With pressure to increase production yields, drive efficiencies, extend asset life and tap into smaller and deeper fields, technological innovation has become an integral component of the oil&gas industry.
However, from our experience, many companies in the sector are missing out on valuable tax reliefs that could support their development costs.
Research and development (R&D) tax credits were introduced in 2000-02 for large companies – to encourage technological innovation. While the scheme has been widely used by some sectors, such as telecommunications, pharmaceuticals and aerospace, many businesses in the oil&gas industry are overlooking this worthy incentive as they do not appreciate just how broad the definition of R&D is for tax purposes.
Many companies are not aware that they are eligible to claim for R&D tax relief on some of their day-to-day operational activities and frequently incorrectly assume that relief is restricted to blue-sky research projects, typically found in pharmaceutical companies or research institutes. In reality, many companies in the oil&gas sector are likely to be undertaking some level of eligible R&D work which will entitle them to make a claim.
Even companies that are already making R&D tax-relief claims may want to consider whether all qualifying activities are being identified.
There are two key criteria when determining whether a project qualifies for R&D relief.
Potentially eligible activity should be seeking to achieve a technological or scientific advance by overcoming technological or scientific uncertainty.
The two criteria interact to broaden the scope of potentially eligible activity. Revised guidance issued by HMRC states that qualifying indirect activities are also eligible to be claimed. Such indirect activities can encompass, among others, training, security, administration and strategic support undertaken for R&D purposes.
As part of oil&gas companies’ business, constant development of processes, products and techniques are central to success across the upstream, midstream, downstream and service segments. Potentially eligible R&D activities are ongoing across the entire oil&gas lifecycle.
For example, in the upstream sector, the analytical tools and techniques used can make a difference to the discovery and production efficiency of hydrocarbon sources.
While the exploration and appraisal (E&A) work, in itself, is not an allowable activity for R&D relief, the development or improvement of the tools and techniques to enable successful E&A could fit within the eligible criteria.
Drilling techniques, fracturing technologies and the development of advanced modelling capabilities to predict the presence of hydrocarbon are all key technological advancements being made within the sector.
Clearly, the relief is equally, if not more, applicable in the service sector, which is frequently part of the teams solving these complex technological problems. In many cases, this is part and parcel of what the service company does and falls outside the scope of its traditional view of R&D, hence the tendency to under-claim.
Furthermore, extending the life of assets and mature fields is becoming more technically challenging as fields reach secondary and tertiary recovery stages, which is leading to the development of new technological methods of intervention and enhanced recovery methods.
In the midstream and downstream sectors, production yield, throughput and product performance are key. Technological advances to increase efficiency, reduce environmental impact and produce new, significantly improved end products, while part of a company’s business activities, may well be part of an R&D project eligible for the tax relief.
The activities do not stop there: software development, system integration and monitoring and metering technologies may pose challenges to the scientists and engineers involved and result in viable technological advances to the industry that should not be overlooked.
Additionally, where oil&gas companies are looking to diversify and offer alternative energy provision, such as renewable-energy supply, the work in this technological field, such as advances in wind turbines, improvements to electrical transmission efficiencies and wave and tidal technology developments, can also attract R&D tax credits.
So how does the R&D tax claim work?
Depending on the size of the company, R&D tax credits can be claimed in the UK under either the small and medium-sized enterprise (SME) or large company scheme.
To qualify for the scheme, the trade of the company where the R&D is undertaken must be within the charge of UK corporation tax; a company can also include UK permanent establishments of foreign companies.
Currently, SMEs are defined as companies (or groups of companies) with up to 500 employees and either a turnover not exceeding 100million euros or an annual balance sheet not exceeding 86million euros. Claims are generally made in a retrospective manner, allowing companies to go back two years to make their claims.
As it stands, the scheme provides large companies with an additional 30% deduction in the calculation of its taxable income for R&D revenue expenditure.
This typically results in an 8.4% tax benefit (assuming 28% corporation tax rate) or 15% tax benefit for oil&gas companies which are liable to 30% tax on ring-fenced trade and the additional 20% supplementary charge.
The additional deduction for SMEs now stands at a generous 75% for expenditure after August 2008, with the additional possibility of cash payments.
These credits are in addition to the existing R&D Allowances (RDA) scheme, which provides an accelerated 100% reduction for qualifying R&D capital expenditure.
Typically, when submitting a claim, it will be necessary to demonstrate how the technical activities in question meet the criteria for R&D and provide support for the expenditure being claimed. As a self-assessment scheme, it is the competent technical professionals (scientists, engineers and IT developers) who determine what is an eligible R&D activity.
As such, a good way to explain to HMRC how the criteria for R&D have been met is to submit, with your claim, a sample set of technical project descriptions detailing the eligible activities included in the claims in a format that supports how those activities meet the definition of R&D for tax purposes.
This can be a difficult task, given that HMRC does not publish recommendations on how technical reports should be structured. Furthermore, many countries offer similar R&D incentives, such that cross-border opportunities should be considered to ensure that the benefits are fully captured on a global level.
With a combination of a tough tax environment and a desire within many businesses to conserve cash, every business is under pressure. R&D is a legislative relief available to business to reduce its tax rates.
Given the pressures mentioned, it would seem appropriate for the oil&gas sector to re-evaluate its claims in the area to bring them up to the level of other sectors, if not beyond.
Elizabeth Gosling is an engineering professional in Ernst & Young’s R&D tax services team
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