The Chancellor has today announced that hoped-for changes will be made to the decommissioning tax relief regime, taking effect from 1 November 2018. The proposed changes will be a world first for a tax regime, and are intended to encourage investment in late-life assets in the North Sea.
A review on the topic had been announced in the Spring Budget earlier this year: our article from the time can be read here. There has subsequently been a public HMRC consultation, and well as a review conducted by a panel of industry experts in conjunction with OGUK, HMRC and the OGA. Following the announcement today, draft legislation will be published in the spring of 2018, with the government intending to legislate in Finance Bill 2018/19. The changes are then expected to retrospectively take effect from 1 November 2018. An outline of the proposed mechanism has today been published by the government here, and we have summarised this below.
Having been integrally involved in a number of the deals described in paragraph 1.6 of the outline paper, as well as responding to the HMRC consultation and liaising with industry on the proposals relating to transferable tax history, CMS welcome this announcement and look forward to considering the detailed legislation and related consequences for our clients and future deals.
What is ‘transferable tax history’ and why does it matter?
Under the UK’s current oil and gas tax regime, costs incurred at the time of decommissioning can be carried backwards and set against the profits of previous tax periods, triggering a repayment of any tax previously paid. This can significantly mitigate the net cost of carrying out decommissioning; however, the relief is only of value where there are historic profits for it to be set off against. In relation to petroleum revenue tax (which historically applied to specific older fields), contractual arrangements can allow a purchaser to benefit from tax repayments made to a previous owner. But in relation to ring fence corporation tax and the supplementary charge – the main taxes applying to O&G activities – the company carrying out the decommissioning must have a sufficient history of profits to trigger a repayment of tax paid on those profits.
For a licence holder that has been operating in the North Sea for some time, this is not likely to be an issue. However, new entrants to the North Sea purchasing late-life assets may well not have a sufficient history of having paid tax to allow them to fully utilise the reliefs available on decommissioning. As a result, the effective cost of decommissioning for such entrants (including late-life specialists) may be prohibitively high. The proposed solution therefore involves allowing a seller that does have sufficient tax history to transfer part of the benefit of that tax history to a new buyer of a licence interest, hence ‘transferable tax history’. When the buyer incurs decommissioning costs, it would then be able to utilise the transferred tax history to trigger a repayment of tax previously paid by the Seller.
This should result in an effective cost of decommissioning for the Buyer that matches that which would have been available in the hands of the Seller. The hope is that this will remove a barrier to new entrants investing in the North Sea and will therefore both encourage deals and maximise economic recovery.
How will transferable tax history work?
While we await the draft legislation, the outline published by the government today sets out at a high level how the mechanism is expected to work. We have summarised the key elements below:
Timing: the legislation will be introduced in the Finance Act 2018/19, but will retrospectively apply from 1 November 2018.
- Scope: The transfer of tax history can only occur on the sale of a field, and whether or not any tax history is transferred is optional in each case. The changes will apply to the supplementary charge and ring fence corporation tax only (as described above, there are already contractual mechanisms available for repayments of petroleum revenue tax to be passed on to buyers).
- Quantum: The amount transferred will be subject to commercial negotiations between sellers and buyers. It will not be tied to the profits of the field being transferred, but will be subject to provisions preventing excessive amounts being transferred. This capping mechanism will be linked to the estimated cost of decommissioning in any applicable decommissioning security agreement, as well as a just and reasonableness test. The amount transferred cannot subsequently be adjusted by the parties.
- Operation: Following a transfer, a buyer will track profits from the transferred field and report these to HMRC. It will not be able to use the transferred tax history immediately: instead, the tax history will be ‘activated’ once the field has ceased production and the loss from the field is greater than the tracked profits of the buyer. The buyer will then be able to carry back losses into that tax history and trigger repayments in the usual way.
The outline also identifies a number of scenarios (commonly encountered in North Sea deals) that will be specifically dealt with in the legislation:
- Multiple fields: Where multiple fields are transferred on one deal, the tax history transferred will be allocated to each field at the time of the transfer.
- Subsequent transactions: If a field that has been sold together with an amount of tax history is subsequently sold again, any tax history transferred as part of the first sale can stay with the field on the subsequent sale. However, the tracked profits of both the first and subsequent buyers must be worked through before the tax history is activated as described above.
- Intra-group transfers: Transferable tax history will only be available for intra-group transfers of a field within a short period before and after the asset leaving the group (ie as part of a pre- or post-transaction reorganisation, but not otherwise).
Given the novelty of the concept, it is likely that the draft legislation published in spring 2018 will be complex, but the changes are a welcome example of the government removing potential barriers to deals in the North Sea and using the tax regime to stimulate investment. It is also expected to result in an additional £70m of tax for the Exchequer to 2023, and so looks like being a win-win change to the regime.