Draft UK oil and gas levy legislation clarifies expenditure relief

A draft version of the Energy (Oil and Gas) Profits Levy Bill, recently published for consultation by HM Revenue & Customs (HMRC), contains all the expected detail on how the investment allowance will work, definitions of the financing costs and decommissioning costs that cannot be deducted, interaction with loss provisions and the administrative provisions.

The legislation provides for the levy to cease to apply by 2025. However, it also contains a mechanism for an earlier possible end should there be a movement of energy prices back down to more normal levels.

The temporary levy was announced in May by chancellor of the exchequer Rishi Sunak as part of a package to tackle the rising cost of living in the UK. It increases the headline rate of tax on ‘relevant profits’ from 40% to 65%, subject to an investment allowance intended to “reward those companies who invest in oil and gas production”.

The term “investment allowance” does not appear in the draft bill. Instead, it provides for 80% of any additional investment expenditure to be an “allowable deduction” in calculating levy profits, on top of any existing reliefs for that expenditure.

Investment expenditure is defined in the draft legislation as capital, operating or leasing expenditure that is incurred for the purposes of “oil-related activities”. Expenditure incurred for “disqualifying purposes” is excluded, as are the costs of financing and decommissioning. All of these terms are defined in the draft legislation.

The draft legislation also expressly clarifies the timing of qualifying expenditure, as sought by the industry. For capital expenditure, the rules follow the general capital allowances provisions that treat the expenditure as incurred at the point that the obligation to pay is unconditional, although where there is a gap of more than four months, this is deferred to the actual payment date. Operating and leasing expenditure is treated as incurred on the date that payment is made. Both rules are overridden by any other provision that would treat the expenditure is being incurred either before 26 May 2022 or after 31 December 2025.

Corporate tax expert Jake Landman said that the ‘disqualifying purposes’ rule was affectively an anti-avoidance rule, designed to prevent the deduction of investment expenditure where it arises directly or indirectly in connection with arrangements with a main purpose of securing a levy advantage. However, the provisions as drafted may not incentivise new investment decisions, as intended by the government.

“The combination of the disqualifying purposes provision, which would prevent deductions where obtaining the relief is one of the main purposes of the expenditure, and the time limited nature of the additional expenditure relief, does not entirely fit with the government’s stated intention of driving new investment decisions,” he said. “The decision-making process for new oil-related investment decisions is very long. Therefore the additional expenditure deduction is more likely to apply to expenditure that is already planned or committed.”

The scope of qualifying expenditure in the draft legislation is very broad. There is no obligation for it to be of a capital nature and it includes, among other things, expenditure made for the purposes of increasing the rate or longevity of extraction of oil; and leasing expenditures on a mobile production or storage asset under a lease of at least five years. However, routine maintenance and repair expenditure is expressly excluded, as is leasing expenditure on an asset in relation to which any company has obtained relief either under this provision or investment or cluster area allowances against the supplementary charge.

In addition, expenditure is not qualifying if it relates to ‘recycled’ assets: that is, expenditure that has already been taken into account for the purposes of the levy, or that would have been had the provisions been in force.

Most of the administration of the tax is drawn from the general corporation tax provisions since the levy, like the Supplementary Charge, will be treated as if it were corporation tax. However, Landman said that firms faced additional burdens in respect of calculating the charge, as well as a new obligation to notify HMRC of levy payments made on or before the date on which they are made. These obligations are backed up by penalties for non-compliance.

“Oil and gas companies will need to ensure that this is factored into their compliance processes,” he said.

“It is interesting to note the introduction of the ‘oil and gas’ in the title of the levy. At a recent session of the House of Commons Treasury Committee, on Monday 6 June, the chancellor commented that he was urgently looking at extending the energy profits levy to the extraordinary profits being made in the electricity generation sector. This version of the Bill certainly does not do that, but perhaps it will when it is introduced to parliament,” he said.