In May we reported that the UK government, in its 2013 Budget, had announced a package of measures designed to encourage investment in the UK's shale gas industry. On 19 July the government honored its pledge to publish an "Open Consultation" to solicit the views of the energy community and others on more detailed proposals for tax incentives and other measures aimed at encouraging early investment in UK shale gas exploration and exploitation. The UK government has said the plans would make the UK the "most generous" fiscal regime for shale gas in the world.

Status of UK Shale Gas

The UK is believed to have large resources of shale gas, particularly in the North of England. A recent report from the British Geological Survey (BGS) estimated there may be 1,300 trillion cubic feet of shale gas in the North of England alone. The government believes that shale gas has "huge potential" to transform the UK's energy supply by reducing the UK's growing dependence on imports. However the UK shale gas industry is in its infancy with only a handful of companies holding exploration licences. The UK government recognizes that significant investment is required just to determine how much of the shale gas "in place" is potentially recoverable, and that attracting that investment will require an attractive fiscal and regulatory framework. The BBC reported the Chancellor of the Exchequer (head of the UK's Treasury), George Osbourne, as saying: "We want to create the right conditions for industry to explore and unlock that potential in a way that allows communities to share in the benefits".

Overview of Taxation Proposals

The UK shale gas industry is currently subject to the UK's oil and gas taxation regime. The government acknowledges that this regime fails to recognize both the slower cost of recovery for shale gas projects compared to conventional offshore developments, and that costs are often spread over a much wider area than a traditional oil or gas field.

Therefore, the government has proposed the following two tax incentives:

  • The so-called "pad allowance", tax on a proportion of income generated from producing shale gas would be reduced from 62 percent to 30 percent for the lifetime of the shale well; and
  • The "Ring Fence Expenditure Supplement" for shale gas projects will be extended from six to ten accounting periods.

Pad Allowance

The government notes that as a contrast to conventional oil and gas reserves, shale gas covers large areas with indistinctly defined boundaries. Current allowances in the UK's oil and gas fiscal regime are dependent on the existence of a clearly delineated field, so would not be appropriate for shale reserves. The government is therefore proposing an approach based at the "pad" level, where a pad is the term used to describe the drilling and extraction site.

The pad allowance would operate by exempting a portion of production income from the Supplementary Charge (currently 32 percent), reducing the effective tax rate on that portion from 62 percent to 30 percent at current tax rates.

The amount of production income exempt from the Supplementary Charge (or the "pad allowance") would be a proportion of the capital expenditure incurred in relation to a shale gas pad. For the purposes of the pad allowance, capital expenditure would be limited to expenditure that would attract 100 percent first year capital allowances.

Companies would start to generate and hold an allowance as soon as they incurred capital expenditure on a pad. Costs incurred prior to the effective date of the introduction of the pad allowance would not contribute to the generation of the allowance. This timing delay could slow down current expenditures.

The amount of pad allowance available to offset against profits in any accounting period would be no more than the amount of production income from the pad. Any allowance not used to reduce the Supplementary Charge otherwise payable by a company in a particular accounting period would be carried forward to the next. The restrictions on such carried forward allowances are not clear from the Consultation.

The Consultation does not propose a specific proportion of capital expenditure that would set the level of the allowance but it does indicate that one may be set, given that 100 percent first year capital allowances will be available under the Ring Fenced Corporation Tax regime discussed below.

Extension of Ring Fence Expenditure Supplement

Oil and gas companies in the UK are subject to the Ring Fence Corporation Tax (RFCT). The RFCT is calculated in the same way as the mainstream corporation tax applicable to all companies but with the addition of a 'ring fence' and a different rate of tax. A ring fence prevents taxable profits (or losses) from oil and gas extraction in the UK and UKCS from being reduced by losses (profits) from other activities or by excessive interest payments. The current main rate of tax on ring fence profits, which is set separately from the rate of mainstream corporation tax, is 30 percent whereas it is 23 percent (reducing to 21 percent from April 2014) for other trades.

Tax deductions for capital expenditure on extraction activities is available in most cases on an immediate basis through the UK's capital allowances regime. Thus companies in initial stages of extraction may have substantial tax losses unavailable for set-off against other activities.

The UK government provides support for companies in the oil and gas sector with ring fence losses through the Ring Fence Expenditure Supplement (RFES). RFES allows companies in the ring fence to uplift their losses (or pre-trading expenditure) by ten percent for up to six accounting periods to maintain their time value until they can be offset against future profits of the ring fenced activities. The aim of RFES is to help companies that do not have sufficient taxable income, typically at the start of a project, against which to set their costs and capital allowances.

The government proposes to extend the RFES for shale gas projects from six to ten accounting periods to recognize the longer payback period for shale gas projects. The extension of the RFES will allow companies without existing ring fence profits to maintain the time value of their losses over a longer payback period.

Other Measures

The UK government has also announced plans to give communities that host shale gas sites £100,000 per site, and up to one percent of all revenues from production.

In addition, the government has given guidance on planning rules for shale gas developments, which will reduce the environmental permitting process from 13 weeks to less than two weeks.

Next Steps

The Consultation asks for responses on specific questions as well as general comments, after which the government will publish a summary of responses later in 2013. Where appropriate, the government will propose legislation implementing its fiscal proposals taking account of responses to the Consultation in the Finance Bill 2014, which will be submitted for Parliamentary approval commencing in March or April 2014.

The full Consultation document is available at: