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.
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.
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.
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.
Government have also announced that they will continue to consider potential changes to the existing allowance for High Pressure High Temperature fields.
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.
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.
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.
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.
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.
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.
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.
It is thought that most if not all oil and gas operations should fall outside the CFC regime.
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.
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.
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