Proposals to introduce temporary amendments to the Norwegian upstream tax regime, put to the Norwegian parliament a couple of weeks ago, and included within the Norwegian budget on Tuesday, have added to calls for fiscal change in the UK to support investment in the UKCS and underpin the oilfield services (OFS) supply chain.
The UK government have never been slow in tweaking the UK’s oil and gas tax regime. Since its inception in 1975 there have been very few finance acts that haven’t included changes to the regime, some more material than others, sometimes in favour of the Exchequer, other times favourable to industry. In contrast the Norwegian regime has been a standout example of stability, some may say rigidity, which makes the recent proposals all the more surprising.
In recent years the UK has seen successive governments recognise the maturity of the UKCS is such that the fiscal terms need to be relatively attractive, to enable the basin to compete for capital against other more prospective basins. Especially in light of the apparent attractiveness of unconventional onshore resources in the US. Thus, the UK regime has not only been a cash flow tax, with a full tax write-off of capital expenditure in the year it is incurred (since 2002), it has also benefitted from a lowering of the supplementary charge to 10% (in 2016 from a high of 32% in 2011), the introduction of a quasi-uplift on capital expenditure (investment allowance) and an uplift of 10% on trading losses brought forward.
The Norwegian measures are mainly designed around providing a 100% write-off of capital investment against the Norwegian special tax (which is applied to income from petroleum extraction), rather than that tax deduction being spread over six years under the current rules. As the UK already has that embedded in its existing regime that isn’t a change that can be made here.
In addition, the Norwegian measures provide that for both 2020 and 2021 any trading loss can be monetised in the form of a tax repayment. That isn’t currently possible in the UK, nor is it likely to be something the UK government will consider changing even on a temporary basis. Moreover, as is the case with the current Norwegian tax repayments available on losses incurred during exploration, the tax repayment on trading losses in 2020 and 2021 can be “pledged”. That enables a bank to lend against the security of the tax repayment. UK insolvency law does not allow for tax repayments to be pledged in this manner.
However, the biggest difference between the two regimes remains the tax rate. In the UK the top rate of tax is 40%, in Norway it is 78%. Because of the significantly higher rate in Norway, the advancement and monetisation of tax relief makes a material difference to the cashflow of an investor. In the year the capex is incurred, the proposed changes increase the cashflow benefit associated with tax relief by around 50% to just over 65% of the capex.
It is a sad reality of the current oil price environment that even if the UK government were willing to provide a tax repayment for trading losses in 2020 and 2021, at the UK rate this might not be material enough for companies to re-evaluate their investment decisions and continue to sanction projects.
The steps previously taken by the UK government to make the regime more competitive have left little room for further manoeuvring. Regrettably, at this moment in time there appears to be no fiscal changes that would provide a material, uniform incentive to make investments in the UKCS. Support for the sector would have to come via non fiscal means. Therefore, it falls principally to industry to carefully navigate through this extremely challenging environment to establish a successful and sustainable future. Those companies that have appropriate capital structures and are able to be agile, adapt and embrace innovation are the most likely to be resilient and emerge stronger than before.
Derek Leith is EY Global Oil & Gas Tax Leader
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