Government policy of maximising the exploitation of the UK’s hydrocarbon reserves.

May 2012

Oil and Gas Budget Measures

The Chancellor announced in his Budget speech today that the Government will introduce a package of oil and gas measures intended to secure billions of pounds of additional investment in the UK Continental Shelf.

 1.   Decommissioning certainty

Legislation is to be introduced in 2013 giving the Government statutory authority to sign contracts with companies operating in the UK and UK Continental Shelf under which they will be given certainty on the relief they will receive when decommissioning assets.

There have been extensive discussions between industry and Government over the last 12 months concerning the possible introduction of some form of contractual assurance arrangement. The Government will consult with industry further to finalise the details of the arrangement.

 Comment:

This is one of the most important developments for the industry in the fiscal area. It has been promoted as a no cost option for the Government, but the Government estimates that it will cost £115 million in 2012-13, but with significantly increased future taxes from 2013-14 onwards,  presumably from additional developments and assets changing hands to parties willing to invest, both encouraged by the change.

There has been considerable uncertainty for many years as to the precise level of relief that will be available to oil companies for expenditure incurred on decommissioning UK oil and gas infrastructure. The existing legislation is complex and the effective level of tax relief depends very much on the precise historic profile of the taxpayer.  This is particularly true for PRT but also relevant for corporation tax (CT and SCT) since effective relief for abandonment costs requires the entity incurring the expenditure to have sufficient current, future, or past taxable profits of the appropriate nature. There are uncertainties as to how the existing tax rules apply in a number of areas and a number of anomalies have been identified where full effective relief may be denied, and there has always been a perception that there is significant risk of law change which may prevent companies obtaining any relief, particularly with respect to PRT and SCT.

These risks have led to an increasing difficulty for assets to change hands.  For example, sellers of field interests typically request security to be provided on a pre-tax basis.  Whilst this increases the cost of providing the security, the main downside of this requirement is that the obligation restricts a purchaser’s borrowing base. 

Additionally, for field interests where the decommissioning costs are significant compared to the overall net value, the difference between the seller’s position that full tax relief will be available for the decommissioning costs, and the buyer’s risked valuation that there may not be full effective relief, can be too big to bridge. We are aware of a number of transactions which have failed as a result of these factors.

Given that Government cannot give a commitment that the UK tax regime will not be changed in the future, a company by company contractual approach is to be introduced under which the Government agree to meet a certain level of the decommissioning cost. We understand that the view is that Government would not be able to easily renege on their contractual obligations (although we have seen some concern expressed about the impact of possible Scottish independence).

Industry and Government have already done a significant amount of work in developing the concept, but there will be further work needed on the detail before the arrangement can be finalised. However  this announcement should be very welcome to all companies with a presence in the North Sea and should encourage other companies to take a closer look at the investment opportunities. 

 2.   Oil and gas field allowances

The Government has announced that a number of new field allowances are to be introduced, and a framework put in place to enable the existing field allowance regime to be extended to cover existing fields as well as new fields. The stated objective is that these changes are specifically designed to increase investment and production in fields that are economic, but for tax reasons are considered to be commercially marginal.

 2.1   West of Shetlands

A new field allowance for particularly deep fields with sizeable reserves, principally targeted at the  West of Shetland area is to be introduced.

New fields” that meet the following criteria will qualify for this new relief:

• Water depth greater than 1,000 metres; and
• Minimum reserves of 25 million tonnes; and
• Maximum reserves of 40 million tonnes, with a straight line taper to no allowance at 55 million tonnes.

The maximum allowance is £3bn, such that at the current supplementary charge rate of 32%, and ignoring discounting, the maximum value of the relief would be £960m for a relevant new field. 

A new field for these purposes will be one with development authorisation on or after 21 March 2012 (i.e. the date of the Budget).

The Government have stated that the new allowance is principally expected to apply to the area West of Shetland and that they will continue to work with industry to encourage further investment in the region.

Comment

It is thought that the reason that the measure includes a minimum field size is to prevent it being available for fields which would otherwise be sub economic, since the stated objective of these field allowances is to encourage development which would not be feasible absent the current tax regime.  In the same way, presumably it has been decided that fields with reserves in excess of the maximum would not need any additional fiscal assistance.  

 2.2   Small Field Allowance

The maximum amount of the small field allowance introduced in Finance Act 2009 will be doubled from £75 million to £150 million. The qualifying criteria will also be relaxed.

The maximum allowance will be available for fields which have reserves in place of 6.25 million tonnes (approximately 45 million barrels) or less, tapering to no allowance at 7 million tonnes (approximately 50 million barrels). The previous thresholds were 2.75 million and 3.5 million tonnes.

Again, for these purposes a new field will be one with development authorisation on or after 21 March 2012.

When originally introduced the maximum tax value of small field allowance was £15m, being £75m multiplied by the supplementary charge tax rate of 20%. By contrast the new allowance will be worth a maximum of £48m (£150 million at 32%) per relevant field.

Comment

Fields which have recently received development consent where the reserves in place exceed the original 3.5m threshold miss out but presumably this is consistent with Government stated policy, since by definition those fields have not needed this incentive to bring them to development.    

2.3   Other Field allowances

 2.3.1    Brown Field Developments

The field allowance regime will be extended to deal with brownfield redevelopment. Details of this measure are to be discussed with industry but an amendment to the field allowance legislation will be introduced giving HMRC the power to extend it to oil and gas fields that have already received development approval and are to undergo additional development.

This will open the way for specific statutory instruments to be introduced to deal with specific instances of relief.

 2.3.2   HPHT

Government have also announced that they will continue to consider potential changes to the existing allowance for High Pressure High Temperature fields.

Comment:

Government have demonstrated by these further measures that they are prepared to legislate to give targeted assistance to the development of fields where the existing high level of taxation provides a disincentive. Following the introduction of the field allowance regime in 2009  interested parties have been lobbying Government to secure such targeted relief on a case by case basis, and this further set of measures indicates that Government are prepared to listen and act on what they perceive to be deserving cases.  The existence of these field allowances does however perhaps make it less likely that there will be any significant reduction in the rate of supplementary charge in the near future, except for the possible operation of the fair fuel stabiliser (see 3 below).

Field allowances are available to shelter the supplementary charge on ring fence profits of a company holding an interest in a field with the appropriate characteristics.

After introduction of these measures there will now be 6 separate field allowances.

1.1      The small field allowance of £75 million for fields which received development consent before 20 March 2012;

1.2      The new small field allowance of £150 million for fields which receive development consent on or after 20 March 2012;

1.3       The ultra heavy oil field allowance of £800 million;

1.4       The high pressure / high temperature allowance of £800 million;

1.5       The deep water gas field allowance introduced in 2010 applying to fields where 75% or more of the reserves are gas, where water depth is more than 300m and the export pipeline is at least 120km; and

1.6     The new £3 billion deep water “Sizeable reserves” field allowance.  

The Government estimate that the measures will cost £155 million for 2012-2014 but then show increased tax receipts from 2014-15 onwards totalling approximately £95 million to 2017.

 3.   Rate of SCT and the Fair Fuel Stabiliser

The rationale for the increase in the rate of Supplementary Charge to 32% in Finance Act 2011 was to fund a Fair Fuel Stabiliser (FFS) when oil prices are high.

The Government also stated that, if the oil price fell below a set trigger price on a sustained basis, the rate of Supplementary Charge would be reduced back towards 20%.

The Government  has now announced that the FFS will be implemented and that a trigger price will be set at £45 sterling (equivalent to approximately $75 based on the latest OBR exchange rate forecast for 2012). The review will be carried out every three years. Whether the trigger price is met will be assessed annually on the first working day of February, starting in 2013. This assessment will be based on two FFS reference prices:   

• The average daily dollar oil price (per barrel) in the three months immediately prior to the date of assessment, and
• The average daily dollar oil price (per barrel) in the week before the date of assessment

In each case the dollar price will be converted to sterling using the average daily Bank of England exchange rate across the period.

Both reference prices are required to be met for the trigger price mechanism operates.

Comment

There is no attempt in the mechanism to recognise the disparity between oil and gas prices which will be a disappointment to a number of companies with predominantly gas assets. There is also no indication as to the level of reduction in SCT that will arise if prices fall below the trigger. Given the current oil price it seems unlikely that this measure will be relevant for the foreseeable future.  

4.   Ring fence capital gains

The press notices confirm that draft legislation which was published last year dealing with the application of the supplementary charge to capital gains will be enacted. This draft legislation changes the law to bring ring fence capital gains arising after 6 December 2011 within the scope of the supplementary charge, and prevents such gains from being transferred to group companies which are not within the scope of supplementary charge. 

Comment

The guidance notes published with the legislation make it clear that HMRC’s view is that the change to bring ring fence gains within the scope of SCT has been made simply to clarify the position and that, notwithstanding the change, they are of the view that the existing law did bring ring fence capital gains within the charge to SCT. Presumably any company wanting to challenge this view will have to litigate to determine whether this is indeed the case.

For those companies who have realised such gains but made an election to hold these over, it is clear that these held over gains will now be taxed at the increased supplementary charge rates. Representations were made that this was anomalous but Government have refused to make any changes to deal with this issue.  

As originally enacted the rules in s171A enabled a capital gain or loss to be moved from a seller into another group company by means of a deemed transfer of the asset immediately prior to sale. The changes made in Finance Act 2009 allowed the actual loss or gain to be transferred. This opened up the possibility of transferring ring fence capital gains within the charge to SCT into an entity which was not carrying on ring fence trade. Without a ring fence trade SCT cannot apply, and therefore the gain would only be subject to CT. This measure prevents any transfer of gains in these circumstances.

5.   Restriction on the rate of oil and gas decommissioning tax relief

As announced at Budget 2011, the Government will introduce legislation restricting the rate of decommissioning tax relief to 20 per cent for supplementary charge purposes.

Comment

The draft legislation was published on 6 December 2011 and there have been a number of discussions with industry concerning the precise scope of this restriction.  Further detailed legislation has not been made available but it is expected that the cap will apply to substantially all expenditure incurred on decommissioning fields, but not expenditure incurred in advance of final decommissioning, such as the plugging and abandoning of redundant wells whilst the field is still producing.

6.   Loss carry back

The Government have also announced that the scope of the extended loss carry back rules that apply to companies with ring fence trades, which currently only applied to losses generated from expenditures qualifying for the special decommissioning relief rules within the plant and machinery legislation, will now apply to losses arising from mineral extraction allowances in respect of decommissioning expenditure.

Comment

The extension of the loss carry back rules is welcome. The intention is that expenditures where relief is capped for supplementary charge purposes are capable of contributing to a loss which could fall within the extended loss carry back rules.

7.       Ring Fence Expenditure Supplement

The Statutory Instrument giving rise to an increase in the rate of RFES from 6% to 10% has now been laid before the House of Commons and will come into force on 23 December 2011 with effect for accounting periods beginning on or after 1 January 2012. No further announcement was therefore necessary in respect of this item. 

8.       Other corporate measures

8.1   Capital gains where non sterling functional currency

There is to be a consultation this summer on whether companies with non-sterling functional currencies should be able to compute capital gains in that functional currency rather than in sterling as is currently required. While the HMRC Press Release only refers to companies, this is one of the issues that industry has been discussing with HMRC in connection with the taxation of decommissioning trust funds.

Comment

The industry may  want to bring the inclusion of decommissioning trusts into these discussions.   

8.2   Corporation tax rates

The mainstream rate of corporation tax is being reduced by a further 1% over and above the previously announced changes such that it will be reduced by 2014 to 22%. The ring fence CT rate remains at 30% and the SCT rate at 32% for the following year.

Comment

There was a suggestion in the Chancellor’s speech that the long term objective is to get down to a single rate of 20% applicable to all companies, but it is assumed that this doesn’t apply to those with ring fence profits.

8.3   Controlled Foreign Companies (CFCs)

The new CFC regime, which has been widely consulted on, is to be included in the Finance Bill with the new provisions applying to accounting periods commencing after January 1 2013. The new regime will contain a number of potential “get outs” starting with an initial gateway test to determine whether the CFC regime is applicable in the first instance. If a company is within the regime the other possible exclusions will need to be examined.

Comment

It is thought that most if not all oil and gas operations should fall outside the CFC regime.

 8.4   GAAR

It has been announced that a general anti-avoidance regime (GAAR) is to be introduced in the 2013 Finance Bill, with a consultation taking place this summer on the precise terms of the legislation.

Comment

It is to be hoped that the many well publicised drawbacks of such a regime, not least the huge amount of uncertainty it will create, will not have too much of an adverse impact on the normal operations of the oil and gas industry. 

8.5.    R&D

An “above the line” R&D credit will be introduced for large companies in 2013, as announced in the Autumn Statement 2011. This will make the credit more visible and is expected to encourage R&D activity.

CW Energy LLP – 21st March 2012