27 May 2002

The Changing Face of UK Oil & Gas Taxation

The UK is generally thought of as a relatively stable political environment in which to make long term investments. However, successive UK governments have regularly changed the fiscal terms applying to oil and gas investments, which inevitably clouds that view.

While each years’ Finance Act typically sees a number of changes to the regime, most of these are to correct technical anomalies and loopholes. Of more concern to potential investors are the fundamental changes that take place. These generally appear to be driven by the desire to either encourage investment or extract more economic rent from the area, depending on the general state of the UK economy, and in particular that of the oil and gas industry.

The Past
In 1975 a specific North Sea regime was introduced under which UK oil and gas exploration and production companies were subject to three tiers of government take; government royalty (royalty), petroleum revenue tax (PRT) and corporation tax (CT). This initial regime has changed significantly over the last 27 years with fairly fundamental step changes in 1981, 1983, 1993, and now 2002.
The early years saw changes happening on a fairly frequent basis, which can be seen as the new regime “bedding down”, once production started to get up and running. For example, the rate of PRT, which started off as 45%, increased first to 60% in 1978, and then 70% in 1979. Also, in 1981 a new, supplementary petroleum duty (SPD), was introduced (to be abolished two years later), together with a further impost, gas levy, payable, at that time, only by the British Gas Corporation.

1983 saw the first fundamental change whereby the rate of PRT was increased, again, to 75%, immediate PRT relief was granted for all exploration and appraisal costs and, for new northern North Sea fields, PRT oil allowance was doubled, and royalty was abolished. These changes were extended in 1988 when the abolition of royalty was applied to Southern Basin and onshore fields developed after April 1982, although at the same time oil allowance was halved for these fields.

The next major change to the regime occurred ten years later when PRT was abolished for all new fields receiving development consent after March 15 1993, and the rate of PRT for old fields was reduced to 50%. As royalty had been already been abolished, for fields receiving development consent after April 1 1982, post 1993 fields were only subject to corporation tax on their profits. Fields that had received development consent before that time continued, however, to be subject to a mix of royalty, PRT and corporation tax depending on when they received development consent and where they were located.

A further nine years on, yet another significant change is now being made, with royalty being abolished for all fields, (albeit at a future date still to be determined), and a new supplementary charge of 10%, levied on all fields, old or new. This supplementary charge will be based on the profits, as computed for corporation tax purposes, but with the significant difference that no relief is given for financing costs. This latest change seems to have been driven by the view that the 1993 changes were too generous to industry.

The Future
Going forward, the marginal rate of tax for the pre 1993 fields that still pay PRT in addition to corporation tax and the new supplementary tax, will be approximately 70%, once royalty has been abolished. Other fields will have a marginal rate of 40%. Although these are marginal, rather than effective, rates of tax, tax is still very significant to the potential return on any North Sea investment.
Investors need to have stability when committing monies to long term investments. However, even after the initial “start up” changes to the regime had settled down, major changes have occurred about once every nine to ten years. Although there may be no more “elephants” to be found in the North Sea, one would expect many development projects to last for more than ten years, and the tax regime at the end of project life can still have a strong influence over the project economics.
The government is now promoting the concept that the latest changes are intended to create a stable regime for the foreseeable future, but has commented that after ten years a change was perhaps due. Given the unexpected nature of this year’s changes, whatever the Government may say to the contrary, there is unlikely to be much comfort that the current regime is going to still be in place in ten years time. One real concern for industry will, therefore, be the level of effective relief that is going to be available for decommissioning costs.

Investors looking to invest in North Sea projects will be understandably concerned as to what the tax regime is likely to be for the whole of their expected investment period. Given the past changes, it is unlikely that investors will ever become comfortable that there will not be further major changes to the regime in the future. As relief for decommissioning costs is going to be a major concern for any potential investor, it will be incumbent on government to work with industry to arrive at an acceptable formula that takes this risk away.
This will be particularly relevant if the government wants to encourage new players to invest in brown field sites, with a view to using new technology to sustain the life of mature fields. If the tax risk factor cannot be removed the levels of future investment in the UK could decline quite rapidly.

Phil Greatrex
C W Energy Tax Consultants Ltd
May 2002


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