The UK Government has proposed that the tax rate on certain profits from UK shale gas production should be reduced from 62% to 30%. This will make the UK’s shale gas tax rate among the lowest in the world.
Under the current tax regime, profits from gas production are ring-fenced and subject to a higher rate of corporation tax of 30% and a supplemental charge of 32%. In addition, for oil and gas produced from oil fields granted development consent before 16 March 1993, Petroleum Revenue Tax is also payable on profits at a rate of 50%. This is deductible as an expense when calculating profits for corporation tax and supplemental charge purposes so it gives an overall tax rate of 81% for such fields and 62% for other fields, although there is a 100% first year allowance for most capital expenditure. The high rate has traditionally been justified by the idea that the exploitation of oil and gas depletes the country’s non-renewable resources and so a premium to the standard tax rate is required. This very high rate has been reduced for certain areas where the extraction of the oil and gas was seen as being technically difficult by the granting of "field allowances", which remove the supplemental charge from certain profits arising in those fields.
The Government has now issued new proposals for the shale gas industry, in a consultation paper published on 19 July 2013; Harnessing the potential of the UK's natural resources: a fiscal regime for shale gas. The Government has proposed an approach based at the pad level (where a “pad” is the term used to describe the drilling and extraction site). The "pad allowance" is to operate in a similar way to existing field allowances, by exempting a portion of the company's income from the supplementary charge and therefore effectively reducing the tax rate on that portion from 62% to 30%. The logic to this is that the costs of shale gas extraction will be high but, while it is easy to identify the discrete fields or reservoirs of oil and gas in conventional production techniques, unconventional hydrocarbons cover larger areas with indistinctly defined boundaries so the existing field allowance system would not be suitable to grant relief. In effect, unconventional production techniques such as hydraulic fracturing would be treated as if they are taking place within a field where field allowances are available so that a proportion of the income, based on the capital expenditure incurred which is eligible for 100% first year capital allowances in relation to the shale gas pad, will be exempt from the supplemental charge. This gives a good incentive for capital investment in these areas.
Contributions to the consultation close on 13 September and can be made directly to HMRC or you can contact the author or your regular K&L Gates contacts.
The new allowance has been designed to address the high upfront costs associated with shale gas projects and to encourage investment in the industry. However, there are a number of material issues which the consultation paper seeks industry input on. In particular, existing field allowances can be used fully over a minimum period of five years but the potential steep decline rates from shale gas production may mean that this period is inappropriate for the pad allowance. The consultation paper also seeks input on the specific proportion of capital expenditure which would attract the allowance.
The primary objectives of the proposals are intended to encourage early investment in the exploration for, and development of, shale gas in the UK and to maximise the economic production of the UK’s shale gas reserves. George Osborne is openly ambitious to make the UK tax regime "the most generous for shale in the world." The proposals will secure this. The tax break for shale gas is significant and it is likely that the proposals will encourage substantial investment in the industry.