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Get Ready for Take Off – The UK’s new shale gas tax proposals revealed

23 October 2013

The UK Government is embarking on a journey to introduce new tax reliefs for investment in the shale gas sector and published a consultation document on 19 July 2013, proposing a variety of tax breaks.

The most significant of these proposals is to reduce the effective rate of tax from 62% to 30% on income generated from shale gas, but the proposed regime provides a number of further subtleties of interest to the broader UK oil and gas sector. This could be the start of a long and bumpy road navigating various political, economic and social issues.

Welcome aboard

Hydraulic fracturing or fracking, is an extraction technique used to obtain gas and oil from shale rock. The process requires water and chemical mixture to be injected at high pressure into a wellbore, as a result of which the shale rock is fractured with gas and/or oil being released through these fractures into the well.

Whilst it could represent a means of extending the security of supply, many in the industry have baulked at likely high costs compared to more conventional techniques. The government views the tax code as one means of alleviating this burden.

Are you sitting comfortably?

Currently profits derived from conventional oil and gas extraction can be 62%, which is levied through two separate charges: 

  • on “ring fence” profits (generally all the profits from oil exploration and production activity), at 30%, and
  • a supplementary charge of 32%.

In addition, some enterprises may fall within the petroleum revenue tax regime (“PRT”), which is charged on the profits of individual fields. Though PRT was abolished for fields given development consent on or after 16 March 1993, for those still falling within the regime the effective tax rate may be as high as 81%.

However, oil taxation is a notoriously complicated and specialised area which, given the complexity of the UK tax code as a whole, is really saying something. A system of allowances is available for off-set against the supplementary charge for certain fields (largely new and certain other qualifying fields) and this is afforded on a “per-field” basis.

Getting ready for take off

To counteract the prohibitively high cost of setting up shale gas operations, the consultation is proposing that similar allowances from the supplementary charge will be available for expenditure incurred in setting up shale gas “pads”.

Production income from shale gas will be exempt from the supplementary charge in proportion to the amount of capital expenditure on the pad site. This aims to acknowledge the disproportionately high costs involved at the commencement of activities.

However matters are not as simple as just providing an allowance within the existing legislation, as shale gas fields do not necessarily have clearly delineated boundaries, as is the case for more conventional fields. The proposals are therefore for the allowances to apply at “pad level”, ie upon each particular drilling site.

Although it is not possible to provide a comprehensive example until the final figures and rates in respect of the allowance are published, the new regime is envisaged to operate as follows. A company owns two pads, both of which have yielded a profit of £100,000 in the tax year.

Significantly greater expenditure was incurred on Pad 1 for geological reasons, so let’s say £120,000 was incurred on Pad 1 and £50,000 on Pad 2. It is expected that all of Pad 1’s profit would be exempted from the supplementary charge, with the excess of £20,000 being carried forward.

Only half of Pad 2’s profit would be exempted from the supplementary charge, with the remaining £50,000 being subject to the rate of 62%. The excess expenditure from Pad 1 could not be applied against Pad 2’s profits.

Going the extra mile

However pad allowance is only attractive to extent there are profits against which to off-set allowances, which is likely to be several years away for shale gas. To combat and compliment this there are two important proposals:

  • Conventional oil and gas companies may utilise the allowance across their existing conventional business income within the “ring-fence”, eg profit from the UK continental shelf. This means that established businesses can benefit their existing business, whilst planning for future income streams from shale gas.
  • The extension of the existing regime of losses. In addition to allowances from the supplementary charge, conventional oil and gas companies benefit from enhancements to pre-trading expenses. Such expenditure is uplifted by 10% and is available to off-set against profits for up to six accounting periods, within the ring-fence.

The Government is proposing that such tax breaks go further for shale gas and companies may carry such losses forward for up to ten accounting periods. The proposed extension of the period within which losses can by utilised reflects the fact that the lead in time for shale gas sites become profitable may be longer than for conventional sites.

Satisfied customers?

George Osborne heralded the proposed regime as the “most generous in the world” and the message was clear that the UK is open for business and investment in shale gas. However, before businesses rush to jump aboard, they are likely to wish for greater certainty regarding the proposals.

In particular the size of the exemption from the supplementary charge is yet to be announced and given the likely costs involved in starting up, it is likely to take more than a token gesture to convince established businesses that the time is right to invest in shale.

Further, businesses will no doubt wish to be clued up as to the regulatory framework, which at present appears unclear. There has been little comment on how planning applications will be addressed in the face of the practical realities of accessing shale gas.

Overall there is therefore still significant work required to finalise the tax regime, regulatory framework, let alone the significant economic, political and social issues which must also be tackled. Therefore whilst the noises from government are positive about investment in the sector, there could be a bumpy ride ahead before this particular journey results in a safe landing.

The consultation was released by the Government on 19 July 2013, with a view to seeking comments by 13 September 2013. Legislation is expected to follow in next year’s Finance Bill. This article was first published in the 4 October edition of Utility Week. See http://www.utilityweek.co.uk/ for further information.