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'Pragmatic' solution needed to decommissioning tax relief if North Sea production is not to be stifled, says expert

The UK government must find a "pragmatic solution" to the tax issues that are hampering the sale of some late-life oil and gas assets in the North Sea, an expert has said.

Energy law expert Bob Ruddiman of Pinsent Masons, the law firm behind Out-Law.com, said that if the issue of decommissioning tax relief is not tackled now it could stifle production.

Ruddiman was commenting as the UK government published a new discussion paper on the tax treatment of late-life oil and gas assets (29-page / 334KB PDF). The Treasury used the paper to outline some of the concerns industry has raised about tax issues and how they impact on trade of, and investment in, late-life assets, including how the cost of decommissioning and the associated system of tax reliefs affects negotiations on sale.

In its paper, the Treasury said it wants to encourage investment in mature oil and gas assets and would potentially consider changing UK tax legislation or guidance to support the transfer of those assets to willing investors, but that it wants to ensure a "fair return" for the taxpayer.

According to the Treasury's paper, while some late-life assets have been traded in recent months, some within the industry believe more of those deals are necessary to "maximise economic recovery" of the estimated 10 to 20 billion barrels oil still available in the UK Continental Shelf (UKCS).

One of the issues highlighted in the paper was the concern among some in industry about the "value gap" that exists between new entrants to the market wishing to buy late-life oil and gas assets and operators selling those assets.

The value gap exists, in part, because new entrants may not be eligible for tax reliefs for decommissioning of assets, whereas long-standing operators may have the "tax history" necessary to raise a claim for such relief, the paper said. This factor, among others, means buyers and sellers can put different valuations on late-life assets and serves as a potential barrier to deals being concluded which would see investment in those assets to extend their life and use for recovering oil and gas from the UKCS, it said.

A "transferable tax history" is one of the changes to UK tax treatment that some within industry wish to see. According to the government's discussion paper, "this would permit a seller to transfer a portion of their ring fence corporation tax payment history to the buyer, alongside the asset as part of the deal".

However, the government said it could be difficult to determine transferred tax history for an asset and that it is also concerned that that tax history would be "treated as a tradeable commodity" unless restrictions were applied.

The government said that further issues also arise, including potential new administrative requirements for operators and HM Revenue and Customs (HMRC). Further questions on how any "premium" obtained by sellers for the transfer of assets' tax history should be taxed, and when buyers should be able to utilise the transferred tax history (TTH) would also need to be addressed.

"If TTH was introduced, it would need to be decided if the tax history generated by the asset following the acquisition could be utilised before the TTH, or the TTH could be set against the decommissioning costs without regard to the profits earned by the asset," the government said. "Alternatively, the decommissioning cost could be set against the buyer’s total post-acquisition tax history, which would include profits from the buyer’s other oil assets."

"Allowing the buyer to use the TTH before post acquisition profits would be simple to model and would give certainty to the buyer that they would be able to utilise the TTH. However, it would be a significant departure from how decommissioning losses are used against normal tax history (on a LIFO basis against total tax history) and could create additional costs for the taxpayer. In particular, prioritising TTH use would 'lock in' the value of the tax history at the tax rate for the years that the TTH was transferred from. This would mean the tax repayment could be at a higher tax rate than the tax rate a normal carry back of losses would receive," it said.

A panel of industry experts has been established by the government to offer a collective view on the tax issues raised in the discussion paper. Industry as a whole has until 30 June 2017 to submit responses to the paper. The government said it would take the feedback into account when deciding on whether to make changes to UK tax rules.

Energy law expert Bob Ruddiman of Pinsent Masons, the law firm behind Out-Law.com, said that if the issue of decommissioning tax relief is not tackled now it could stifle production in the North Sea.

"Historically, vendors of assets typically sought to pass the decommissioning liability to the new owner and to have themselves removed from the statutory requirement to be responsible for decommissioning," Ruddiman said. "There is, however, a new breed of operator who, aided by improved technologies, are better placed to extract difficult-to-access oil and gas reserves, but there are several blockages which have deterred asset acquisition from the large majors."

"One sticking point is that a complex ownership history of mature assets – with tax breaks allocated to those previous owners and the current operator – offers little encouragement to new entrants to the UKCS who will not benefit from tax concessions and fear being landed with the eventual decommissioning burden. The reality is we are now living in a lower-for-longer or lower-for-ever world, depending on where you sit on the Brent oil price spectrum, and with that has come a greater realisation that the existing owners might need to retain a degree of responsibility for the decommissioning," he said.

"The view I put forward to the Treasury, as one of a number of industry contributors, is that while there will be a natural desire to create a perfect solution that tracks down every pound of tax relief allocated to date to North Sea assets, that is probably not going to be possible and there is a need to find a pragmatic solution. That solution may need a change in mind-set with UKplc taking the view that decommissioning relief will unlikely be a perfect match between asset and owner, that the government has already had the benefit of the tax paid in respect of these mature assets, and that bridges have to be built to allow the North Sea to see out its days," Ruddiman said. 

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