CW Energy LLP

Finance Bill (No. 3) 2011

The Finance Bill was published on March 29th2011. The following are our initial thoughts on the provisions that we believe are of most relevance to the oil and gas sector.

The following topics are discussed below:  Part A – the Increase in the SCT rate; Part B – Minor Oil & Gas Tax changes; Part C – Capital Gains Tax De-grouping changes; Part D – Branch Profits Exemption; Part E – Capital Gains Tax Value Shifting; and Part F – Intangible Assets.

Part A   

Increase in the SCT rate

As predicted in our previous Newsletter the Finance Bill has been drafted on the basis that the increase in SCT announced in the Budget is to apply to accounting periods which straddle Budget Day on a simple time apportionment basis. Therefore the effective combined rate of CT and SCT for 2011 for a company with a December 31 2011 year end is 59.3%. The proposal to cap relief for decommissioning costs to a 20% rate of SCT is not however contained in the current Finance Bill, and will presumably be contained in FB 2012.


Unlike when SCT was introduced there is little scope to allocate the profits of the straddling period to mitigate the effect of the rate change. This could be seen as unfair if profits have not accrued evenly over the year. It will nevertheless be worthwhile reviewing the position towards the end of the year in the light of actual prices, lifting patterns, exchange rates, major transactions, etc. to determine whether any planning can be carried out.

Industry has been pointing out the adverse effects that this change will have on future investment in the North Sea, both as a result of the adverse effect on returns but also the signal such a major change gives investors as to the stability of the UK tax regime.

Companies who have not already done so should express their concerns to Government. There have been some reports that Government may be prepared to introduce measures to assist particular developments, beyond the “marginal gas” scenario mentioned in the Budget papers.

There will be discussions between Government and industry concerning the formula to be introduced to adjust the SCT rate should the oil price fall. We believe that these discussions may be an opportunity to build in a mechanism to enable the differential value of gas and oil to be recognised. 

The new 32% SCT rate was substantially enacted on 23rd March 2011under a resolution passed under the Provisional Collection of Taxes Act 1968, which will be relevant for quarterly accounting. One may also be required to disclose the deferred tax effect of the proposed restriction to 50% on the rate of tax relief for abandonment.

Instalment Payment Impact

The legislation is to treat the additional tax which arises as a result of the SCT rate during the straddling period, as an additional liability for that period.

This will mean that for a company with a December year end there will be six instalment amounts to calculate for the 2011 liability.  As is the case under existing law there will be three instalments to collect the 50% liability, payable on 14 July, 14 October and 14 January 2012.  In addition there will be three further instalments payable on7 October, 7 January, and 14 January 2012 to collect the additional 9.3% SCT mentioned above.

Part B

Minor Oil & Gas Tax Changes

The most significant of these “minor” changes is the one which extends capital gains tax reinvestment relief such that reinvestment in exploration and appraisal expenditure qualifies for the relief for disposals after March 24th 2010. Following industry representations the wording now makes clear that appraisal, as well and exploration and development, costs are included.


This change is extremely beneficial to the industry and effectively means that any reasonably active player should be able to plan to avoid capital gains tax on the sale of its North Sea licence interests. It also significantly changes the risk reward analysis for drilling wells where a group has sold on an asset at a gain.

As dealt with in previous Newsbriefs, the Finance Bill includes amendments to changes introduced in recent Finance Acts, following lobbying by industry.  These changes clarify the rules which extend a field life beyond the date the licence expires where not all the assets are situated in the UK; allows re-commissioned fields to qualify as new fields for the purposes of the SCT Field Allowance rules; and amend the development licence swap rules so that adjustments to the consideration for interim period cash movements do not prevent the provisions from applying.


These changes are to ensure that the provisions operate in the way they were originally intended, and it is to be hoped that following the new procedure of putting most new legislation out for comment before it reaches the Finance Bill stage, this will mean that such type of changes will rarely be needed the future.

Part C

Capital Gains Tax De-grouping changes

As anticipated in previous Newsbriefs, the Finance Bill includes the draft clauses to provide for an effective exemption from the de-grouping charge where a transferee company leaves a group as a result of its shares, or those of another group member, being sold.

The clauses now incorporated in the Bill are virtually unchanged from the previously published draft.

The effect of the proposed legislation will be that any gain arising on a deemed disposal as a result of a company leaving the group will be treated as additional consideration for the disposal of the relevant shares; thus, if the disposal of the shares qualifies for the SSE, the whole of the gain, both actual on the sale of the shares, and deemed, arising as a result of the de-grouping charge, will be exempt. Any loss arising on such a deemed disposal will be added to the base cost of the shares but this is unlikely to be of any significance in practice.

The sale of the transferee shares would need to be within the charge to capital gains tax in order for this provision to apply.

The existing provisions which allow companies the ability to roll over the de-grouping gain or to reallocate the gain within the group will be repealed and in their place changes will be made to section 171A to allow for a de-grouping gain to be reallocated under those provisions. However if a company leaves a group otherwise that as a result of a sale of shares e.g. by means of a new issue of shares, the de-grouping charge will remain within the company.

Whereas the published Finance Bill clauses contemplate the provisions becoming effective from Royal Assent, since publication of the Bill the Government has announced that it will be possible to advance the effective date of the provisions, by election, to April 1 2011. The election must be made by the principal company in the group and will apply to all the companies in the group regardless of when the intra group asset transfers occurred. The election must be made before 31st March 2012 and must also be countersigned by any company which has left the group after 31st March 2011 but before the election is made.


These provisions effectively mean that in most cases there will no longer be a chargeable gain arising in the company being sold as a result of the company leaving the group owning assets which have been transferred from other group members in the previous 6 years.  Care will need to be taken however with structures that involves issuing new shares to third parties which could cause the issuing company or any affiliate to leave the group otherwise than via a disposal to which SSE applies. The ability for groups to elect for the provisions to apply from 1st April 2011 is also welcome and will enable groups to plan without the uncertainty of when the Bill will become law.

Relaxation of SSE rules

There are also provisions amending the SSE rules to allow SSE to be available on the sale of the shares in a newly incorporated company, or a company which would not otherwise meet the investee trading company test, if assets are transferred into it from another group company. Previously it was necessary for the seller’s group to have owned the shares in the target company for at least 12 months and for that company to have been a trading company for at least this period of time.  The new provisions modify these rules by deeming the period of ownership of the transferee company to include any the time that the transferred assets have been used for a trade within the group.  In these circumstances the transferee company will also be treated as having carried on the trade for this same period.


The effect of these rules is that a newly incorporated company can be used to sell trading assets providing those assets have been used as trading assets within the group for at least 12 months. Note however that for these rules to apply the assets must be used for trades carried on by both the transferor and the transferee so the transfer of exploration assets may not qualify under these rules in which case it would be necessary to hold the shares in the transferee for at least 12 months.

When trading assets are to be sold there is now a clear choice as to how this can be done.  The assets can either be sold by way of an asset sale (if for example it was expected that reinvestment relief can be claimed to exempt a ring fence gain) or they can be transferred to a fellow subsidiary and the shares in that company sold, without generating any capital gains charge, providing the conditions are satisfied.

This will mean that there will be no need to keep assets in separate companies, and all of a group’s interests can be amalgamated in fewer appropriate companies. This greatly simplifies group structuring for holding assets and will also mean, for example, that there is no need to retain dormant companies from which assets have been transferred in order to avoid the de-grouping charge. 

Part D

Branch Profits Exemption

The Finance Bill clauses dealing with the exemption for foreign branch profits and losses have a significant number of amendments to those published for comment in February, although the basic principle is largely unchanged. The rules have however been expanded to include more detailed provisions for the recapture of past losses and anti-avoidance.

Basic Principles

The clauses provide that if a UK resident company makes an election, the profits or losses attributable to all its non UK permanent establishments (PEs) are excluded from the profits and losses subject to UK tax.  The election, once made, applies to all accounting periods starting after the date of the election, and is irrevocable following the start of that first period.

The rules do not apply to “small” companies to the extent they have profits attributable to a PE in a jurisdiction with which the UK does not have a “full” treaty.


It is thought unlikely that many E&P companies will be small even in the exploration phase so this limitation is unlikely to be of significance even if operations are undertaken in jurisdictions where there is not a full treaty.

It may not always be clear whether pure exploration operations will constitute a PE in the other jurisdiction.

Exempted Profits and Losses

The election will exempt all profits and losses (subject to some specific exemptions), including actual capital gains and losses (although some of the wording is difficult to interpret) attributable to non UK PEs, provided the company carries on a business in the other territory through a PE.

The profits and losses which are exempted are computed in accordance with the relevant treaty, or if there is no relevant treaty in accordance with the OECD Model Treaty.

If the PE has any plant and machinery there is a deemed disposal at tax written down value at the time the election becomes effective (subject to some anti-avoidance provisions), and it has to be assumed that allowances that would have been available, absent the election, are claimed each year in determining the profits of the PE going forward.

Any profits of the PE that are subject to UK withholding tax at source remain within the charge to UK tax notwithstanding the election having been made, as do profits from plant and machinery leasing.

If a UK resident company only has non UK PEs and makes the election it would nevertheless still seem necessary to prepare UK tax returns to demonstrate the calculation of the profits excluded each year, unless HMRC agree this will not be necessary.


It would appear that the capital allowance provisions have little practical impact other than in determining when pre commencement losses (see below) are absorbed or to prevent an asset being transferred out of the PE at a later date with a high TWDV. There are no corresponding provisions related to MEA or RDA allowances. 

Claw-back of past losses

If the company has accumulated brought forward losses (ignoring capital gains and losses) attributable to its PEs at the start of the first period following the date of the election, that have accrued in the accounting periods ending in the six years to that date (or longer if the losses are more than £50 million in respect of any one PE), all future profits of the PEs up to the cumulative amount of the losses remain within the charge to UK tax. If the company has more than one PE, it can make an irrevocable election to have this test applied separately to different permanent establishments.

There is now an anti-avoidance provision to prevent this rule being sidestepped by the transfer of the assets of a PE of another group company, which would seem to apply regardless of when the transfer occurs. 

Anti-avoidance measures

There are anti-avoidance provisions which keep trading profits and losses within the charge to UK tax if those profits are subject to a lower level of tax unless either they are less than £200,000 p.a., or there is no tax avoidance motive. A lower level of tax is tax less than 75% of the tax that would be payable on the profits if the profits were subject to UK tax (ignoring any foreign tax credit). There is no tax avoidance if in respect of any transaction undertaken by the PE which results in any reduction in UK tax, that reduction is minimal or it was not one of the main purposes of the transaction to avoid UK tax, AND avoiding UK tax was not one of the main reasons for the company carrying on the business in the permanent establishment. If the second but not the first test is met only a just and reasonable amount of the profits of the PE remain within the charge to UK tax. 


It is thought that even though there are a number of non UK jurisdictions where oil and gas activities are undertaken that have “lower levels of tax”, these rules are unlikely to impact the oil and gas sector. E&P activities have to be carried out in the relevant jurisdiction such that the second test will always be met, and it is therefore only transactions for non E&P activities that might be caught.

Effective Date

The new rules become effective on Royal Assent which should be this summer, so it will be possible for companies to make an election in 2011 such the exemption will apply for the first time in 2012 (subject to there not being accumulated losses attributable to the PEs at that date in which case the exemption will be denied until past losses have been recouped).

Part E

Capital Gains Tax Value Shifting

As announced at the time of the Budget the CGT value shifting rules are to be amended as part of a number of simplification measures for Capital Gains Tax. The measure is essentially as previously announced with the existing regime being replaced by a new targeted anti-avoidance rule, to apply to disposals of shares after Royal Assent of Finance Act 2011 (probably July 2011). 

The new rule will apply where there is a disposal of shares or securities by a company, arrangements have been entered whereby the value of those share or securities is materially reduced, and the main purpose or one of the main purposes of those arrangements is to obtain a tax advantage.  In these circumstances any gain or loss on disposal of the shares or securities will be computed as if the consideration for the sale was increased by such an amount as is “just and reasonable” having regard to the value shift.

There is a specific exemption in the case of a value shift attributable to an exempt distribution, although this is narrowly drawn. Draft guidance on the application of the new law was issued at the beginning of the year.

The depreciatory transaction rules, which limit the amount of an allowable capital loss on a disposal where value has been stripped out of a company, are also being amended such that any depreciatory transactions that occur more than 6 years before the disposal can be ignored.


Where the disposal of shares qualifies for the substantial shareholdings exemption the value shifting rules will have no effect.  However, there are a number of circumstances where disposals might not fall within the substantial shareholding exemption and care will need to be taken to ensure that the new rules do not create an unexpected tax charge, for example in the case of distributions made as part of a winding up.

Part F

Intangible assets

The Finance Bill includes clauses to ensure that any goodwill that relates to, or is derived from, or is connected with an oil licence (or an interest in an oil licence), is excluded from the scope of the intangible asset rules, as well as the licence itself. This change will apply for accounting periods ending on or after 23rd March 2011, and is treated as always having had effect.


Under IFRS it is possible to create goodwill on the transfer of a licence interest where the acquisition is treated as a business combination. Previously, in our view, the write off or impairment of such goodwill could qualify under the intangible asset regime such that tax relief could be obtained for the full amount of the acquired asset as shown in the books of the company over time. HMRC have stated that this was not the intention of the legislation and this change ensures that an acquisition of a North Sea licence cannot generate goodwill qualifying for intangible asset relief and that no further deductions are available for existing goodwill for periods ended after 23 March 2011.As such the impact of the change is retrospective.