In the Autumn Statement (5 December 2013), one announcement causing surprise and consternation to the UK North Sea oil and gas sector (UKCS) was that a ring fence was to be introduced in relation to certain UKCS profits made by an oil contractor, and that, within that ring fence, a cap was to be imposed on the amount deductible for lease payments made to an associated company.
The measure provoked a strong adverse reaction from both contractors and oil companies, and, following an informal consultation, some ameliorations have been announced – the class of affected asset is now limited to drilling rigs/ships and accommodation units, the amount of the cap has been increased (from 6.5% to 7.5%), and the fact the asset may be laid up between jobs is taken into account. Also, the impact of the regime will be reviewed after one year of operation. But the fundamental proposal remains pretty much as originally announced.
Draft legislation was published on 1 April 2014, and is open for consultation until 9 May 2014.
The new rules apply to a contractor if it carries on activities (oil contractor activities) which are
Relevant offshore services are the provision, operation or use of a relevant asset in, or in connection with, the carrying on of exploration or exploitation activities in a relevant offshore area by the contractor or any associated person.
The relevant offshore area is UK territorial waters and the UK continental shelf.
A relevant asset is a structure (including a ship or other vessel) that
As would be expected, associated person is defined widely, including
Lease and leasing are also given a wide meaning.
Connected also has a wide meaning, including an extended definition of common control.
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The ring fence
Oil contractor activities will now be treated as forming a separate trade of the oil contractor, subject to tax at the normal corporation tax rate (not the higher rates applicable to oil companies). The ring fence requires that the profits of that activity are segregated from any wider trade, and are subject to restrictions in terms of loss reliefs (broadly, losses arising outside the ring fence cannot be sheltered by profits within it) and deductions for interest expenses and exchange gains and losses. However, the principal restriction is on the deduction for hire payments in respect of relevant assets (see further below).
Lease payment cap
The amount of lease payments paid for relevant assets that is deductible within the ring-fence is limited to, broadly, 7.5% of the capital cost of the asset to the relevant group.
If payments subject to restriction are made by more than one company, the cap is split between the payers on a just and reasonable basis.
If the asset is not used in the relevant offshore area throughout the relevant accounting period, the 7.5% is time apportioned, by reference to the period of relevant offshore area use to total use. If the accounting period is less than 12 months, the 7.5% is time apportioned.
Lease is widely defined, and includes hire purchase, conditional sale etc.
The capital cost is the consideration given to acquire the asset when first acquired by an associated person, plus incidental expenses (other than financing costs) and any capital improvement expenditure (which increases the value of the asset) since acquisition. If the asset is leased from a third party which is not an associated person, the capital cost (and incidental costs) is the amount that would have been paid had the asset been purchased not leased, plus any improvement expenditure. If items have been removed from the asset since acquisition, the cost is reduced to reflect this.
An anti-avoidance provision disregards any arrangements entered into with the main or one of the main purposes of avoiding the cap on payments.
If the cap results in the whole of the rental not being deductible, the excess amount is available to be taken as a deduction outside the ring fence, or surrendered by way of group relief, if the oil contractor has other UK taxable activities.
The ring fence regime and cap apply from 1 April 2014; if that falls in the middle of an accounting period, one period is treated as ending on 31 March 2014, and another as commencing on 1 April 2014. Losses carried forward can only be used within the ring fence if they would have fallen into it had the rules applied at the time the loss was made.
Restriction for oil companies where no lease between associated persons
This is intended to apply where an oil company leases a relevant asset directly, in circumstances where the restriction would have applied had the asset been leased to the oil contractor. For example, the oil company could lease a drilling rig from one member of a group, and obtain the related services from a separate company. In this case, the cap applies to the oil company within its normal UKCS ring fence (with the result that the impact of the cap may be more significant, because of the higher rate of tax applicable to oil companies). Again, an anti-avoidance provision applies to arrangements which have a main purpose, or one of their main purposes, as the avoidance of the restriction.
The new rules give rise to some interesting issues, which no doubt will be raised during the consultation process. For example:
Norton Rose Fulbright will be participating in the consultation process; if you have any points you would like raised, or if you would like to discuss this briefing, please contact the contact listed in this briefing, or your normal Norton Rose Fulbright contact.
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