Decommissioning remains a big consideration for any investor in the UKCS and, indeed, anyone divesting their interests. This is especially the case where the interests in licences which are changing hands are mature assets with a significant number of wells and attendant infrastructure.
It’s not surprising, given its significance, that the tax treatment of decommissioning expenditure has been the subject of much debate in recent years, and given rise to more than a few misconceptions.
For decades it has been understood that the UK levies tax on oil and gas companies on the profits of their UK and UKCS oil and gas production activities, without any ability to offset expenses or losses from other activities – referred to as the “Ring Fence”.
Of course, the general framework of corporation tax doesn’t provide that tax is charged on the accounting profits per se, but the difference between accounting profits and taxable profits may most often only be timing differences.
For example, tangible assets will be depreciated for accounting purposes at a certain rate whereas the tax code provides for tax depreciation on qualifying capital expenditure at a different rate.
For oil and gas companies one of the most significant, and extreme, timing differences is on decommissioning. Such companies are required to create Asset Retirement Obligations which ensure that the estimated decommissioning cost for a field is fully provided on the balance sheet of the company by the time it comes to decommission the field.
The Ring Fence tax provisions do not provide for a deduction of the cost of the Asset Retirement Obligation as the cost is charged to the income statement but only when the actual decommissioning costs are incurred in abandoning the wells and infrastructure.
Therein lies a misconception of the UKCS oil and gas tax regime, namely that the government is providing a subsidy to the oil and gas industry in giving tax relief on decommissioning expenditure. This claim is given greater force because decommissioning expenditure is so significant it can create a trading loss and give rise to a repayment of tax.
In truth, it is a consequence of the design of the Ring Fence tax regime that companies pay tax on profits greater than their actual profits during field life, but then receive the previously denied tax relief on decommissioning at the end of field life. In effect the companies have made a loan to the government in relation to the tax relief on decommissioning expenditure and that loan is repaid when the decommissioning takes place.
It’s a shame to spoil a good story with facts, but decommissioning tax relief is not and never has been a subsidy. Moreover, any future government who wishes to retroactively deny tax relief on decommissioning will find that the provisions of the
Decommissioning Relief Deed, introduced in 2013, ensure that oil and gas companies are protected against such legislation.
Derek Leith is EY global oil and gas tax leader