Decommissioning UK oil and gas installations: driving down the cost

The Petroleum Act 1998 establishes a decommissioning regime which protects the taxpayer from bearing decommissioning costs. The Secretary of State for Energy and Climate Change can serve notices requiring recipients to submit a costed decommissioning programme for approval, which then gives rise to a decommissioning obligation. While the liability usually rests with current licensees, it can also extend to other parties, such as owners of the offshore installations, former licensees and their respective parent and associated companies.

Tax relief for these costs is given at the point they are incurred and the decommissioning carried out. Relief is given against:

There are currently just over 100 fields within the PRT regime (those given development consent before 16 March 1993), but only a minority of these generate PRT receipts.

The relief for decommissioning costs (which typically takes the form of a 100% deduction for qualifying expenditure) is available at a rate of:

HM Revenue & Customs (HMRC) indications suggest the gross cost of GB£33 billion is in reality a net cost of only GB£13 billion after tax (see above, The cost of decommissioning).

Decommissioning costs will generally produce losses both for RFCT/SC and PRT purposes. While these losses can be carried back indefinitely for PRT purposes, there are restrictions in relation to RFCT/SC. Originally, carry-back of losses for RFCT/SC was limited to three years, but following consultation with industry this was extended to allow losses to be carried back to 2002, with losses being offset against most recent profits first.

A distinction must be drawn between a default and a non-default scenario.

Non-default scenario. In the non-default scenario for RFCT and SC (subject to the restriction of 20% on SC), where the DRD holder is meeting its own decommissioning liabilities the reference amount will be calculated by applying the prevailing rate of RFCT (or SC, but capped at 20%) to the expenditure. If the expenditure generates losses that are offset against previous profits (that is, carry-back) then the reference amount will be calculated using the rate of RFCT at the time those profits were taxed. If the DRD holder has insufficient tax capacity because, for example, this has been reduced by taking on a defaulting party's decommissioning costs, a shortfall payment can be claimed under the DRD. Although the relief is capped at 20% for SC, in a movement from the original consultation position, the terms of the draft DRD adjust the reference amount where the combined RFCT and SC marginal rate is greater than 50% so that the combined rate of relief is not less than 50%.

Default scenario. In the default scenario, the reference amount is fixed at 30% for RFCT and capped at 20% for SC. Unlike the non-default scenario, the RFCT rate and SC rate are fixed and not calculated by reference to prevailing tax rates. If the actual amount of relief the DRD holder can access through the tax system is less than the reference amount, a claim under the DRD can be made.

There is a statutory definition of decommissioning expenditure which defines the categories of expenditure that qualify. It is helpfully wide and there is also an extension so that decommissioning expenditure on onshore infrastructure which is used for the purposes of offshore production will also qualify.

To protect the Exchequer against potential "misuse" of the DRD system, amendments are proposed to the Capital Allowances Act 2001, which will restrict the available capital allowances applying to the decommissioning expenditure. These measures are aimed at artificially inflated claims and inappropriate claims under the DRD.

The first measure is to restrict allowances to the mere cost of providing a decommissioning service where the provider is a connected party. In limited circumstances (for example, for planning or project management services) a cost-plus method can be used to determine expenditure. The maximum amount of the "plus" has been set at 10%. This is a change from the proposals contained in the original consultation document which indicated that there would be no allowances at all for decommissioning costs paid to a third party. However, HMRC were not persuaded simply to accept transfer pricing principles (that is, arm's length pricing) as the sole determinant of the amount of allowable expenditure.

A targeted anti-avoidance rule operates to restrict allowances where the transaction has an avoidance purpose (that is, one of the main purposes is to obtain a tax advantage that would not otherwise be obtained). This is in spite of the fact that RFCT, SC and PRT will be covered by the General Anti-Abuse Rule to be introduced in April 2013.

The published draft DRD also contains an anti-abuse clause to prevent DRD holders from obtaining an enhanced entitlement under the DRD where they have entered into an "inappropriate arrangement". This would cover the inclusion of features in a transaction the main purpose of which is to secure a payment from the government under the DRD. Further protection for the Exchequer comes in the form of a clawback mechanism in the event that a DRD holder recovers from third parties in respect of expenditure that has given rise to a shortfall payment (including an obligation on the DRD holder to seek recovery from third parties where it is entitled to do so).

For PRT purposes, guaranteeing tax relief and calculating the reference amount is more complicated because it is a field-based tax. As with RFCT, there will be a distinction between a default and a non-default scenario.

Non-default scenario. In the non-default scenario, the reference amount is linked to the PRT history of both the DRD holder and any of its predecessors in respect of the field and how much PRT they have paid which will be certified by HMRC. If the DRD holder has insufficient PRT capacity because it has incurred a defaulting party's decommissioning liabilities, then the PRT reference amount will be calculated by disregarding the imposition decommissioning expenditure. This will enable it to obtain shortfall payments under the DRD in respect of subsequent non-default expenditure. The form of the certificate has yet to be finalised but it will be issued by HMRC on request by a DRD holder, and updated certificates can be requested on a six-monthly basis. A DRD holder can request certificates both in relation to its own PRT history and those of its fellow licence-holders (which are relevant to it in the case of default by another licence-holder). Information provided by a DRD holder for the purposes of the DRD will be subject to a confidentiality obligation on the government unless waived by the DRD holder.

Default scenario. In a default scenario, the reference amount will be calculated based on the amount of PRT relief as would arise as a result of setting the imposition decommissioning expenditure against the remaining available profits for the field, as certified by HMRC. This should deal with the issue raised in consultation that the defaulting party may have insufficient PRT history and itself look to access a prior owner's PRT history, for example because an interest in the field has changed hands a number of times. As noted above, a DRD holder may request certification from HMRC both of its own PRT history and those of its fellow licence-holders. The DRD contains a confidentiality obligation on the DRD holder which would cover information on fellow licence-holders' PRT field history.

As in a non-default scenario, the certification process for a field will be a key element in ensuring that the DRD works properly and that participants sign up to DRDs. The current draft DRD provides for certificates to be issued six-monthly as there is the possibility that companies may be under-securitised if there are changes to the PRT history and certification after security has been calculated and posted. We expect that contractual decommissioning security arrangements will provide for security to be recalculated and posted as certificates are issued

The Finance Bill 2013 contains provisions denying the availability of unrelieved field losses (UFLs) where a DRD holder has incurred decommissioning expenditure as a result of a default. UFLs are losses which remain after having been relieved against assessable profits for the same field, and in some circumstances can be relieved against the assessable profits for another field.

In a default scenario, once a payer has carried back losses against its own PRT history, any remaining losses will not generate a UFL as they will allow a payer to make a DRD claim.

The draft DRD also covers the position if PRT is abolished (as many would hope, given the relatively small number of fields to which it applies). In those circumstances the reference amount is calculated as of the last period of account where PRT is in place.

Decommissioning security agreements usually provide for the establishment of trusts and for actual cash to be put into the trust, or make alternative provision in favour of the trustee (for example, standby letters of credit, unconditional demand bonds) by the licence holder. Without an express provision to the contrary, these trusts would be within the scope of the UK inheritance tax regime and inheritance tax charges could apply when monies were paid out of the trust or on each ten-year anniversary. Therefore, the Finance Bill 2013 is drafted to confirm that UK inheritance tax will not apply and the property in the trusts will not constitute relevant property for the purposes of inheritance tax.