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Mairi Massey PwC UK
Mairi Massey is Energy Tax Director at PwC UK
The United Kingdom HM Treasury has opened a consultation on the proposed tax treatments of late-life oil and gas assets; a positive move for all stakeholders involved.
The U.K. Continental Shelf (“UKCS”) is currently in a perceived decline, with many fields reaching the end of life, and exploration at an all-time low. Coupled with a sustained period of low oil price, the government's aim of Maximising Economic Recovery (“MER”) from the basin is a challenging one.
Field operators and their joint venture partners have recorded significant impairments against the value of their assets, caused by the drop in oil price, and have been striving to accurately estimate the cost of decommissioning. The reduction in value/price has of course stimulated Merger & Acquisition (“M&A”) transactions, and prompted larger players to engage in divestment programs, with decommissioning never far from the headline deal announcements.
A recent example is the sale by Shell of a significant bundle of assets to Chrysaor for around $3.8 billion. Decommissioning estimates for these assets is some US$3.9 billion, with Shell retaining responsibility for the first $1 billion of decom spend, and Chrysaor picking up the tab on costs above $1 billion. Similarly, last year's acquisition of E.ON's UKCS assets by Premier Oil plc for $135 million saw the parties agree to share the decommissioning costs relating to Ravenspurn North and Johnston fields. Premier also stated that the acquisition included historic tax paid of $250 million which could be accessed on decommissioning.
Against this backdrop, the consultation document released by HM Treasury (“HMT”) in March 2017 has put a formal framework around tax and late-life asset transaction discussions which industry, advisers, HMT and HM Revenue & Customs (“HMRC”) had been having for many months.
Agreeing up front who deals with the burden of decom costs is clearly key to any deal, as is a deep understanding of the tax rules around it.
In simple terms, oil companies do not get tax relief for decommissioning until they actually incur expenditure. So those large accounting provisions you see in their financial statements haven't actually had an impact on the cash tax position. Essentially, tax has been (and for some, still is) paid on what is arguably an inflated profit. This tax paid creates “tax history”.
When an oil company then starts a decommissioning program, it will typically generate tax losses as the decom expenditure is tax-deductible. These losses can be carried back for many years against its Corporation Tax and Supplement Charge tax history, generating refunds which are in many cases very significant.
If they were then to sell oil fields, the tax history does not transfer with the asset—instead it remains with the seller and may never be realized (a notable exception is Petroleum Revenue Tax (“PRT”) which is attached to oil fields and hence has different treatment)).
The issue is that often the value gap is too great—the seller has tax history and buyers can't create tax capacity, for example, so often sellers can't realize value and a sale falls through. Making this a more level playing field would allow more deals to happen.
HMT's consultation attempts to deal with this value gap by proposing a system where a company's tax history would be attributed somehow to its assets, thus each field interest would carry a transferable tax history (“TTH”). HMT proposes that on a sale, the buyer could acquire the TTH relevant to the assets acquired. This would allow the buyer to incur decommissioning costs, carry back resulting losses and achieve tax refunds almost as if the expenditure was being incurred by the seller.
This idea is in principle a good one—but like all good ideas, HMT realize a number of technical issues will arise and have asked for views to help address these.
Our initial assessment is that the issues identified by HMT are indeed very complex. To achieve a reasonable estimate of TTH per field, and to utilize effectively in future will require burdensome administration for both seller and buyer.
HMT may want to consider a simpler, more pragmatic solution to all of this. Most companies are anticipating refunds at historic tax rates of 40–50 percent. If HMT could agree to a blanket refund at say 40 percent on transferred assets, then the administrative aspects would be much simpler for buyers and for HMRC. However there would be winners and losers so this approach is likely to be more controversial.
The consultation document also asks for comments on decommissioning for PRT fields (note PRT was applicable for fields obtaining development consent prior to March 24, 1993). Currently, a seller retaining decommissioning responsibility would need to remain on the field license (typically a tiny percentage share) otherwise it would not be able to carry back its losses and consequently would not be able to access a refund of PRT history. Similar to the discussion on TTH, a more pragmatic approach might solve this problem.
In recent years, we've seen a number of deals stalled by concerns over unquantified decommissioning liabilities. The UKCS is the first basin where this issue is coming to the fore and it's becoming a more relevant deal issue, with sellers seeking to optimize their portfolios and strengthen their balance sheet by offloading late life non-core assets, and buyers wanting to mitigate exposure to increasing costs of decommissioning and short-term cash outflows.
The consultation also mentions losses. There is a swathe of anti-avoidance legislation to prevent tax avoidance using losses as a result of transfer of business. Some of this legislation arguably uses a sledgehammer to crack a nut and is impacting genuine commercial deals. HMRC will obviously be concerned to review whether the legislation needs to be relaxed.
In summary, it is a really positive move that HMT are seeking views on these issues from stakeholders. What is more difficult is avoiding additional complexity in our tax regime—more pragmatic solutions are possible as outlined above.
HMT need to hear from as many affected companies as possible to gain a better picture of winners and losers, and to more accurately assess the impact of the issues and proposals described.
We will be responding to the condoc—will you?
Mairi Massey is Energy Tax Director at PwC UK
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