backIntroduction
Against the backdrop of higher development costs for aging oil and gas fields, depressed global oil prices and projections of slower global economic growth, the UK government announced significant tax cuts in its Budget 2016 worth 1 billion over five years to support the UK oil and gas industry. The move will see the Petroleum Revenue Tax (PRT) effectively abolished. Further, an existing Supplementary Charge for petroleum companies will also be reduced from 20% to 10%. In addition to reductions to the headline rate of tax, the UK government also indicated other fiscal changes that will allow petroleum companies to access certain tax allowances in order to encourage investment in key infrastructure and certain tax relief relating to decommissioning costs in order to encourage new entrants for, and development of, late-life assets.
The tax cuts form part of the UK governments efforts to drive investment in, and to maximise economic oil and gas recovery from the UK Continental Shelf (UKCS). This was instigated following an independent review and study of the industry [1] which highlighted that, among other things, urgent action was needed to create a more competitive and efficient operating environment to attract investments and thereby maximise economic oil and gas recovery and avoid premature decommissioning of key assets.
This article focuses on changes to the headline rate of tax applicable to the UK oil and gas industry and discusses the potential impact of, and the reaction to, the Budget 2016.
Existing UK oil and gas tax regime
The current UK oil and gas tax regime comprises three elements: (i) Ring Fence Corporation Tax; (ii) a Supplementary Charge; and (iii) Petroleum Revenue Tax.
The Ring Fence Corporation Tax applies to petroleum companies in the same way that it applies to all companies except with the addition of a ring fence the ring fence covers a companys taxable profits derived from oil and gas extraction in the UK and the UKCS . Companies may not reduce their ring fence profits by losses incurred from their other activities or by excessive interest payments. The current rate of tax on ring fence profits is 30% (as opposed to an existing 20% mainstream corporation tax). A first year allowance is available up to 100% of all capital expenditure.
Further, there is an additional 20% Supplementary Charge on a companys ring fence profits but no deductions are permitted for finance costs. The Supplementary Charge, however, may be reduced by various allowances such as the investment allowance, cluster area allowance or onshore allowance.
Finally, PRT, a field based tax, is charged on profits arising from oil and gas production from individual fields which were given development consent before 16 March 1993 PRT was abolished for all fields approved for development thereafter. The rate of PRT is 35%, having previously been reduced from 50% to 35% in 2015. PRT is deductible as an expense for the purposes of calculating Ring Fence Corporation Tax and the Supplementary Charge.
The marginal tax rate, therefore, is 67.5% on income from fields paying PRT and 50% for other fields.
Changes in Budget 2016
The UK government announced two significant tax cuts to the existing UK oil and gas fiscal regime the changes will effectively abolish PRT and halve the Supplementary Tax from 20% to 10%. The zero rate of PRT will apply to all chargeable periods ending after 31 December 2015. As for the new rate of the Supplementary Charge, this will apply for accounting periods commencing on and after 1 January 2016, with transitional rules applying to accounting periods before that date.
To effect the proposed tax cuts, legislation will be introduced in Finance Bill 2016 to amend: (i) section 1 of the Oil Taxation Act 1975 to reduce PRT from 35% to 0%; and (ii) section 330 of the Corporation Tax Act 2010 (CTA 2010) to reduce the rate of the Supplementary Charge from 20% to 10%. Additional amendments to the CTA 2010 will be made to permit greater access by petroleum companies to certain tax allowances. The details for tax relief related to decommissioning costs have yet to be published and it remains to be seen what relief will be proposed.
Budget 2016: Impact and Reactions
Whilst the reduction of the Supplementary Charge and effective abolition of PRT appear significant, the impact of the proposed tax cuts should be considered in the context of the current application of these taxes on petroleum companies operating in the UKCS. Based on industry sources, there are approximately one-hundred oil and gas fields that are potentially subject to PRT ( i.e., fields receiving development consent prior to 16 March 1993). Sixty of these fields, however, have never been profitable enough to pay the tax. Further, see Figure 1 which shows the UK governments revenues over the years by tax category from oil and gas production. Arguably, under existing market conditions, the impact of these tax cuts on UKCS operations is not as significant as it first appears.
[2]****
The proposed tax cuts have been universally welcomed by industry, but some commentators suggest that the Budget 2016 was a missed opportunity by the UK government to be more radical by abolishing the Supplementary Charge altogether in order to simply the tax regime or to provide allowances for exploration or production to encourage further investment. Others suggest that the changes are in line with a long history of fiscal policy changes by the UK government in response to the rise and fall of the price of oil, a legacy of fiscal uncertainty that provides little assurance to investors.
Comment
Whether the Budget 2016 will do enough to support the UK oil and gas sector in the current market conditions remains to be seen. However, following the Wood Report, it is clear that the UK government now recognises that it urgently needs to create a competitive environment in order to attract investment with the aim of maximising economic oil and gas recovery of the UKCS and this probably includes a fiscal policy that is more reflective of the UKs ageing oil and gas fields.
[1] The Wood Review dated 24 February 2014 and a subsequent study dated 25 February 2015 by Dr. Andy Samuel, chief executive officer of the new UK oil and gas regulator the Oil and Gas Authority (see energy newsletter article titled UKCS: Maximising Economic Recovery and the Oil and Gas Authority dated 20 March 2015).
[2] https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/466923/Tax_Chart_Oct_2015.pdf