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Welcome to the European Tax Blog.

Some of Europe's brightest legal minds look at the tax issues across Europe which could impact multinational businesses.

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Taxing oil and gas: a new tax and an investment incentive

The introduction of the “Energy Profits Levy” announced by the UK Chancellor on 26 May 2022 to take effect from the same date would appear to reverse the trend to reduce tax rates and increase incentives for investment as the North Sea oil and gas industry reaches a mature stage. The Levy will be charged at a rate of 25% on the profits of oil and gas companies from upstream activity in the UK and on the UK Continental Shelf, taking the total rate of tax on such profits to 65%, and could impact transactions that were signed before the commencement date impacted, particularly where they include contingent payment arrangements linked to future commodity prices or performance that will now see profits taxed at a higher rate.

To a degree, the Levy’s impact has been balanced by the inclusion of a new allowance (available from the point of expenditure) which is designed to incentivise investment. The investment allowance will entitle oil and gas companies to an 80% tax deduction on investment expenditure in the UK North Sea and will be available to reduce extraordinary profits subject to the new Levy. This blog post provides an overview of both aspects of the measure based on the information published by the UK Government – see in particular this policy paper and technical note; draft legislation is not yet available.

Energy Profits Levy: commencement, scope and operation

The Levy will apply to profits arising from 26 May 2022. It will be legislated for through a standalone Bill, which the Government will likely introduce soon after Parliament returns from recess on 7 June. Companies with accounting periods straddling that date will need to apportion their profits. In future years, if oil and gas prices return to historically more normal levels, the Government will phase out the Energy Profits Levy. The Bill will also include a sunset clause, removing the tax after 31 December 2025.

By way of scope, the new Levy will not apply to the electricity generation sector. However, the Government intends to reform the existing pricing regime to reflect the costs of electricity production, rather than being pinned to gas prices as part of its Review of Electricity Market Arrangements in Great Britain.

The Levy will apply to a company’s “ring fence profits”, computed with a number of adjustments: finance costs will be disallowed (as is currently the case for Supplementary Charge), as will decommissioning costs. It will be charged as if it were an amount of corporation tax.

The Levy will be included in the three instalment payment regime for large companies; for accounting periods that straddle the commencement day, however, the Levy payment for that straddling period will be made in the final instalment payment.

Investment allowance and loss relief

A “super-deduction” style investment allowance will also be introduced as part of the measures announced on 26 May. This will be generated on investment expenditure (consisting of capital expenditure and some operating and leasing expenditure) at 80%, which can be immediately used to reduce extraordinary profits subject to the Levy. Combined with the reliefs available under the existing regime, this nearly doubles total tax relief on investment - meaning that, for every £1 invested, a company will receive 91p in tax relief. Therefore, the more that a company invests, the less tax it will pay.

This will be available to companies at the point of investment, rather than once income is received from the field subject to the investment, in contrast to the equivalent allowance for Supplementary Charge. As with the Supplementary Charge investment allowance, there will be restrictions on the generation of allowances on the acquisition of assets that have already received allowances in the ring fence.

Losses not fully utilised against Levy profits in the current period may be carried back against up to 12 months of Levy profits (or 3 years in the case of terminal losses) or carried forward to set against future Levy profits; alternatively, they may be surrendered by way of group relief in-year to another company in the group with Levy profits. However, such losses cannot be used against Ring Fence Corporation Tax or Supplementary Charge profits; likewise, Ring Fence Corporation Tax losses cannot be used to reduce profits subject to the Levy. Historic losses cannot be carried forward into the new Levy regime, ensuring they do not reduce Levy profits.

Separately, but importantly for groups with significant existing carried forward losses, loss relief for Ring Fence Corporation Tax and Supplementary Charge remains unchanged.

This post was co-authored by Kyle O'Sullivan.

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