Upstream oil and gas taxation changes - Energy Profits Levy

Introduction

On 26 May 2022 the Chancellor of the Exchequer, Rishi Sunak, announced a package of measures to provide £15 billion government support to help with rising costs of living.

This package is funded in part through the introduction of a new tax, the Energy Profits Levy (the Levy), which is expected to raise £5 billion over the course of the next year.

Energy Profits Levy

Introduction

Currently, the oil and gas sector is subject to two principal taxes on profits: the 30% Ring Fence Corporation Tax and 10% Supplementary Charge which combine to give a 40% headline rate tax (Petroleum Revenue Tax is set at 0%). This has been the case since Supplementary Charge was reduced from 20% to 10% in 2016.

The Levy will be an additional 25% tax on UK oil and gas profits, yielding a total headline rate of 65%.

The tax will take effect for profits arising on and after 26 May 2022, with legislation expected to be published in advance of the UK Parliament’s summer recess on 21 July. Government has stated that this is a temporary measure that is expected to be phased out no later than 31 December 2025, or sooner “when oil and gas prices return to historically more normal levels” (see Energy Profits Levy – Technical Note).

It is understood that the government will also be considering the position in relation to windfall profits within the electricity generation sector, but no details were announced on this.

Key design elements

Several of the anticipated design elements have been outlined within government technical notes and factsheets, while drafting of the legislation is still in process as at the date of this bulletin, key points are as follows:

• The Levy will apply at a rate of 25% tax on UK oil and gas profits.
• The tax base for this calculation is expected to closely align with that of Ring Fence Corporation Tax with a few notable differences, namely:
  • Finance costs are to be left out of account (akin to the calculation of adjusted ring fence profits which are subject to the Supplementary Charge);
  • Decommissioning costs will not be deductible;
  • A new Investment Allowance will be created which will provide a super-deduction for the purposes of the Levy. Qualifying investment expenditure (which will include capital expenditure as well as some revenue expenditure and leasing costs) will be deductible at a rate of 180%. Unlike the existing investment allowance for supplementary charge purposes, this new allowance will not require ‘activation’ (with relevant income, which can take several years) and will be immediately deductible in the year of spend.  The ‘cut off’ for qualifying expenditure has not yet been confirmed.
• Notably, brought forward Ring Fence Corporation Tax losses will not be relievable in the calculation of the Levy. This could bring many more upstream companies into a tax paying position.
• The new rules come into effect on 26 May 2022, companies with accounting periods that straddle this date will need to apportion their profits accordingly. No additional detail has been provided yet on the manner of this apportionment and whether pro rating will be required or whether other methods of allocation may be acceptable.
• The legislation will contain a sunset clause such that, if oil and gas prices do not reduce in the near-term, the Levy will come to an end on 31 December 2025.
• The Energy Profits Levy will be included in the three-instalment payment regime for large oil and gas companies. However, for accounting periods that straddle 26 May 2022, the entire levy payment for the year is to be made with the final instalment payment.
• As with the Supplementary Charge investment allowance, there are restrictions on the generation of this allowance on assets acquired that have already attracted allowances inside the ring fence regime.
• Unlike the existing Supplementary Charge investment allowance, the new Investment allowance will be capable of creating/increasing a Levy loss.
• Energy Profits Levy losses can be relieved as follows:

i. 12-month carry back against previous levy profits (with the carry back extended to three years for terminal losses);

ii. Carry forward against future levy profits; and

iii. Claimed by another group company against their in-year levy profits.

• Levy losses will not be capable of being used to relieve Ring Fence Corporation Tax/Supplementary Charge or vice versa.

• Additional information will be required within companies’ corporation tax returns to report profits under the Levy and companies will be required to submit information on the Levy payable in respect of that period.

Our view

The announcement will increase the headline tax rate on UK oil and gas companies higher than at any point in the last decade and marks a departure from the principle that the tax burden will fall as the basin matures (as outlined in HMT’s 2014 “Driving Investment” paper to which successive governments have recommitted) and also a potential departure from the principles of the Decommissioning Relief Deeds which sought to provide some certainty on the deductibility of future decommissioning costs.

The new levy also adds complexity for affected companies who will now pay three different taxes on their profits – a tax, a charge and a levy.

Oil and gas companies may question whether the policy delivers on its aim to tax extraordinary profits for a number of reasons, including:

1. Many companies required to pay under the Levy will not have generated any profits over the entire lives of their portfolios to date (due to having incurred significant start-up costs);

2. The Levy will apply to all profits, including those where hedging arrangements have meant that super-profits have been passed to derivative counterparties; and

3. There is, at present, no sign that taxable items not associated with increased commodity prices will be excluded (for instance the receipt of Petroleum Revenue Tax refunds or chargeable gains).

However, it is encouraging that the government has included a significant investment incentive attached to the Levy, and that it has reduced the threat to energy security from early decommissioning by precluding this spend from generating relief.

The government has sought a delicate balance between:

i. Redistributing the benefit of extraordinary profits, which by its reckoning have not been the result of recent changes to risk taking, innovation or efficiency, rather an incidental surge in global commodity prices; and

ii. Safeguarding investment in the UK oil and gas sector. The introduction of further tax incentives on investment will be welcomed by companies that are already investing heavily in UK extraction.

While windfall taxes are rare and can potentially destabilise business confidence, government has been careful to reduce this risk as, although it is immediate, this tax remains prospective. Industry will also welcome the large investment incentive, meaning for every £1 invested in the UK oil and gas activities, over 91p will be received in tax relief across the three taxes, enabling industry to fulfil its intentions to invest in and secure vital energy supplies in the UK over the coming years.

Companies affected will now need to evaluate the impact of the proposed Levy on their portfolios and future spending plans, as well any impact on relevant decommissioning security arrangements.