HMRC have recently published a consultative document on possible changes to the tax rules for valuing non-arm’s length sales of UK equity gas. Following the perceived success of the changes to the market value rules for oil introduced in 2006 HMRC indicated over 12 months ago that they were considering a similar approach for gas using published prices.
Whereas the changes made to the market value methodology for oil were driven by a revenue protection motive it seems that the main driver for a possible change to the gas regime is a desire to reduce the amount of time which HMRC must necessarily spend in agreeing values. The existing methodology for gas provides that the market value is the value which the gas in question would realise in a sale under a hypothetical arm’s length contract, having regard to all circumstances relevant to the actual disposal.
This requirement means that in practice HMRC have been obliged to agree valuations on a case by case basis with each company, as the precise circumstances surrounding each sale will differ. There is a practical difficulty in that finding actual arm’s length contracts against which proposed valuations can be tested is often difficult, since the terms of those contracts will themselves represent the specific circumstances surrounding the disposal of the gas in question.
HMRC have expressed a concern that the lack of uniformity leads to a lack of transparency and consistency between companies. As a result it is also difficult to assess whether the current methodology does ensure that appropriate values are captured within the upstream tax regime.
There are three issues for consultation
- The valuation point: Whether the existing requirement for market value to be determined at the beach should be retained or NBP valuations should be used which would be more in line with open market practice
- The market value methodology: What market prices should be used, for example day ahead, month ahead, or some combination of these
- Whether there should be an adjustment to the pricing methodology for production risk
For companies which have already agreed a methodology with HMRC for a period of time there is a suggestion within the document that these agreements might possibly be grandfathered.
The document states that representations should be made by August 2.
The consultation period, given it will fall partly in the summer holiday period, is not very long, particularly as this is a complex area where HMRC have taken over a year to pull their thoughts together, but it is understood that HMRC are prepared to extend this period.
We believe that the main weakness of the existing methodology is the uncertainty which it generates for companies. It is possible to obtain an agreement with HMRC in advance, but agreeing a methodology can be time consuming. In some circumstances companies have therefore taken the view that a better result can be obtained by simply entering into agreements on terms which they believe are arm’s length and making sure that they are in a position to support those agreements on enquiry if necessary.
A statutory basis may not give an “appropriate” transfer price in every circumstance.
In our experience HMRC already seem prepared to agree “straightforward” methodologies based on day ahead, or month ahead prices, perhaps on the basis that the values produced over a period of time represent a reasonable proxy to those values which would result from more complex arrangements. The current somewhat flexible system would therefore seem to give a satisfactory result for many companies and the move to a statutory basis may represent an unhelpful development for those who may wish to adopt more complex transfer pricing arrangements.
We will be reviewing the document in more detail in due course, and would be happy to discuss the issues raised with companies if they have particular concerns.
CW Energy LLP