The draft Energy (Oil and Gas) Profits Levy Bill published on 21 June 2022 (the Bill) shows the difficulty, and danger, of using purpose tests in legislation when the Government is seeking to use tax to influence behaviour. It can have the effect of rendering the measure meaningless.

As well as looking to raise £5bn from the new levy in the first year, the policy background states that 

"The government has also been clear that it wants to see the oil and gas sector reinvest its profits to support the economy, jobs, and the UK’s energy security. That’s why, within the levy, a new ‘super-deduction’ style relief is being introduced to encourage firms to invest in oil and gas extraction in the UK."

Or, to put it another way, the government wants firms to invest in oil and gas extraction in the UK in order to obtain the 'super-deduction' style relief (my colleagues' post which discusses the Bill generally refers to this as the "new investment allowance" which is implemented as an additional deduction from the ring fence profits that form the tax base for the levy).  

But unfortunately clause 5 of the Bill says that, if you have arrangements with a main purpose of obtaining the 'super-deduction' style relief, you do not get it. A Catch-22. We want you to make an investment which you would not have made, but for the tax relief, in order to get the tax relief. But if you make the investment to get the tax relief, we will not give it to you.

The basic rationale for purpose tests was well set out in HMRC's "Simplifying Unallowable Purposes Tests" discussion document in 2009 which answered the question "why do policymakers need to consider purpose tests?" as follows: 

"The Government’s policy is that the tax system should not disrupt or distort normal commercial activities. Instead, it should apply fairly and consistently to these activities. Conversely, tax avoidance can involve transactions which go beyond normal commercial behaviour."

That is why they do not work at all well when you are deliberately trying to use the tax system to "disrupt or distort normal commercial activities" and to encourage someone to make an investment they would not, but for tax, have made.

We have been here before. When the bank levy was introduced in 2011, it also had two stated aims, one an amount of money to be raised from a specific subset of taxpayers, the other a particular behavioural change. The behavioural change was to encourage banks to adopt less risky funding profiles by switching from short-term funding to long-term funding, which attracted the levy at half the rate, or from short-term or long-term funding to equity or other excluded liabilities, which were exempt. 

The problem was that the original draft of the bank levy legislation had an equivalent of clause 5. So the policy statement was that the levy was designed to encourage you to reduce your bank levy liability by adopting a less risky funding profile. But the draft legislation negated that by saying that, if you entered into any arrangement with a main purpose of reducing your bank levy liability, it would not work (what became paragraph 47(1) Schedule 19 Finance Act 2011). When that was pointed out in consultation, that led to the white list of acceptable behaviours in paragraphs 47(7) to (12) Schedule 19 FA 2011 which you could undertake with a main purpose of reducing your bank levy liability. So, for example, paragraph 47(8) says that arrangements to increase your long-term funding, on an ongoing basis, are excluded from the main purpose test.  

Unless and until a similar white list is included in this legislation, to clarify when it is acceptable for a taxpayer to change their normal commercial activity in order to obtain the super-deduction, it looks like it will be unobtainable by design. Except, that is, for expenditure that the firm was going to incur anyway. Which rather defeats the stated purpose of the super-deduction in the first place.