In his pre-election budget the Chancellor has responded to calls to reduce the tax burden on the oil and gas companies, but is it a case of too little too late?
As already announced the government have confirmed a package of measures which is intended to “substantially reduce oil and gas taxes to improve competitiveness in the North Sea” in today’s Budget. The government states that this package of measures is expected to lead to over £4 billion of additional investment and at least 120 million barrels of oil equivalent of additional production in the next 5 years, boosting oil production in 2019 by 15%.
The Finance Bill is to be published on 24 March 2015. As Parliament will be dissolved on March 30 there will be a very limited time for discussion so it is hoped there will be enough support for these provisions such that they will be included in the Finance Act.
Tax rate reductions
As widely rumoured the rate of supplementary charge is to be reduced by a further 10% in addition to the 2% reduction announced last year, such that the rate will be restored to the pre-2011 rate of 20%.
This reduction will be backdated to apply from January 1 2015.
In addition the government announced that the rate of PRT is also to be reduced to 35% with effect for chargeable periods ended after 31 December 2015.
A table of the old and new rates is set out below.
The reduction in the SCT rate will be welcomed by those companies which are currently tax paying.
However, most oil and gas companies are not currently taxpaying due primarily to their heavy investment programme. Although these companies will benefit from lower rates in the future (should they be maintained), and the expectation of these lower rates may encourage further investment, most of the benefit of the rate reductions in the short term will be enjoyed by companies with mature projects who are in harvest mode, i.e. not looking to reinvest in the North Sea.
Indeed, although the government state that the package of changes will provide certainty for investors and create the right conditions for the basin to flourish and deliver maximum economic benefits for the UK, one of the main weaknesses of the current system is that there is no certainty that the rates announced will remain in place.
As can be seen from the above table, although the headline reduction in the PRT rate is 15%, if the company is also paying CT and SCT, when the reduction in SCT has been factored in, the actual benefit translates to an overall reduction in effective PRT from 19% to 17.5% i.e. only 1.5%
Those companies which expect to be PRT paying in CP I 2016 and future periods will welcome the change but given that PRT applies to only the larger mature oil fields, it is questionable whether this is the best target for relief. The expected cost of this measure is £335m in the years up to and including 2019/2020. This contrasts with an expected cost of £965m for the reduction in SCT and the investment allowance over the same period.
However the real cost for government is likely to be much less than this as for many fields the reduction of tax rate will simply represent a cash flow benefit since much of the PRT to be paid will be repaid on abandonment.
The other oil and gas measures included within this Budget were announced as part of the Autumn Statement 2014, as part of the plan for reform of the oil and gas fiscal regime. They are set out below:
At the Autumn Statement date the Government undertook to consult on a new industry wide cost based investment allowance and following this consultation the allowance is now being introduced.
Details of the allowance are not due to be published until the end of this week but it has been announced that it will apply to expenditure incurred after April 1 2015, and that the rate of allowance will be 62.5%.
Through the consultation phase there have been a number of issues raised by the industry and we will have to see which, if any, have been taken up by Government once the detailed provisions are announced.
The reduction in the rate of SCT to 20% that was also announced of course reduces the quantum of the benefit of this allowance.
The new allowance is of general application and also provides a level of certainty that was not present in the previous field allowance regime, and it is hoped that this measure will go some way to stimulating more investment in the North Sea. However, this new allowance provides no immediate benefit to the many companies that are not currently tax paying, and it will be interesting to see if Government have thought about this issue. One possible measure to allow for the lost benefit arising due to the delay in using them would be to provide an RFES style uplift for these allowances.
The investment allowance is very similar to the new cluster allowance that is being introduced, the main difference being that in the latter case income from any part of the cluster can trigger the allowance whereas it is expected that only income from the field in question will trigger investment allowance.
While it is understood that the transitional rules will provide adequate protection for owners of fields that have already qualified for an “old” field allowance or are close to development consent, there could be many instances where the new investment allowance is worth significantly less than the previous regime. This is particularly the case for small new pockets of reserves where the existing volume based small field allowance provided a welcome boost, and it is hoped that this will not mean that otherwise economic prospects will not now be developed, or that companies will be discouraged from even looking for such accumulations.
The government has confirmed that they will provide £20 million of funding for a programme of seismic surveys to boost offshore exploration in under-explored areas of the UK Continental Shelf.
Whilst this measure is welcome concern remains that exploration activity is at a historical low and further incentives are needed to ensure that the government policy of maximum economic recovery from the North Sea can be achieved.
The new Oil and Gas Authority is to be given the powers it needs to scrutinise companies’ plans for decommissioning programmes to ensure they are cost effective.
Again this measure was confirmed at the Autumn Statement 2014 with draft legislation published at that time. Details were set out in our earlier Newsbriefs. There are to be a number of amendments to the scheme. The legislation will allow changes to the definition of qualifying expenditure to be changed by secondary legislation. In addition the law is to be clarified to ensure that expenditure on the acquisition of a licence interest will not qualify.
One of the main issues with the Brownfield allowance regime was that it only applied to capital expenditure. This change will at least provide the opportunity for the scope of the cluster allowance to be wider and to cover certain “revenue” expenditures which we believe should be supported under the MER principle such as expenditures aimed at generating incremental production or at preventing a reduction in the rate of production.
There were also a number of non-oil and gas measures which nevertheless could be of importance to the oil industry.
Diverted profits tax (DPT)
As expected, it has been confirmed that the DPT tax, which was announced in Autumn Statement, is to be included in the Finance Bill.
While the detail is not yet available it is understood that there will be some changes to the original proposals, following representations made, mainly around the economic substance tests, but the provisions are otherwise as originally announced (see our newsletter of January 15th this year).
While HMRC’s stated intent is that the provisions are only aimed at catching aggressive tax planning and to generate early disclosure on transfer pricing issues, and our understanding is that the measures were introduced primarily to ensure groups generating revenues in the UK pay their “fair share” of tax, they are potentially of relevance to the oil and gas sector, particularly the support sector, and could therefore have an indirect adverse effect on upstream companies that are already suffering under the current climate.
Some service company activities which are caught by the so-called bareboat charter rules introduced last year could also fall foul of these DPT rules. In such circumstances, if no effective relief for the costs subject to the bareboat cap is obtained, the capped costs will be left out of account in arriving at any DPT charge.
It is not thought that many activities of upstream groups will fall within these provisions but we will need to see the final draft clauses and detailed guidance that we understand is to be issued next week.
Loss refresh prevention
A new TAAR is to be introduced which will limit the availability of certain carried forward reliefs, including trading losses, where profits are introduced into the company under arrangements having the obtaining of a tax advantage as one of its main purposes. As with the proposed diverted profits rules there is an exclusion if the other economic benefits of the arrangement exceed the tax advantage.
The introductory wording in the HMRC Press Release refers to contrived arrangements to convert a brought forward relief into something more versatile, but later defines the tests that will apply in much more general terms.
The reliefs that are covered by the TAAR are trading profits, non-trading loan relationship deficits, management expenses, qualifying charitable donations treated as management expenses, and management expenses arising on the cessation of a property business.
It appears that simple intra group asset or trade transfers could fall within these rules which, if correct, could have a significant impact on oil and gas groups which quite often have losses locked into one company which they would plan to utilise by reorganising the group if other group companies had successful projects.
The new TAAR does not appear to apply to pre trading losses so the change to the pre trading change of ownership TAAR, which the industry successfully lobbied for last year by the Industry, should not be affected. The new TAAR could however prevent groups that own companies which have trading losses ever being able to sell those companies to recoup some of the losses of unsuccessful ventures.
CW Energy LLP
March 18 2015