In today’s Autumn Statement the Chancellor acknowledged the need for the tax system to offer some help to the oil and gas industry, which is seen as a very important industry for the economy as a whole. He announced a number of changes, and noted that further proposals would be announced by the Chief Secretary to the Treasury, Danny Alexander, tomorrow.
The specific changes announced today; the reduction in supplementary charge, the extension of RFES, and the introduction of a cluster allowance, all of which are dealt with in more detail below, are to be introduced in the spring 2015 Finance Bill, and we would expect them to be enacted prior to the General Election in May, as there is understood to be cross party support for the measures.
While we will have to wait and see what is announced tomorrow, it is expected that there will be a further round of consultations on a number of specific issues that have been identified in the general call for evidence consultation that has taken place this year with a view, presumably, to including such changes in the second Finance Bill of 2015 anticipated at the end of summer / early Autumn following the General Election.
In addition to the above measures mentioned in the Chancellor’s speech a number of other changes are also being introduced now (see “Other Changes” below).
Reduction in Supplementary Charge (SC) rate
The rate of SC is to be reduced from 32% to 30% with effect for profits generated after January 1 2015. Treasury has stated that the aim is to encourage additional investment and drive higher production, and that they aim to reduce the rate further in due course as when the Government can afford to do so.
It is not thought, given the limited number of companies actually paying SC, that this change is likely to cost Government much (the Government estimate is £55m for next year), and can be seen as more of a token gesture of sympathy to the oil industry at a difficult economic time. It is unlikely to have much impact on investment initially as the rate reduction is not much more than 3% of the prior 62% rate, the reduction has a corresponding impact on the value of field allowances, with for many companies the benefit being long into the future. It does however indicate that the Government acknowledges that change is needed. It must be hoped that real lasting effective changes will come out of whatever further consultation takes place next year.
It will not be possible to take account of the drop in rate in calculating deferred taxes until the change has been substantially enacted, which is not likely to be until next spring, although if the effect of the reduction is expected to be material then a company should disclose its impact in its next set of results.
Ring Fence Expenditure Supplement extension
After a number of years of lobbying the Government have agreed to increase the maximum number of periods for which Ring Fence Expenditure Supplement claims are available from 6 to 10.
However claims 7 to 10 will only be available in respect of losses and pre trading expenditure incurred after 5 December 2013, together with supplement thereon.
We will have to await the draft legislation next week to determine the exact mechanics of this change but, based on the wording of the announcements to date, it seems likely that one will have to maintain two “parallel” RFES pools, a total pool (which can generate 6 periods of claim) and a post 5 December 2013 pool. Any post 5 December 2013 loss will need to be included in both. Both pools would be uplifted for each period when a claim was being made on the first pool but the second pool would remain “dormant” until the first pool had generated 6 periods of claim. Once 6 periods of claim had been made the amount of losses in the first pool would become irrelevant and only those losses in the second pool would be eligible for RFES. There presumably will be specific provisions dealing with the offset of profits or unrelieved group ring fence profits, which we would expect to work in the most favourable way such that profits would be set against the first pool to the extent possible and only an excess profit set against the second.
This measure is targeted at providing relief for new expenditures rather than existing losses which seems sensible, although perhaps less generous than hoped for by companies with existing losses. Groups which moved into loss for the first time after 2013 will benefit most from these changes whereas groups which have already made RFES claims (perhaps in modest amounts) will not benefit to the same extent. An alternative methodology where each year’s spend can be uplifted would have more merit but it seems that this approach has been rejected, not least we understand because of its perceived computational complexity. However this new proposal would seem to have many of the same computational complexities.
It is of course possible for groups which are still in an overall loss position and have used their 6 periods to obtain additional periods of RFES on new spend by arranging for that spend to be incurred by a new entity. There are issues with this type of planning and this new measure will therefore ensure, at least for the next few years, that such planning does not need to be considered.
Now that it is clear that the additional claims will not apply to pre December 5 2013 losses companies will need to carefully review their position and projections before the end of the year to determine whether claims already made should be withdrawn.
It appears that there is to be no extension to the time limit to of two years in which claims can be withdrawn (in most cases) which is unhelpful.
It is unclear why the measure is backdated to 5 December 2013 (the date of the 2013 Autumn Statement) but perhaps this is simply to align the change with the onshore allowance which was introduced from that date. The use 5 of December will, however introduce a degree of computational complexity which is unwelcome.
The Treasury estimate that the cost of these measures will be £20 million over the next 6 years with no cost until 2016/17. This seems to be a very conservative estimate of the benefit, although perhaps reflects the period over which these losses will arise.
New Cluster Allowance
After extensive consultation and discussions the final form of the cluster allowance has now been decided. It will be given at the rate suggested in the consultation process, i.e. 62.5% of qualifying relievable capital costs in a cluster. The percentage can be altered by regulations. “Relievable” means that the expenditure is incurred for oil-related activities, namely oil extraction activities as defined in s274 CTA 2010, or activities consisting of the acquisition, enjoyment or exploitation of oil rights. The rules will broadly follow those adopted for the onshore “shale” allowance introduced last year.
Unlike the onshore allowance the rate of allowance which has been set was not increased from the indicative rate given in the consultation document which could be disappointing for some companies.
There is no specific definition of capital so it is considered that the normal case law precedents apply. This has been an area of contention for the additionally developed (“brown field”) allowance but is perhaps less likely to be an issue here where the costs concerned will initially primarily be exploration and development costs which will typically all be capital.
Qualifying costs are those in respect of capital expenditure incurred in relation to a cluster area on or after 3rd December 2014. Once an area has been determined as a cluster area all subsequent qualifying capex will qualify for the allowance.
The cluster area allowance is generated when the costs are incurred by the company incurring those costs in the cluster concerned.
A “cluster area” is defined to mean an offshore area which DECC determines to be a cluster area. The determination process is similar to that for existing field determinations, giving affected licensees the right to make representations on any proposed determination.
A cluster area will not include any previously authorised oil field unless this has been decommissioned before the cluster is determined.
Companies will have an option before a cut-off date (yet to be specified but suggested in the consultation process to be 1st January 2017) to exclude a field from the cluster determination if another allowance would be more beneficial.
The criteria which will determine what is a cluster e.g. whether there is an HPHT or uHPHT prospect in the area, are not set out in the legislation but presumably will be specified in secondary legislation. The Treasury have suggested that these will be set at pressure more than 690 bar and temperature more than 149° Celsius, lower limits than those originally proposed.
We assume that the absence of a requirement for an HPHT field in the legislation is that this can be used as a more general allowance and that other types of areas will ultimately be capable of being determined as a cluster.
There seems to be an element of subjectivity in the determination of a cluster area as this can only be determined by DECC. The taxpayer is allowed to make representations but unless the criteria for establishing a cluster are made more specific it is difficult to see on what grounds any objection could be made.
The cluster allowance activated in any period is the smaller of the closing balance of unactivated allowance at the end of the period and the company’s relevant income from that cluster for that period. As with other field allowances the activated allowance is deductible from the company’s profits subject to the supplementary charge.
The Treasury have listened to a number of the representations that were made through the consultation period: for example there no longer needs to be commercial alignment between all of the participants in the cluster; if one participant in the cluster fails to meet its obligations it will not have a detrimental effect on the other participants; and there will be no loss of allowance if the HPHT prospect fails to meet the relevant requirements. There is however still no possibility of relief if there is never any income generated from the cluster.
A reimbursement of costs on the acquisition of a licence does not qualify if any part of the original cost qualified for a cluster allowance to the seller.
There are detailed rules which apply to determine the level of allowances in periods where there are transfers of interests and in particular there is a requirement for part of the allowance to be transferred with a cluster licence. The transferor can elect specify the amount to be transferred within a minimum and maximum range. If no election is made the minimum amount will automatically transfer.
In addition to the items mentioned in the Chancellor’s speech the following changes were also announced.
- Abolition of the Fair Fuel Stabiliser price based trigger point for both the supplementary charge and fuel duty.
- Provision of funding for the Oil and Gas Authority to ensure that it will have the resources it needs to carry out its function effectively.
- Establishment of a new £5 million fund to provide independent evidence directly to the general public about the robustness of the shale regulatory regime, and ensure that the public is better engaged in the regulatory process.
- Allocation of £31m for a system of subsurface research test centres, to establish world leading knowledge applicable to a number of energy technologies including shale and carbon capture and storage.
- A commitment to bringing forward proposals for a shale long-term investment fund, in the next Parliament.
The Fair Fuel Stabiliser was generally thought not fit for purpose, being fixed in sterling rather than dollars, and being based on price rather than profit.
The other measures are not directly fiscal but are to be welcomed as they seek to address some of the previously identified issues particularly around the difficulty of progressing shale gas exploration.
Non “Oily” matters
There is a proposal to limit the level of banking profits that can be sheltered by brought forward losses.
There are many companies in the oil and gas sector that are carrying forward significant levels of losses but this measure seems specifically directed at the banking sector as a result of them having been “bailed out” by the UK Government, and it is not thought that such a restriction is ever likely to be imposed on the oil and gas sector which by its long term nature is always likely to go through periods of loss making particularly as a result of major developments in difficult locations.
The rate of the above the line R&D credits is to be increased from 10% to 11% with effect from April 1 2015.
There doesn’t appear to be any proposal to change the rate applicable to ring fence profits. The benefit of this relief has always to a certain extent been limited in the oil & gas sector due to the propensity to capitalise most R&D type costs. However this increase should be of some benefit to the industry, albeit HMRC recently rather disappointingly notified the industry that they were not proposing to do anything about the instalment payment cash flow disadvantage that arises for ring fence companies if a credit rather than an enhanced deduction is taken.