Budgets come and go with monotonous regularity, and in recent years companies with UK oil and gas exploration and production activities have experienced frequent, unexpected and unwarranted tax increases.
Thankfully, budget 2013 held no such surprises and in contrast demonstrated that rarest of qualities – it contained measures which will be good for the oil and gas sector and for UK plc.
After two years of engagement between the Government and oil & gas industry – led by Oil & Gas UK (OGUK) and supported by Ernst & Young – the Chancellor’s 2013 Budget confirmed oil and gas companies will be able to enter into contracts with Government during 2013 such that decommissioning tax relief will be guaranteed at specific levels.
In essence, where a company has to bear someone else’s share of decommissioning expenditure, for example as a consequence of another party’s default, they will be guaranteed tax relief at a minimum level of 50% (the prevailing ring fence corporation tax and supplementary charge rates for decommissioning expenditure), plus for pre-1993 fields petroleum revenue tax (PRT) relief equivalent to what the defaulter would have achieved.
The result is that companies will be able to accept post tax security for decommissioning and concerns about the future abolition of PRT where a company is anticipating a repayment on decommissioning have been completely removed.
The change in the quantum of decommissioning security required should enable more licence interests to change hands, the freeing up of capital, and much greater investment in the UK Continental Shelf (UKCS).
Ancillary benefits are that companies are also protected, even where there is not a default, from any future erosion in the base of expenditure which qualifies for decommissioning relief; and various inconsistencies or gaps in the tax legislation governing decommissioning tax relief have been rectified.
Inevitably, there is still a huge amount of complexity to deal with as claims for relief have to be made under the tax code before they are claimed under the Decommissioning Relief Deed (the contract that each company will sign with government); and the rate of PRT relief that can be assumed in a Decommissioning Security Arrangement will usually not be a straightforward calculation.
The Deed itself is a very detailed document as it has to clearly set out the underlying policy around claims and payments, prevent any possibility of double claims and protect government against any abuse in the same manner that the tax code would operate.
On the other hand, it needs to provide enough certainty to the company signatory to enable it to accept post tax security. This has been a difficult balance to strike.
There is likely to be some further fine tuning of the legislation and the Deed between now and the Finance Act but the bulk of the work has been done, and the result is a very good one for industry and the Exchequer.
In addition to the decommissioning changes, at the time of writing, we still await secondary legislation on the Brown Field Allowance, or additionally developed oil fields to give it its proper legislative title, which is a significant step forward in incentivising incremental investment in existing fields and should lead to greater reserve recovery and increase the longevity of infrastructure.
Turning to the much discussed topic of shale gas, the Budget included an announcement that Finance Bill 2014 will see legislation introducing field allowances for shale gas production as well as an extension of Ring Fence Expenditure Supplement (RFES) for such expenditure.
The fine detail of these provisions will be worked out between industry and government over the course of the remainder of this year. On the face of it the proposals will be embraced by the oil and gas industry as they will allow the costs of exploration and development of shale gas deposits to be relieved at a rate of 62%, but will provide for a lower effective tax rate on production.
For companies who can’t get up-front relief as they do not pay tax at present the extension to RFES will be welcome, but not as well received as a tax credit would be.
Given the fact that tax rates are not the only impediment that the embryonic UK shale gas industry has to overcome, the Government has also committed to having a clear and effective planning application process in place by the end of the year. Indeed it is committed to defining the objectives, remit and responsibilities of the new Office of Unconventional Gas and Oil. Both these steps will be welcomed by those with ambition to see the potential of shale gas being realised in the UK.
Outside of the upstream sector the Budget continues in the theme of Britain being open for business.
Derek Leith is a senior partner at Ernst & Young