HMRC have recently written to industry to set out their views on the tax treatment of the costs of decommissioning certain assets. The announcement that a “cap” on the amount of relief for decommissioning costs for the purposes of the Supplementary Charge is to be introduced has led to a discussion as to the scope of the cap and this in turn has led to a more fundamental review of the rules under which relief is given.
One area where HMRC have set out their views is the costs associated with plugging and abandoning a well. They have agreed that the cost of pulling the production string and cutting away the well head at the mud line qualify as decommissioning of plant and machinery. However, they have not agreed that the cost incurred in setting cement plugs is the demolition of plant and machinery or of any other asset.
HMRC’s view that capping a well is not demolition seems strange; for example the Oxford English Dictionary (OED) defines demolition as:
“To destroy (a building or other structure) by violent disintegration of its fabric; to pull or throw down, pull to pieces, reduce to ruin”
This view contrasts with previous HMRC guidance which clearly stated that they believed the cost constituted demolition; for example, the very first Oil Taxation Office manual stated:
“Meaning of Abandonment
5.3 ……. Thus, for example, the cost of plugging wells on a field abandonment is accepted as expenditure on the demolition of plant within CAA90s62 (now s.26 CAA 2001)……..
5.3.1 ……………….. The killing of wells is done by plugging the well with cement and the dismantling of the platform may take place years later. It has been accepted that all the series of actions that make up abandonment are incidental to this and, subject to other conditions being met, may be relieved under CAA90s62, CAA90s62A or CAA90s62B (now s26 and ss163 to 165 CAA 2001).”
If this revised view that capping the well was not demolition were correct this would suggest that no relief would be available for this cost under the “general decommissioning” of plant and machinery rules in S163/164 CAA 2001 or under S433 CAA 2001 of the MEA rules, costs of demolishing an asset representing qualifying MEA expenditure. There is however a suggestion that specific legislation may be introduced to deal with the issue.
Further, HMRC have recently indicated that they believe that the costs of abandoning a well could fall within s403 CAA 2001, which provides tax relief for the expenditure on acquiring a mineral asset. This is on the basis that the obligation to abandon is effectively taken on when the licence is granted and in this sense the cost is part of the cost of acquisition. We think this argument is flawed in the context of wells except perhaps those exploration wells which are commitments under the terms of the issue of the original licence (although in our view the plugging of these wells is likely to qualify for RDAs).
If relief did fall to be available under S403 then it would be restricted to a 10% WDA. There is also S410 to worry about, which restricts qualifying costs under S403 in respect of UK oil and gas licences to the original amount paid to the Secretary of State. Although HMRC have indicated that they don’t believe the restriction is relevant in the context of well costs the rationale for this statement is unclear.
If HMRC are correct that the act of capping a well is not demolition we believe that there may nevertheless be arguments to support a 100% claim for relief without the cap as currently worded applying.
The other unhelpful view which has been set out in the HMRC correspondence is the view that the costs of removing drill cuttings is not expenditure on the restoration of land. It is unclear why they have come to this view, but again there is the suggestion that there might be legislative change to deal with the issue.
It is our belief that the sea bed is land for these purposes (The Interpretation Act clearly provides that land includes land covered by water).
Restoration is defined in the OED as… “to bring back to the original state…”
It seems therefore that the costs of removing cuttings, which has the effect of clearing the seabed to leave it in the condition which it was in before the drilling operation occurred, should fall to be treated as restoration of that sea bed, but HMRC do not agree.
The Treasury have now published the long awaited consultative document of Decommissioning Relief Deeds and this notes that there is uncertainty as to the relief which is available under current law for the above areas, as well as in connection with decommissioning studies and onshore costs and that discussions will continue. It is likely that there could be further legislative changes in Finance Act 2013 in this area.
HMRC seem to be using the pretext of the discussions with industry to lock in a certain level of relief for decommissioning costs under the “contractual” approach as an opportunity to “clarify” the workings of the legislation in this area. In does seem that there may be a trade-off here in that part of the cost of obtaining certainty is that there are new restrictions enforced in the scope of that relief.
In the meantime taxpayers will have to take a view when filing their 2011 returns as to what relief can be claimed under current law. These views could also have an effect on the calculation of tax provisions, particularly when looking at 2012 and future years and in considering the extent to which the cap applies.