The one-week consultation left little time to comment on the draft legislation for the Energy (Oil and Gas) Profits Levy (the Levy) which applies to certain profits of oil and gas companies from upstream activity in the UK and on the UK Continental Shelf arising between 26 May 2022 and 31 December 2025. Fortunately, however, a number of important changes have made their way into the legislation as enacted on 14 July in addition to some more minor changes to make provisions work as intended.
Scope of the Levy
The starting point for identifying profits subject to the Levy is the company’s ring fence profits or loss for the period and then a number of adjustments are made – including leaving out of account financing costs and decommissioning costs. In response to feedback from the industry on the draft legislation, section 1 now provides that repayments of petroleum revenue tax related to losses generated by decommissioning expenditure will not be taxed under the Levy. These are repayments that are typically taxed under the ring fence corporation tax and supplementary charge and as explained by the Chief Secretary to the Treasury, at the Second Reading of the Bill in the Commons, this approach is ‘consistent and fair’ since wider decommissioning expenditure is also left out of account for the Levy.
Scope of the investment allowance
The scope of the investment allowance came up repeatedly during the parliamentary proceedings. It was emphasised that, as the Levy is targeted at extraordinary profits from oil and gas upstream activities, any relief for investment must be related to oil and gas upstream activities and this is how the legislation has been drafted. However, some uncertainty remained about whether this would include spending on decarbonising oil and gas production, for example, by using electrification (such as expenditure on generators which includes wind turbines, transformers and wiring). During the passage of the Bill through parliament, the Chief Secretary to the Treasury confirmed that capital expenditure on electrification, as long as it relates to specific oil activities within the ring fence, will qualify for the allowance. The allowance will not apply to carbon capture, usage and storage, however, as these are not ‘oil-related’ activities.
Attempts to amend the Bill to provide expressly that electrification investment which decarbonises upstream oil and gas activities is eligible for relief failed. The Financial Secretary to the Treasury confirmed during the Committee Stage in the Commons that there will instead be clarification in written guidance.
In response to criticism in parliament that the allowance does not incentivise expenditure on renewables, the Financial Secretary to the Treasury pointed to other tax levers and non-tax levers to support non-oil and gas investment, including the super deduction and the UK’s research and development tax credit scheme. Also, returns on investment on renewables are taxed at the normal corporation tax rate (currently 19%) rather than 65% which is the total tax burden on oil and gas profits within the scope of the Levy. She also referred to the contracts for difference scheme, providing developers of low carbon electricity generation with direct protection from volatile wholesale prices, and the £1 billion carbon capture infrastructure fund. This was reiterated by the Chief Secretary to the Treasury, at the Second Reading.
Anti-avoidance provision now workable
A significant improvement is that the anti-avoidance provision which is built into the investment allowance and sets out when expenditure is incurred for ‘disqualifying purposes’ is no longer so widely drafted as to prevent anyone benefitting from the 80% investment allowance (a concern with the draft legislation emphasised by Mike Lane in his post The 'super-deduction': unobtainable by design?'). The former Chancellor envisaged the investment allowance acting as an incentive for the oil and gas sector to invest more in oil and gas extraction in the UK in order to pay less tax under the Levy. The purpose test in section 5 is now limited to circumstances where there are ‘contrived arrangements’ or an ‘attempt to circumvent the intended limits or exploit other shortcomings of the legislation’ so it should now be possible to invest in oil-related activities in order to get a deduction from the Levy. This is, however, subject to the points made in our earlier blog post about the timing of when expenditure is treated as incurred being too restrictive given the long lead time for a lot of oil and gas projects. No changes were made to this aspect of the investment allowance.
What is the normal level of pricing?
In his announcement of the Levy on 26 May, the former Chancellor said that the Levy will expire on 31 December 2025, but that it would be phased out earlier if and when oil and gas prices return to historically more normal levels. This statement attracted numerous calls for the trigger to be legislated for or for there at least to be some transparency about the circumstances that would need to exist before the Levy would be phased out. When the Financial Secretary to the Treasury was asked what the 'normal price' was, she referred to the comments that the former Chancellor made when he was questioned on this by the Treasury Committee. He said: “The last time this was done, a price target was published, which was $74 or $75 for Brent…If you look at average Brent price over the last five or 10 years, that will give you something like $60 or $70 for oil…so that gives you a sense.” The Financial Secretary to the Treasury confirmed this is something the government will be considering in due course and should not be taken as an assurance that the Levy will be phased out if prices get to this level.
What is the expected economic impact of the Levy and investment allowance?
The Impact Assessment published on 11 July shows the measure is expected to raise £5bn in its first 12 months at current market prices but the table of costing is currently empty. This was commented on at the Second Reading when the government was asked how much investment allowance is expected to be claimed and how this would affect the amount it would raise. The response was that the final costing will be subject to scrutiny by the Office for Budget Responsibility in the next forecast. Further work is also being undertaken to finalise HMRC’s operational costs for the new Levy.