The UK’s oil & gas industry is hotly anticipating the introduction of Transferable Tax History (TTH) to the UKCS taxation regime with effect from November 1, 2018.
The measure is intended to help further the OGA’s principle of “right assets in the right hands” by removing a potential barrier to new entrants. It is important to remember though that TTH will not unlock significant acquisition activity by itself, and the industry will need to remain open to the innovative deal structures which have emerged in the UKCS in recent years.
There has been an emerging trend in the UKCS of smaller, nimble entrants to the basin acquiring late-life, underperforming assets from the oil majors.
These new companies can bring in efficiencies and sometimes cutting-edge technology well-suited to maximising recovery from ageing fields, which is at the forefront of the government strategy for the mature North Sea basin.
However, these same companies are also often the least able to bear costs of decommissioning at the end of the field life.
In addition, access to decommissioning relief on corporation tax (Ring fence corporation tax and the supplementary charge, currently totalling 40%) is predicated on the availability of a history of tax payments against which the decommissioning costs can be set.
The new entrants with no such history thus find themselves in a position where they need to ensure that the acquired asset will generate sufficient tax history over its remaining life to attract the full benefit of tax relief.
The introduction of TTH
TTH is set to alleviate the above concerns and benefit new entrants in the UKCS with little or no tax history of their own acquiring assets from established players in the basin.
In short, it will allow a seller to transfer the benefit of a specified amount of the seller’s tax history to the buyer at the time of an asset deal. The buyer will then be able to carry back decommissioning costs against not only its own tax history, but also that portion of the seller’s tax history.
The ability to transfer tax capacity on an asset deal – the most favoured deal structure in the UKCS – will reduce the risk to smaller companies of carrying out decommissioning without obtaining full tax relief for their costs, and will level the playing field in this respect between them and the established players.
Previously, to obtain the same benefit, a corporate sale would need to be utilised, since the tax history of a target company will stay with it on a share sale. However, a corporate sale is a tricky proposition if the entity in question holds multiple assets and cumbersome to the purchaser for a host of other reasons, including the assumption of all the liabilities of the company.
Asset “hive-downs” preceding a corporate sale have in the past been used to make corporate transactions more palatable, whereby a new company would be set up, the relevant assets transferred to it and such company subsequently sold.
While tax losses can be transferred to the new company on a hive-down (subject to a stringent business continuation requirement), the history of tax payments cannot, thus making it an unattractive option for late-life assets and bringing us back to the benefit of TTH.
The continued importance of deal structures
While the introduction of TTH will be welcomed by many late-life specialist companies, we do not think it should be seen as a “silver bullet” for fixing the challenges of M&A activity in the UKCS.
In the case of a significant number of assets, the maturity of the relevant field is such that even TTH will not make it economic for a new entrant to acquire the asset and assume full decommissioning liability, because the expected return from the field over its remaining life will not generate enough profit to sensibly fund the remaining element of decommissioning costs after netting off the available tax relief.
In light of this, we expect the trend of oil & gas companies using innovative deal structures for mature assets in the UKCS to continue, with the seller retaining all or some decommissioning liability (and thus claiming tax relief in respect of the retained part).
We do not see this as an impediment to transactions, as increasingly there will be benefits for the seller in realising short term value from the sale of the field and re-allocating those resources elsewhere, and by delaying decommissioning spend due to field life extension measures employed by the buyers.
While TTH may not single-handedly help deals with significant value gaps across the line, it is an additional tool in a buyer’s and seller’s toolbox to help close that gap.
Together with innovative structures that are designed to further close the value gap between buyer and seller, to allow buyers to finance transactions, and to address decommissioning liabilities, it promises to open up an exciting chapter in the UKCS history, reallocating assets across the players in the industry in the spirit of MER UK and breathing new life into the M&A market in the North Sea.
Penelope Warne is senior partner, CMS