EY’s Derek Leith explains why it is unlikely we will see any further changes to the North Sea fiscal regime in the Autumn Statement 2016. However, the oil and gas industry will have huge interest in what the Chancellor has to say on the many other pressing issues affecting the wider economy.
With significant changes made in the last two Budgets, there is unlikely to be much enthusiasm within government for further reductions.
Arguably the supplementary charge rate could be reduced further, perhaps even to 0%. Such a change would reflect the view that “super-profits” do not exist in the UKCS in the current environment or at this stage of the basin’s maturity.
However, the investment allowance was introduced with great fanfare only last year, and has a positive incentive effect for companies investing in the UKCS. It is perhaps unlikely that government would wish to effectively repeal the investment allowance just a year later, and it is not clear a reduction in supplementary charge would bring about the level of investment needed to justify it.
Tax incentives for exploration are often mooted as a solution, with envious glances in the direction of Norway’s exploration tax credit – which guarantees a tax refund of 78% of the qualifying exploration cost. However, the substantial structural difference between the tax rates applying to UK and Norwegian activity suggests an exploration tax credit would have much less effect in the UK than in Norway.
It is more realistic to ask whether investment allowance could more effectively incentivise exploration. As things stand, outside of “clusters” determined by the regulator, investment
allowance is only given on successful exploration; as the allowance has to be activated by production income from the relevant field, unsuccessful exploration will never benefit.
It would take little effort to amend this position so as to allow investment allowance on exploration to be activated by income from another field – this would end the oddity that the availability of the incentive is determined by the outcome of the activity rather than the activity itself – although this could be seen as playing at the fringes.
Changes to the tax system are unlikely to create a wave of developments in the short-term; one could say that between 100% first year allowances for most capex and the investment allowance, the tax system is already quite conducive to encouraging development expenditure. Harnessing the benefits of new technology and locking in reduced costs in the supply chain are likely to have a more meaningful impact on getting new developments across the line.
At the other end of the cycle, decommissioning has been a major consideration for some time, and has only been exacerbated by the downturn in the oil price. Managing the liability effectively, and at a minimal cost through ongoing security arrangements, is critical to the outcome the industry will ultimately achieve.
However it is also capable of being one of the major stumbling blocks in late-life asset transactions, from both a commercial perspective and a tax one. While Budget 2016 brought some certainty in relation to a seller’s ability to get tax relief for decommissioning obligations retained on an asset disposal, it hasn’t necessarily resolved all issues.
For example, transactions where sellers want to get a clean break from an asset, but the buyer may not generate sufficient taxable profits from the asset to absorb the decommissioning expenditure and get effective relief remain problematic.
HM Treasury is consulting informally to try and establish whether this issue is causing market failure, and it would be premature to expect any changes to be announced at the Autumn Statement.
Derek Leith, is an EY Partner and head of Oil and Gas Taxation