On December 11th the Government published the draft Finance Bill 2013 clauses and a draft Decommissioning Relief Deed (‘the Deed’), together with the responses to the Consultative Document on the Deed.
This marks the latest stage in the continuing consultation on the changes needed to the current fiscal regime in order to provide greater certainty as to the level of tax relief which will be available in respect of decommissioning expenditures.
The draft Finance Bill clauses accommodate the introduction of the Deed, clarify the tax relief for decommissioning costs in certain other areas, and include some other, mainly decommissioning related, changes.
A. The Draft Deed
The following sets out the main features and our understanding of the principles behind the Deed, but does not go into the detail of the drafting and other changes to the Deed which we think will be needed to achieve these principles to properly protect industry.
What does the Deed do?
The Deed provides for payments to be made by Government to a company where the actual tax relief received by the company in respect of decommissioning expenditure is lower than a specified notional amount of tax relief- the “Reference Amount”.
Who can enter into the Deed?
The parties to the Deed are the Government Counterparty, currently envisaged to be the Treasury, and any company which is currently liable to carry out, or may in future be subject to a duty to carry out, decommissioning.
When will the Deed become effective?
It is intended that the Deed will become effective on signature by an individual company and that it will be irrevocable unless terminated by both parties by written agreement.
How does the Deed work?
Mechanically the Deed works by comparing two amounts in respect of “Decommissioning Expenditure”; the “Decommissioning Relief” and the “Reference Amount” for each relevant tax.
Where the actual Decommissioning Relief is less than the Reference Amount the “Government Counterparty” undertakes to make a payment, a “Difference Payment”, to the company of that amount. Any Difference Payment is calculated separately for ring fence corporation tax (RFCT), supplementary charge (SCT), and petroleum revenue tax (PRT).
Decommissioning Relief is the amount of tax relief received in respect of Decommissioning Expenditures incurred by the company (or in certain cases for PRT purposes by a past holder of the relevant field interest).
The Reference Amount is a notional level of relief in respect of Decommissioning Expenditures which is broadly calculated with reference to the scheme for providing tax relief in respect of Decommissioning Expenditure represented by the statutory code in place at the time that Finance Act 2013 obtains Royal Assent.
What expenditures qualify for a guaranteed level of relief (Decommissioning Expenditure)?
For corporation tax and supplementary charge the definition refers back to “general decommissioning expenditure” for the purposes of the Capital Allowances Act.
For PRT the Deed relates to expenditure on “closing down, decommissioning, abandoning, or wholly or partly dismantling or removing qualifying assets” or “carrying out qualifying restoration work consequential on the closing down the field or any part of it”.
Where PRT losses are carried back in a field to an old participator on cessation of production under the rules in Schedule 17 Para 15 FA 1980, expenditure incurred by the new participator is treated as Decommissioning Expenditure of the old participator for the purposes of the Deed.
Default and Non Default Situations
Another key concept within the Deed is that the level of guarantee in respect of Decommissioning Expenditure differs depending on whether the Decommissioning Expenditure is incurred by a company as a result of an obligation which has fallen on it as a result of the default of another company which is a party to a JOA or other similar agreement, so called Imposition Decommissioning; or any other Decommissioning Expenditure, so called Ordinary Decommissioning.
Very broadly relief available in respect of Imposition Decommissioning expenditure is more certain, and in certain circumstances at a higher level, than would be available in respect of Ordinary Decommissioning.
If an affiliate of a defaulting company picks up the liability the expenditure will not be treated as incurred under an Imposition and will therefore be treated as Ordinary Decommissioning expenditure.
How is the Reference Amount determined?
A. Ordinary Decommissioning Reference Amounts
In the case of Ordinary Decommissioning expenditure the Reference Amount is calculated for each relevant tax as follows:-
1. Ring fence corporation tax
The Reference Amount is the amount of relief that would be available for RFCT purposes in respect of Decommissioning Expenditure under “Existing Legislation”.
In respect of tax capacity there is one important modification in that, if the reason that the company has insufficient tax capacity is because it had already utilised all or part of its capacity as a result of having to incur Imposition Decommissioning expenditure, then the Reference Amount is increased to take into account the tax relief which the company would have received had it not already used up its Tax Capacity in this way.
2. Supplementary charge
A similar approach is taken in respect of the calculation of the Reference Amount in respect of supplementary charge, except that the intention is that the rate of relief will be capped at a maximum amount of 20%.
In order to allay industry’s fears that the Government might choose negate the effectiveness of the Deed by increasing the rate of supplementary charge whilst reducing the ring fence corporation tax rate, in these circumstances the Deed provides for the 20% cap to be increased by an equal amount to any reduction in the rate of ring fence corporation tax.
3. Petroleum Revenue Tax
The PRT Reference Amount works in the same way as for RFCT and SCT. It is the amount of relief that would arise in respect of allowable Decommissioning Expenditure in respect of the field under Existing Legislation. If PRT has been abolished the calculation is to be done by reference to the law at the time of abolition and on the assumption the decommissioning expenditure was incurred at the time of abolition.
This amount is then reduced to reflect the RFCT and SCT liability which would have arisen on PRT repayments equal to the PRT Reference Amount calculated using the RFCT and SCT rates which would have had applied in respect of the RFCT and SCT Reference Amount for that Decommissioning expenditure.
B. Imposition Reference Amounts
1.Ring fence corporation tax
The Reference Amount is simply calculated by multiplying the Decommissioning Expenditure by 30%.
The Deed states that in calculating the allowable Decommissioning Expenditure, one has to reduce the actual amount of Decommissioning Expenditure by any actual PRT relief received in respect of that expenditure plus any PRT Reference Amount received.
A similar approach is adopted for SCT. The rate applied is fixed (rather than capped as in the non-imposition case) at 20%.
3. Petroleum Revenue Tax
In respect of Imposition Decommissioning expenditure the concept is that in addition to the company’s tax capacity in respect of the field (taking into account any previous owners’ capacity), the Reference Amounts should also reflect the defaulting party’s capacity to receive PRT relief in respect of Decommissioning Expenditure.
Specifically the Deed provides that the Reference Amount in respect of any particular amount of Imposition Decommissioning expenditure is to be based on the rate of relief which is set out in a certificate produced by HMRC, in respect of that expenditure. This certificate will take into account the relief which the company or its predecessor could enjoy in respect of all or part of the field interest, in respect of those costs, together with the relief available to any defaulting party and its predecessors in respect of the costs in connection with all or part of the interest in the field.
The Reference Amount is reduced to reflect RFCT and SCT relief available in respect of the Decommissioning Expenditure.
In determining the Reference Amounts the fact that a previous owner may no longer exist is to be ignored.
Mechanics of the certificate
It is acknowledged that further thought is needed in respect of the PRT certification process and a place marker to that effect is included within the draft Deed.
Limitations on the level of Relief
There are limits to the overall amounts payable under the Deed. The guidance notes to the draft Deed state that in respect of PRT the amount relievable under the tax code and recoverable under the Deed is restricted to the greater of the Claimant’s and the defaulting party’s chains of PRT histories. However the wording in the present draft is not very clear as to whether this goal is achieved.
For non-default situations the Deed is intended only to provide for payments to be made as a result of shortfalls in tax relief that arise from changes in tax law and not as a result of any other circumstances which may result in the company receiving less tax relief than it theoretically may have done based on existing legislation.
Similarly if the tax relief available has reduced because of a change in law which has reduced the profits taken into account for the purpose of tax no payment will be made under the Deed.
Billing and payment
The current proposal is that a company will be required to make a claim under the Deed in order to receive payment of any Difference Amount. The earliest point in time that a claim can be made is submission of a tax return (and there will be a time limit after which claims cannot be made).
Given the tax returns for RFCT and SCT are typically filed up to 12 months after the end of the accounting period in which expenditure is incurred there could be a significant delay from the point in time that company was obliged to incur expenditures and when the payment is received. However, in the case of PRT a claim under the Deed can be made as soon as the PRT expenditure claim has been made.
A company may not assign its rights under the Deed except to or in favour of a bank or financial institution in relation to the financing of its business activities.
The Government Counterparty may assign or transfer its rights and obligations to any “successor in relation to those rights and responsibilities”.
There are a number of anti-abuse provisions included within the Deed which seek to limit any payments due under the Deed in certain circumstances.
It appears that there is still a lot of work to be done to make sure that the provisions of the Deed achieve the Government’s objectives of, primarily, enabling companies to provide security for decommissioning on a net of tax basis. It is crucial if the Deed is to be successful in this role that there are no major weaknesses in its approach otherwise certain companies are likely to continue to resist net of tax provisions in certain circumstances. We have identified a number of issues where we believe the drafting needs to change, and will be discussing these with interested parties over the next few weeks.
B. Draft decommissioning related legislation
1. Decommissioning Deed Enabling legislation
The Government will be empowered to enter into Decommissioning Relief Agreements with ”Qualifying companies” providing that in circumstances where there is a shortfall of tax relief for “Decommissioning Expenditure” as compared to the Reference Amount the Government will pay the difference to the company.
The clause also confirms that any payments made under the Deed will not be subject to tax in the hands of the recipient.
As part of the procedure to verify Reference Amounts HMRC are given powers to relax their confidentiality restrictions so that where a company is a party to a Deed, it will be able to make disclosures to that company to enable that company to enable its PRT Reference Amount to be determined.
These provisions are required to enable the Government to enter into the decommissioning relief agreements with companies. The intent is that any company that might be called upon to fund decommissioning costs could potentially claim under such an agreement.
2. Definition of “Decommissioning Expenditure”
As part of the link between the decommissioning relief agreements and tax legislation there is a new definition of decommissioning expenditure which encompasses the four categories of decommissioning costs used in the definition in s163 CAA 2001 for plant and machinery, plus an additional item relating to the restoration of any land. As such it mirrors the definition of decommissioning expenditure used for the purposes of capping the rate of SCT relief for decommissioning costs.
During discussions on this matter it was clear that the Government wanted a consistent definition for decommissioning costs between the Deed, the provisions restricting relief for supplementary charge purposes, and the provisions allowing relief. As currently drafted this objective does not appear to have been achieved.
3. Annual Report to Parliament on Decommissioning Deeds
The Treasury will be required to report to Parliament every year, from 2015, setting out the number of decommissioning relief agreements entered into in that year, and the total number of agreements in force at the end of the year.
The Treasury will also have to report how many payments have been made under any decommissioning relief agreements, stating the total amount of payments that have been made under the agreements both for that year and cumulatively, together with an estimate of the maximum amount liable to be paid.
It is understandable that Parliament would like to keep abreast of the Government’s exposure to payments under these arrangements, but it is not clear how the estimates of likely future payments will be made as these will, unless Government changes the law relating to relief for decommissioning, only occur in the event of default by one of the parties in a field where inadequate security has been provided, and such situations are difficult to predict. It is also not clear over which period this estimate is supposed to be made.
4. Consequential restrictions to PRT claims
There are provisions included within the legislation to restrict the actual relief available for PRT expenditure where that expenditure has given rise to a claim under a decommissioning relief agreement. This can arise where the claim was made on the assumption that costs of the company (or another company) are relievable in a particular way, but where in fact relief is available to be claimed in a different way.
Further, where a claim has been made under a Deed on the basis that certain profits would have been reduced those same profits cannot also give rise to a repayment in respect of other costs. The rules also apply to deem the predecessor company to have received tax relief for costs which are the subject of a claim.
It follows that if a company has made a claim under a Deed that the costs forming the basis for the claim should not also give rise to actual PRT relief.
Similarly if tax capacity has been taken into account in a claim under the Deed that capacity cannot also be taken into account in any other claim.
5. Changes to PRT loss carry back rules in the event of default
Where there is a default in respect of decommissioning costs, and another company (the contributor) is required to pick up the defaulter’s decommissioning costs, for PRT purposes the Schedule 17 rules that carry certain losses back to a previous participator are turned off in respect of any costs incurred by the contributor (including their own share of costs if relevant).
There is a particular difficulty where there has been a change of ownership of a field and losses are generated on decommissioning which exceed the new participator’s profits. Although the excess loss can be carried back and set against the profits of a previous participator in most cases, there are circumstances where the loss making company may not receive effective relief for its expenditure. This could be where, for example, contractual arrangements under which the licence interest was transferred to the new participator, or indeed a subsequent new participator, did not provide for the benefit to be passed back, or where a previous participator no longer exists. In order to ensure that a coherent scheme exists in the case of default, in these circumstances the Reference Amount for the purposes of the Deed takes into account the tax capacity of a relevant previous participator, regardless of any contractual arrangement, or whether that company exists. The effect therefore is that rather than repayments being made in respect of that proportion of a loss which would have previously been carried back to the old participator under the tax system, the contributor receives effective relief under the Deed via a Difference Payment.
In any event it is important to note that the switching off of the paragraph 15 rules only applies in the case of default and therefore it remains an important commercial consideration to ensure that appropriate provision is included within any sale and purchase agreements to ensure new participants are able to obtain effective PRT relief for abandonment costs in circumstances where there is a likelihood of losses being carried back to the previous owner.
The switch off of Schedule 17 may lead to a loss of relief for a participators own costs which would not appear to be protected by the Deed.
6. Costs paid to a connected party
Decommissioning relief under the P&M provisions will be restricted where decommissioning services are provided by a connected party. For the connected party payer, claims for relief are restricted to the cost to the connected party provider of providing the service. This is, however, subject to certain relaxations.
These provisions also include restrictions on deductions where transactions are entered into to obtain a tax advantage, with the remedy being to negate that tax advantage.
7. Removal of charge to Inheritance Tax on Decommissioning trusts
A further element of the package was a proposal to remove the Inheritance Tax charge on decommissioning security trust funds. The effective date of this is to be 20 years before the date of the 2013 Budget, due to take place on 20th March 2013.
The imposition of Inheritance Tax has always been seen as anomalous by the industry, particularly given the commercial nature of such funds and that other specific trusts had previously been so exempted. Industry bodies, in particular Brindex, have lobbied for a change for many years and it is pleasing to see that this anomaly is finally to be removed. However income within any UK resident trusts will continue to be taxed at the trust rate of income tax
8. Onshore installations and site restoration
There is to be an extension of the special tax reliefs for offshore plant and machinery decommissioning expenditure to certain expenditure on onshore installations and site restoration.
The meaning of general decommissioning expenditure for plant and machinery purposes is to be extended to include work carried out in connection with onshore assets used for the purposes of offshore oil and gas production. For these purposes the relevant onshore instillation means any building or structure which is or has been used for purposes connected with the extraction of mineral deposits in or under the bed of the territorial sea or a designated area of the Continental Shelf. As a result of these amendments costs of decommissioning such onshore installations will be eligible for the 100% FYA under section 164 CAA 2001 and the extended loss carry back rules in section 42 CTA 2010.
The extended relief does not cover assets connected solely with the production of onshore fields. This relief is likely to apply predominantly to the onshore terminals for offshore fields such as St Fergus and Sullom Voe.
9. Expenditure on Site Restoration
The existing MEA rules dealing with restoration costs are to be rewritten for the purposes of ring fence trades. A new s416ZA is to be introduced which substantially mirrors the approach taken for plant and machinery allowances in respect of “general decommissioning expenditure”. As a result site restoration expenditure, whether incurred before or after the company ceases its mineral extraction trade, will be treated as expenditure qualifying for a 100% MEA allowance and the extended loss carry back.
There has been some doubt as to the basis on which some costs can be claimed, in particular the costs of removing drill cuttings, and whether the heading under which relief was sought affected the ability to carry the losses back. There is no definition of restoration included within the new clause but we understand that costs such as removing drill cuttings are intended to be included.
While these clauses essentially constitute a tidying up exercise, the inclusion of the losses generated by such costs to the extended carry back provisions is welcome and should remove uncertainty in this area.
10. Decommissioning expenditure taken into account for PRT purposes
FA 2012 introduced provisions to cap SCT relief for decommissioning expenditure incurred after March 21 2012 to 20%. This was achieved by requiring the profits subject to SCT to be grossed up by a suitable factor applied to the decommissioning costs that had given rise to effective relief in an accounting period, such that when the grossed up profits were taxed at 32% it had the effect of only giving relief for the decommissioning costs at 20%. Where the decommissioning costs also give rise to effective PRT relief a further adjustment to the SCT profits was required, this time to reduce the profits subject to SCT by a suitable factor applied to the decommissioning costs that had given rise to effective PRT relief, with the intention that the overall effective relief for decommissioning costs which had given rise to PRT relief would be 75%, which was the overall effective rate before the SCT rate was increased from 20% to 32%.
The drafting in Finance Act 2012 was extremely complex and after a detailed review CWE had pointed out to HMRC that the provisions didn’t achieve this objective whenever there were CT losses that were being carried forward or carried back to reduce SCT profits in a different period. The provisions are therefore being changed to ensure that they do have the intended effect in all circumstances.
This amendment is welcome and we believe that the provisions do now have the intended effect, subject to the definitions of allowable decommissioning expenditure for CT and PRT purposes being the same. It is however surprising that, given that this change is correcting an anomaly in the original legislation, it is only effective from the date of Royal Assent of Finance Act 2013, and has not been back-dated.
11. Abandonment Guarantees and Abandonment Expenditure
11.1 Abandonment Guarantees and Non Taxable Fields
Since Finance Act 1991 was enacted specific relief has been available for CT purposes for expenditure on abandonment guarantees, but the availability of this relief was linked to relief for the cost being available under the PRT code. When PRT was abolished for new fields in 1993 the CT provision was not updated. These changes rectify that omission and now provide that CT relief is available not only if the expenditure on obtaining an abandonment guarantee does qualify for PRT relief, but also where it would have done so had the field in question not been a non-taxable field for PRT purposes. The change is effective for expenditure incurred on or after the date of Royal Assent of the Finance Act 2013.
It is a little surprising that this change is not being made retrospectively as it is correcting a clear anomaly in the legislation, although in practice companies have typically taken the view that relief is in any event available under basic principles. It is however understood that HMRC have no intention of challenging claims for relief until the new law becomes effective.
11.2 Subsidy Rules
To facilitate the “guaranteed” nature of decommissioning expenditure in conjunction with the Decommissioning Relief Agreements referred to above, the PRT subsidy rules are being “turned off” in the case where decommissioning expenditure is met directly or indirectly by a guarantor under an abandonment guarantee. Similarly, the specific subsidy rules for CT (and income tax – although these are unlikely to have been of any practical relevance) which deny relief for any expenditure met by a receipt under an abandonment guarantee are also to be dis-applied in these circumstances.
While the specific CT decommissioning subsidy rules are being repealed, no change is proposed to the general subsidy rules in Chapter 1 Part 11 CAA 2001. It would therefore appear that relief will still be denied in certain cases, although we do not believe this is the intention.
A number of the PRT provisions in FA 1991 and CT provisions in CTA 2010 (plus income tax) dealing with relief for payments made to guarantors by defaulting participators, and any subsequent recoveries by guarantors, under abandonment guarantees, are abolished as these are now to be dealt with under the decommissioning security agreement provisions and some rewritten provisions for corporation tax (and income tax).
The rewritten provisions bring into charge to ring fence CT (and income tax) any net benefit received by a person (the “contributing company”) who is themselves carrying on a ring fence trade and has met someone else’s decommissioning costs. A net benefit is the excess of the sum of a) any receipts from a guarantor of the original defaulter, plus b) any recoveries from the defaulter, plus c) any tax relief obtained by the contributing company on the default payments it has had to pick up.
These provisions would therefore appear to give sellers an incentive to push for the overfunding of decommissioning security as they (and Government) would benefit from any overfunding in the event of a default.
12. Other Non-Decommissioning Related Draft Finance Bill Clauses
12.1 “Above the Line” R&D Credits
Rather than obtain a “super deduction” of an additional 30%, on top of the actual expenditure in respect of qualifying R&D spend, against taxable profits, there will be an option for expenditure incurred from the date of Royal Assent of the Finance Act 2013 to receive a taxable credit from the Government. This latter option will become obligatory in 2016. For R&D that qualifies for a ring fence trade the credit will be 49% of the expenditure, whereas for R&D qualifying for other trades the credit will be 9.1% of the expenditure.
The intention behind this change is not to significantly change the quantum of benefit available, but to make it more “visible” and therefore hopefully encourage more R&D activity. For a large company with non ring fence profits that incurs 100 of qualifying R&D spend, the choice is to take an additional deduction of 30, which at a tax rate of 23% is worth 6.9, or to take a tax credit of 9.1, which will give rise to a tax liability at 23% of 2.1, i.e. a net benefit of 7. Following lobbying by the oil and gas industry a company with ring fence profits that incurs allowable R&D has the choice of taking a deduction of 30 that will save 18.6 of tax at the combined 62% rate of tax, or to receive a credit of 49 which will give rise to a tax liability, at 62%, of 30.4, i.e. a net benefit of 18.6. Ring fence qualifying expenditure of 100 will therefore give rise to an overall tax saving of 80.6 (62 plus the 18.6 above), or 99.6 if PRT relief was also available.
12.2 Tax rates
The main ring fence corporation rate is to remain at 30% for the 2014 financial year despite the main rate for other industries dropping to 21% for that year. The small company ring fence rate will remain at 19% (20% for other industries).
It seems very unlikely that ring fence profits will be taxed at the same rate as applies to the rest of corporate tax payers for the foreseeable future.
12.3 General Anti Avoidance Provision
A GAAR provision will be introduced for arrangements entered into on or after the date of Royal Assent of the 2013 Finance Act. The provision will apply to SCT and PRT, as well as corporation tax.
The extent of these provisions will no doubt be subject to much debate over the coming months but, given the arrangements must be “abusive”, as defined, and have as one their main purposes the obtaining of a tax advantage, it is not thought that many transactions undertaken by upstream oil companies will fall foul of these provisions.
12.4 Non sterling capital gains tax calculations
Disposals of interests in shares on or after the date of Royal Assent to the 2013 Finance Act are to be computed in the company’s functional currency, and then translated into sterling at the spot rate on the date of disposal. Costs or proceeds paid or received in a currency other than the company’s functional currency at the relevant time should be translated into the company’s functional currency at the spot rate at the time they are paid or received for the purposes of calculating the functional currency gain or loss. If the company changes its functional currency any costs incurred prior to that are converted from the old to the new functional currency at the spot rate at the date of change.
As the change only applies to disposals of shares, and not other assets, and most share disposals are now protected by the substantial shareholding exemption, this new provision is unlikely to have any impact on the oil and gas sector.
CW Energy LLP
January 22, 2013