Global Tax Alert | 17 December 2013
UK Finance Bill 2014 includes clauses relevant to oil and gas industry
On 10 December 2013, draft clauses for inclusion in the UK Finance Bill 2014 were released. This Alert provides initial commentary on the draft Finance Bill 2014 clauses that have specific relevance to the UK oil and gas industry.
There were no further announcements of note in connection with the proposed changes to bareboat chartering. Buried within the ”Overview of Legislation in Draft” document was confirmation that draft legislation will be published in January 2014, with the changes having effect in relation to leasing payments made on or after 1 April 2014. Additionally, the document confirmed the Government's intention to cap the deductible bareboat charter cost for the composite service provider to 4% of historic capital expenditure, plus a proxy for finance costs at 5% on half the capital cost.
It is regrettable that the lack of detail accompanying this announcement has led to significant uncertainty within the industry as to the effect of the proposed restriction. For example, from the announcements to date it is difficult to ascertain which ”large offshore oil and gas assets” are to be affected by the new rules. It appears that HMRC (HM Revenue & Customs) is likely to apply a cost threshold of £2mn in determining ”large” for these purposes. Should that prove to be the case, the scope of this measure could be much wider than anyone initially envisaged.
There are a number of companies that have been in advanced negotiations over contracts for the use of large offshore assets, and, not surprisingly, those negotiations have been affected by the announcement. It is apparent that E&P (exploration and production) companies will face increased costs as a consequence of these restrictions, and the shortage of rigs in the UK market may become even more chronic. The consequences of this for both exploration and appraisal activity and marginal development projects are yet to be fully understood. It will also be of concern to business that the Government is not using the internationally accepted doctrine of using arm's length pricing to calculate intercompany charges (raising the question as to whether the Government will take a similar approach in other situations).
It is imperative that the industry establishes and communicates the impact of these proposals for future activity in the UK continental shelf (UKCS), to ensure the Government understands the full economic effect they may have.
Alongside the draft Finance Bill 2014 clauses, the Government published its response to the shale gas consultation (the draft onshore allowance clauses were published on 5 December). One point of note is that there is no intention to define ”capital expenditure” within the legislation. Instead, guidelines will be produced. Since the allowance is calculated as 75% of qualifying capital expenditure it will be key to understand what is to be included. The current indication is that most expenditure of a capital nature will be:
- • Expenditure qualifying for 100% allowances
- • Costs of the site
- • Costs of gaining access to hydrocarbons
- • Costs of restoring capital assets to their original position during production
- • Mid-life plugging and abandonment
The consultation document also confirms that the Government intends to allow the transfer of the onshore allowance between sites after a period of three years after the expenditure has been incurred. It should be noted that an election needs to be made in order to transfer the allowance, and the election cannot be made until the beginning of the fourth accounting period after the period in which the allowance was initially generated. The election then has effect from the commencement of the following accounting period. Therefore, in practice, it may be more than four years after the incurring of the expenditure before the benefit of the allowance can be obtained against income from another site.
Extension of ring fence expenditure supplement for onshore activity
The draft legislation for the ring fence expenditure supplement (RFES) extension consists of a new set of provisions mirroring very closely the existing RFES provisions. While it increases the length of the UK's tax legislation still further, it does appear the clearest way to legislate for the changes. The allocation of profits and losses between onshore and offshore activity is an area where complexity might be expected; the legislation generally takes the approach of allocating any losses between onshore and offshore activity on a ”just and reasonable” basis, while profits are generally assumed to be set off by offshore losses before onshore losses.
Extension of reinvestment relief and substantial shareholding exemption to pre-trading companies
These announcements indicated a very helpful extension to the reinvestment relief and substantial shareholding exemption (SSE) rules, with the intention of encouraging exploration and appraisal activities. The SSE extension is relatively straightforward. However, the reinvestment relief extension has been drafted with a very narrow application. An E&A (exploration and appraisal) company would be able to get the benefit of reinvestment relief, but only if it reinvested the proceeds in E&A activity prior to its trade commencing. It seems both anomalous that a company monetizing its investment in an E&A asset with a view to later developing it would not be able to treat the development expenditure as a qualifying reinvestment, and that a company could monetize its investment in an E&A asset, then incur expenditure on further E&A activities after commencement of trading but have that E&A expenditure excluded from being a qualifying reinvestment. The very restrictive application of this extension appears at odds with the Government's comments in the response to the shale gas consultation.
For additional information with respect to this Alert, please contact the following:
Legal Ernst & Young LLP (United Kingdom), Aberdeen, Scotland
- • Derek Leith
+44 1224 653 246
- • Colin Pearson
+44 1224 653 128
Legal Ernst & Young LLP (United Kingdom), London
- • Neil Strathdee
+44 20 7951 4017
- • Andrew Ogram
+44 20 795 11313
- • Robert Hodges
+44 20 7951 7205
Ernst & Young LLP, UK Tax Desk, New York
- • Matthew Newnes
+1 212 773 5185
- • Sarah Churton
+1 212 773 5994
EYG no. CM4043