The Oil and Gas related provisions in the draft 2014 Finance Bill (published last week) continue on the whole to demonstrate Government's commitment to the sector. Following years of mounting criticism by industry over Government's perceived opportunistic and perhaps short term approach to the industry as a source of taxation, a more coherent and cooperative approach has emerged. This attempts to take into account industry's concerns, and appears attuned to the importance of both new field development opportunities, and the economics of continued production in the case of existing licences. The approach is wider in scope than merely focussing on the tax system – by way of example for a review of other recent developments relating to both offshore oil and gas production and shale gas exploration see our previous Bulletins which can be found here and here. But importantly it also involves fine tuning of the tax system (usually in the form of allowances and other tax incentives) to ensure projects remain economic. Success here, which will have to be measured over years and may be decades, should deliver optimal returns to industry, the public sector, and the economy as a whole.
With these comments in mind, the 2014 Finance Bill measures include important tax incentives for non-conventional Oil and Gas exploration and production on shore (this primarily means shale gas). More detailed provisions are aimed at simplifying M&A transactions, by extending reliefs usually available only once production has commenced to the pre-trading phase as well.
Another clear theme of the draft Finance Bill 2014, in line with the approach in recent years, focuses on closing down avoidance opportunities. These are identified, not just by the UK Government, as eroding the tax base and leading to companies not paying their "fair share of tax". In this context the OECD Base Erosion Profit Shifting (BEPS) project, as well as other forums, have highlighted the concern that fundamental principles of domestic and international taxation may have to be revisited, including concepts such as the meaning of permanent establishment, and the principles of transfer pricing. It is interesting to observe in this context that the UK Government may have begun already its own review of such concepts – at least in the context of the taxation of Oil and Gas activities. The Finance Act 2013 contains provisions which restrict allowances in the context of decommissioning services supplied by a connected party to a cost plus 10% amount. There is no longer therefore reliance on familiar arm's length principles, or more sophisticated transfer pricing concepts, but instead the fixing of margins at a given level. The draft Finance Bill 2014 echoes a similar approach in the context of the provisions restricting deductions for intra group leasing payments, by introducing fixed caps. It remains to be seen whether such measures will achieve their goal of preventing abuse, as opposed to creating distortions in the market, if the tax system gives preferential treatment when contracting with non-group companies. Again assessment of success or otherwise will require the hindsight of several years.
The rest of this Bulletin provides a short summary of the relevant provisions in the draft Finance Bill 2014, some of which are still subject to formal consultation.
Shale gas or “pad” allowances
A new onshore allowance known also as the “pad allowance”, reflects Government's commitment to providing incentives for the development of shale gas in the UK.
The pad allowance will have effect for capital expenditure incurred on and after 5 December 2013. The measure is designed to support the early exploration, appraisal and development of onshore oil and gas projects which are economic but not commercially viable at the current tax rates. It will cover onshore conventional and unconventional hydrocarbons (including shale gas).
The broad effect of the allowance will be to reduce the amount of adjusted ring fence profits which are subject to the supplementary charge (currently levied at 32%), resulting in an effective tax rate on production of 30% (instead of 62%). The portion of profits reduced by the allowance will be dependent on a company’s capital spend on onshore oil and gas projects and will broadly be an amount equal to 75% of capital expenditure incurred by a qualifying company.
The allowance will not be available for onshore projects which have already received development consent. New onshore oil and gas fields will be removed from the scope of existing field allowances. Transitional arrangements will be put in place for companies currently developing projects.
Ring fenced expenditure supplement
The draft Finance Bill 2014 contains provisions to extend the number of accounting periods a company can claim Ring Fence Expenditure Supplement (RFES), which is available currently at the rate of 10% in relation to qualifying expenditure or losses on onshore oil and gas activity from 6 years to 10 years. These changes will apply to losses or qualifying pre-commencement expenditure arising or incurred on or after 5 December 2013.
Extension of the substantial shareholding exemption
Measures are proposed to extend the scope of the substantial shareholding exemption (SSE), which allows disposals of shareholdings in trading companies to be effected free of corporation tax on chargeable gains.
One of several conditions that needs to be satisfied for the SSE to apply is that the disposing company must have held a substantial shareholding in the target company for a 12 month period in the two years prior to disposal. Finance Act 2011 introduced a number of measures to facilitate pre sale hive downs of trading assets into new special purpose vehicles shortly before the sale of such special purpose vehicles. One of these changes relaxed the "12 month" requirement, by deeming shares held in a subsidiary as held for 12 months (whether or not this is actually the case), where the subsidiary acquires intra group assets from another group company, and the latter has used the assets for the purposes of a trade for more than 12 months. Therefore, when determining whether the relaxation applies, a key factual question will be whether the transferred assets were used for the purposes of a trade.
The draft Finance Bill 2014 proposals provide that a "trade" for these purposes includes oil and gas exploration and appraisal activities, so actual production activities are no longer required. This therefore extends the SSE relief to pre-production activities, and should facilitate tax neutrality in the context of licence sales at the appraisal and exploration phase.
The measure will take effect for disposals occurring on or after the date that the Finance Bill 2014 receives Royal Assent (so likely to be around July 2014).
Offshore employment intermediaries regime
Under the offshore employment intermediaries rules, HMRC will hold offshore employers responsible for accounting for the pay as you earn (PAYE) and national insurance contributions (NICs) liabilities of any workers the employer places in the UK. If the offshore employer defaults on its NICs and PAYE liabilities HMRC could pursue any intermediary businesses, and ultimately the end user. HMRC will also require intermediaries to file quarterly tax returns detailing information about all the workers that are employed offshore, who they place or engage. Where there is no intermediary, the reporting obligations will fall on the end user of the labour.
In October 2013, HMRC confirmed that it would introduce a modified version of the rules to cater for the complex employment / contractor structures that apply in the oil and gas sector. Where the offshore employer has an associated company, body or agency based in the UK, then that entity will be responsible for accounting for the NICs and PAYE of its offshore associate. Where the offshore employer does not have an associated company in the UK then the oil field licensee(s) will be responsible for accounting for the tax and NICs. The latter scenario is subject to a certification scheme available in the case of "compliant" offshore employers. Whilst a certificate is in place it will remove HMRC’s ability to enforce any unpaid PAYE and NICs against the licensee(s). HMRC may revoke the certificate at any time.
The new regime is expected to come into force on 6 April 2014.
New CGT exemption
The draft Finance Bill 2014 introduces a new form of reinvestment relief.
By way of recap, sections 152 and 154 Taxation of Chargeable Gains 1992 (TCGA) provide rollover relief where trading assets are disposed of and the disposal proceeds are reinvested in other trading assets (in each case provided that the assets fall within specified categories). The relief acts as a deferral, as any gain on the relevant disposal is in effect rolled over into the new asset and so only "crystallised" on the disposal of that new asset.
A more generous form of reinvestment relief is available at section 198 TCGA for companies with ring fence oil and gas trades which make a disposal of assets used in the ring fence trade, and use the proceeds to acquire such new assets. Where the section 198 TCGA relief applies, the gain is wholly exempted from charge (there being no rollover or deferral). Changes introduced in Finance Act 2011 confirmed that exploration, appraisal and development expenditure incurred in the course of a ring fence trade is to be treated as the acquisition of assets for purpose of the relief.
The draft Finance Bill 2014 proposals introduce a new form of reinvestment relief for companies carrying on pre trading oil and gas exploration and appraisal, i.e. companies which do not yet have a ring fence trade (because generally a ring fence trade does not commence until production), and so would not benefit from the existing reinvestment relief provisions. Broadly, disposals and acquisitions in the course of oil and gas exploration and appraisal activities (by a company that does not have a ring fence trade) will qualify for the new relief, which like section 198 TCGA provides a full exemption from gains on the disposal of relevant assets.
This measure will likely take effect for disposals made on or after the date that the Finance Bill 2014 receives Royal Assent (so likely to be around July 2014).
Cap on certain intra group leasing payments
Finally, several new measures relating to the tax treatment of leasing oil and gas equipment, primarily drilling rigs (so called "bareboat charters") have been proposed. These are aimed at preventing offshore contractors who lease equipment to oil and gas operators from using associate companies in tax havens to minimise their UK tax bill.
The first proposal is that the amount of relief for such intra group leasing payments be capped by reference to a percentage (proposed to be 4%) of historic capital cost of the asset the subject of the lease, together with an amount to represent the financing costs of newer assets (proposed to be 5% of half of the original cost).
The second proposal impacts in the recipients of such leasing payments. The proposal is to create a new "ring fence" for profits generated by these leasing activities. The profits within this ring fence would be taxed at normal corporation tax rates but those profits will no longer be able to be reduced by other tax reliefs derived from activity outside the UK Continental Shelf.
Details of both of these measures have not yet been provided: draft legislation is not expected until January 2014. There will also be a consultation on the measures early next year.