Pressure on the Government to take action on the cost of living crisis led to the announcement of a new “temporary” and “targeted” tax on certain oil and gas profits arising from 26 May 2022. A draft Energy (Oil and Gas) Profits Levy Bill (the “Bill”) to introduce this new tax and an associated new investment allowance (although the Bill does not describe it as such) was published on 21 June 2022 for comments by 28 June 2022 – clearly, a very short consultation timeframe.
The Energy (Oil and Gas) Profits Levy (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%. It will be charged “as if it were an amount of corporation tax” so it can slot into the existing corporation tax administration framework.
The Levy is expected to raise around £5bn over the first year which will go towards the new cost of living measures which the Chancellor also announced on 26 May 2022. The Bill does not, however, include any mechanism (such as a power to change the Levy rate) to ensure that these expected revenues are actually raised. So, it appears that the rate and parameters of the Levy are fixed, regardless of how much revenue is raised.
As expected, the Bill draws on the provisions in Chapter 6 of Part 8 of the Corporation Tax Act 2010 on the Supplementary Charge. There are, however, certain key differences, in particular in respect of the tax base for the Supplementary Charge and the Levy.
How is a time-limited application of the Levy ensured?
The Levy will apply in respect of corporation tax accounting periods which begin on or after 26 May 2022 and end on or before 31 December 2025. These are referred to as “qualifying accounting periods”. An accounting period which straddles either of these dates is broken into two separate periods with only the part within these dates counting as a qualifying accounting period. There are rules for apportioning profit or loss to the separate accounting periods which straddle the commencement or end date.
In this way, the Bill includes the expected sunset provision of 31 December 2025. The original announcement had indicated that the Levy could be phased out earlier “if oil and gas prices return to historically more normal levels”. This indication is repeated in the draft explanatory note, but the Bill does not include any provision in this respect. It neither requires nor empowers the Government to phase out the Levy in such circumstances – which is not surprising given that the concept itself is vague and, with pricing having fluctuated quite widely over time, it is not clear how far back prices should be compared. This means that, regardless of any changes in oil and gas prices, the Levy would not end before 31 December 2025, unless the Government brought forward amending legislation in the future.
Which profits are subject to the Levy and how does the new investment allowance work?
The Levy will apply to the “levy profits” for a qualifying accounting period. Levy profits are based on the company’s ring fence profits or losses subject to certain adjustments. Importantly, these adjustments overlap with the adjustments made for the purposes of the Supplementary Charge – in both cases financing costs are left out of account – but they are not the same (decommissioning costs, in particular, are treated differently).
The new investment allowance is implemented as one such adjustment. If a company has incurred expenditure that meets certain conditions, it will be treated as having incurred an additional amount of expenditure equal to 80% of the amount invested, and this additional expenditure is allowable in full as a deduction in calculating the levy profits. The conditions are that the expenditure must:
- be capital expenditure, operating expenditure or leasing expenditure;
- be incurred for the purposes of oil-related activities, and not incurred for disqualifying purposes (see below discussion of the anti-avoidance provisions); and
- not consist of financing or decommissioning costs.
A just and reasonable apportionment is required in certain circumstances, for example, if investment expenditure is incurred partly for oil-related purposes and partly for other purposes or where only part is operating expenditure, or only part is leasing expenditure.
When a company is treated as having incurred investment expenditure for these purposes depends on the type of the expenditure. In relation to capital expenditure, this is determined in accordance with section 5 of the Capital Allowances Act 2001 under which the general rule is that the expenditure is treated as incurred as soon as there is an unconditional obligation to pay it. This general rule is, however, subject to certain exceptions. If, for instance, the expenditure is not required to be paid until a date more than 4 months after the unconditional obligation to pay has come into being, the expenditure is to be treated as incurred on the payment date. Operating expenditure or leasing expenditure are treated as incurred on the day on which they are paid. These rules are subject to an override that, if the expenditure had otherwise been treated as incurred before 26 May 2022 or after 31 December 2025, it is treated as not having been incurred in a qualifying accounting period.
Overall, this means that the investment allowance may not be as generous as it appeared when the measure was first announced, and it is questionable whether it really works as an incentive for new investment. Given the long lead time for a lot of oil and gas projects, in practice, the investment allowance will likely benefit only those projects that are ready for final approval in a fairly limited window and not those sanctioned between now and the end of 2025 where a material part of the expenditure will not be incurred for the purposes of the legislation until after 2025.
Is there any incentive for green investments?
Not under this measure. In order to qualify as investment expenditure, the investment must be incurred for the purposes of oil-related activities. So any expenditure on renewables or green energy would not reduce the amount of the Levy chargeable.
How much of a compliance burden will the Levy be?
Often when there is a new tax (and there have been many in recent years) the bulk of the legislation is taken up with all the administrative and mechanical provisions necessary to collect the tax. This is certainly the case with the lengthy legislation for the plastic packaging tax. In this case, however, by treating the Levy as if it were an amount of corporation tax, the Levy can piggyback on the existing framework for the administration of corporation tax, including the instalment payments regime for large companies, with certain modifications. This will ease the compliance burden for both business and HMRC – both of whom will already be familiar with the administration of the Supplementary Charge which is also charged “as if it were an amount of corporation tax”.
Affected businesses will, however, have to gather the data and undertake the necessary computations to work out the Levy. There is also a requirement to notify HMRC of Levy payments made on or before the date on which they are made. Where group payment arrangements are in place, it will be the responsibility of the company responsible for discharging the group’s obligations under those arrangements to give notice of the Levy payments. If there are no group payment obligations in place, it will be for the company paying the Levy to give notice.
How will losses be relieved?
Normal loss relief rules do not apply to reduce levy profits. The Bill includes its own loss relief regime which applies for the purposes of the Levy (see Schedule 1). This is separate from the loss relief for Ring Fence Corporation Tax and Supplementary Charge which remains unchanged.
Levy losses can be used to relieve only levy profits. They can be carried back 12 months before the start of the levy loss-making period to earlier qualifying accounting periods in which there were levy profits. (Carry back for terminal levy loss relief claims can be up to three years, subject to anti-avoidance provisions.)
Any unrelieved levy losses remaining after any carry back can then be carried forward to subsequent qualifying accounting periods or surrendered to another company in the group which has levy profits in an overlapping period. The levy loss group relief rules are based on the existing group relief rules, including the rule that any payments made by the claimant company to the surrendering company for the relief are tax neutral. However, levy loss group relief applies only where the claimant and surrendering companies are members of the same group (i.e. where one is a 75% subsidiary of the other or both are 75% subsidiaries of a third company); meeting one of the consortium conditions in Part 5 of the Corporation Tax Act 2010 would not be sufficient.
The provisions in CTA 2010 on change of company ownership and on transfers of trade without a change in ownership are applied to levy losses, with minor modifications.
Are there anti-avoidance provisions?
No new tax is complete without corresponding anti-avoidance provisions. There are two anti-avoidance provisions which restrict or deny the deduction for the additional expenditure through which the new investment allowance is implemented (clauses 5 and 6) and two which restrict or deny the use of levy losses (Schedule 1, paragraphs 4(6) and 20).
The investment allowance (in the form of the additional expenditure deduction) is not available in respect of expenditure incurred for “disqualifying purposes” which is defined in clause 5 as expenditure arising from arrangements the main purpose, or one of the main purposes, of which is the securing of a “relevant levy advantage”. The relevant levy advantage follows the definition of “tax advantage” familiar from other anti-avoidance legislation.
The recycling of assets to generate additional expenditure is prohibited by clause 6. Additional expenditure is available only for expenditure on new assets, not on assets on which any company has previously incurred expenditure which was taken into account for the purposes of the Levy (or would have been so taken into account if the Bill had been in force and applied to the expenditure).
In the case of terminal losses, carry back of "terminal qualifying levy losses" for more than 12 months is not permitted where, on one company’s ceasing to carry on the ring fence trade, a person who is not chargeable to the Levy begins to carry on any of the activities of the trade and the purpose test is satisfied. The purpose test is satisfied where the cessation of trade is part of arrangements the main purpose, or one of the main purposes, of which is to secure the more favourable treatment for terminal qualifying levy losses (Schedule 1, paragraph 4(6)).
There is a very broad anti-avoidance provision at the end of Schedule 1 (paragraph 20) to counteract a “levy advantage” involving levy losses where there are arrangements the main purpose, or one of the main purposes, of which is to obtain a levy advantage by reference to a qualifying levy loss. The definition of levy advantage mirrors that of relevant levy advantage in clause 5. In addition to the purpose test being satisfied, it must be “reasonable to conclude” the arrangements are, or include, steps that lack a genuine commercial purpose or are contrived or abnormal; or “reasonable to regard” the arrangements as circumventing the intended limits of relief provided by Schedule 1, or as otherwise exploiting shortcomings in the legislation.
How has the oil and gas industry so far reacted?
Stability of the tax and regulatory regime is crucial to promoting investment in UK oil and gas. Concerns have been expressed by the industry that the Levy will destabilise the North Sea’s investment climate and jeopardise oil and gas investments which can take decades to develop. This could result in a decline in oil and gas production in years ahead, rather than providing the reliable sources of energy that the UK needs until alternative energy sources are able to meet its energy requirements.
Could there be further similar taxes?
The Levy had originally been announced as the “Energy Profits Levy”. The Bill has added the parenthesis “(Oil and Gas)” to the title which may be a hint that other energy levies may yet be introduced, for example on electricity generating companies. The Government intends to reform the existing pricing regime in the electricity generation sector 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 set out in its Energy Security Strategy. But this review will take a while and in the meantime, the Chancellor announced that the Government is evaluating the scale of the profits in this industry and is considering appropriate action.