By OGJ editors
HOUSTON, Nov. 2 -- The North Sea oil industry should brace for tax hikes from the UK Treasury, given rising oil prices worldwide, said an Ernst & Young LLP tax analyst in Aberdeen.
"Oil companies are one of the most obvious targets for tax increases and fiscal change," said the analyst, Derek Leith. "It is almost inevitable that the government will want to get its 'fair share of economic rent' from oil companies as world oil prices continue to rise."
Leith noted the current North Sea fiscal regime appears "muddled" because tax rates vary greatly with the ages of oil fields.
"Corporation tax hikes, in recent years, have resulted in a very pronounced suspension of exploration activity and investment in producing fields, particularly by the supermajors," Leith said. The UK's corporate tax changes 3 years ago rocked the industry.
In April 2002, the UK government imposed a supplemental tax for oil and gas companies with the effect of adding 10% to the 30% corporate tax all UK companies pay on profits. For fields subject to the 12.5% royalty—those that received development approval before April 1982—the supplemental tax pushed the aggregate marginal tax rate to as high as 74%. The marginal rate is the combined effect of all taxes and offsets on the next unit of earnings (OGJ Online, Feb. 17, 2003).
The UK Offshore Operators Association Ltd. reported that industry paid more than £5 billion in direct taxes during 2004. North Sea tax revenues for 2005-06 are forecast at £7-10 billion, depending upon oil prices. Companies operating in the North Sea have paid £203 billion (2004 prices) in the last 40 years, the report said (OGJ Online, July 19, 2005).
Leith believes it is "almost inevitable that principled revenue-generating tax reform" will be introduced this year as Chancellor Gordon Brown struggles with a projected deficit in public finances.
Tax options
UK tax officials will consider some sort of change to the current tax regime, Leith said.
"Let's hope that any such change will be made with a view to the long-term stability of a sector which is critical to the UK economy and provides incentives to benefit companies that continue to invest in the North Sea."
When asked what oil companies might expect in the way of tax changes, Leith made the following suggestions:
-- Progressive tax rate based on commodity prices: "One way for Brown to deal with any opposition to higher rates of corporation tax, or supplementary charge, would be to link the higher rate to commodity prices," Leith said. "Thus if the current large price rises were reversed, the effective tax rate would also come down. The problem with such a system is that it is difficult to differentiate between oil pricing and gas pricing. And can it be made to work in a way that investment decisions are not influenced [by] a very complex calculation?"
-- Petroleum Revenue Tax (PRT): There has been speculation that the PRT could be removed entirely and that the government could increase the supplementary charge. At present, payment of PRT depends on a field's production and on when the field was developed. The marginal tax rate for a pre-1993 field can be 70%, compared with 40% for newer fields.
"The current regime is a legacy of the past and is not what you would design if you were starting from scratch. Arguably, if it were to be abolished and replaced the distortions created by the current system could be ironed out," Leith said. "Government may take the view that there has never been a better time to change the regime than now, given oil prices. However, any such change is fraught with difficulty because some companies would stand to gain, whereas others would be significantly disadvantaged, potentially plunging the industry into chaos."
-- Windfall tax: Leith said a windfall tax would be counterproductive to encouraging a more favorable investment market, and it would only provide "a temporary sweetener" for Brown, who needs a more sustained source of income to ease his budgetary woes.
-- Changes to decommissioning: The legislation around decommissioning was drawn up over 20 years ago when the prospects for the development of the North Sea and the players in it were very different. Existing rules only allow companies tax relief on actual decommissioning expenditure if their profits from the previous 3 years are sufficient.
"The legislation needs to be reexamined to enable companies to defer decommissioning as long as possible, maximizing production from host fields and small incremental satellite fields," Leith said. "This would benefit employment and the economy and, not least of all, future tax revenues for the Treasury."
