29 Mar 2016

Badly Targeted Incentives?

The Chancellor stated that his Budget delivered the biggest boost to the oil and gas industry in over 20 years. So why is the whole industry not celebrating?

A reduction in tax rates provides no immediate benefit to those not currently paying tax as a result of past and current investment, namely the vast majority of the industry at present. On the other hand it provides a windfall benefit to those who are tax paying whether or not they are planning to invest in the UK.

We think it would have been preferable that any Government giveaway should have been targeted directly at encouraging investment in the sector. A Norwegian style rebate of potential tax relief on exploration was always going to be too expensive in the current economic climate, but the cost of the measures, as set out in the Treasury Red Book, could have been used to provide a limited subsidy against targeted investment in the basin.

The reduction in the PRT and SCT rates will no doubt be welcomed by those paying or expecting to pay such taxes in the short to medium term. However are those companies the ones who will be prepared to invest in the North Sea? They might be, but there is no guarantee.

PRT paying fields were developed before 1993 and many own old infrastructure on which many other fields depend. It is vital that there is investment in these assets but will their owners want to invest in them even following the rate reductions? The owners are often groups with large international portfolios and may well have better investment opportunities elsewhere. The UK North Sea is a notoriously expensive place to do business and the hurdle rates that international companies put in place to value investment decisions can be difficult to meet for a UK North Sea investment.

In the short term investment in PRT paying fields has been made more attractive than that in other fields because current expenditure can give rise to immediate recovery of past PRT paid through loss carry backs. A very clever piece of lobbying by those companies and perhaps this will encourage investment!

We believe a better approach for PRT would have been to provide tax reductions by way of investment allowances such that they were only available to those prepared to invest in the assets. The principle has already been set by the reinvestment allowance for capital gains and the Investment Allowance for Supplementary Charge, so it is a shame that the Chancellor did not look at precedent to determine how best to incentivise the sector.

We also don’t think the reduction in the SCT rate is well targeted. For those prepared to invest there is already the investment allowance which ensures that all but real super profits will be sheltered from SCT. It is those companies who are not spending which are likely to pay SCT at the full rates and it is those companies which are therefore likely to benefit the most.

If it was felt that future investment needed the further encouragement of paying lower taxes we think a reduction in the main CT rate would have been more appropriate. Perhaps government should have looked to extent the investment allowance regime into the CT world.

One of the main challenges for the North Sea is trying to help get assets into the hands of those wanting to invest. The confirmation by HMRC that their view of existing law is that sellers who retain the obligation to decommission would be able to obtain CT relief is welcome. However for PRT fields it appears that under existing law the only way for this to work is for such companies to stay on the licence which is unlikely to be a preferred route in many cases.

As it stands the value of PRT assets to the current owners has just gone up overnight as a result of the reduction in the rate, benefitting the owners but making it more expensive for companies wanting to acquire those assets.

Further it is only those companies which have previously paid PRT which can obtain effective relief for investment. Anyone wanting to acquire such interests and invest, without any PRT paying history, must wait until cessation of production to recover the benefit of past PRT paid. A more useful measure would have been an extension of the loss carry back to previous owner rules.

Overall our view is that the rate changes do little for those companies wanting to invest, they also do not help to get assets into the hands of those companies while providing a windfall to companies in harvest mode. We believe that they are likely to provide little or no benefit to the sector as a whole in the long run with no guarantee that savings will be reinvested by the few companies that are actually expected to be tax paying in the medium term.