Energy profits levy on oil and gas sector enacted but actual implementation is unclear
The UK parliament passed legislation (Energy (Oil and Gas) Profits Levy Act) on 14 July 2022 that introduces a new temporary windfall profits tax on oil and gas producers in the British North Sea. The levy, which is expected to generate about GBP 5 billion in the first year of implementation, was proposed as a result of the recent surge in oil and gas prices due to global circumstances and aims to help fund more cost-of-living support the government is providing for UK families (e.g., cash handouts to help with energy bills). The legislation includes an investment allowance that will help companies reduce their tax if they reinvest their profits in the UK.
The energy profits levy applies to oil and gas profits arising on or after 26 May 2022 and will apply until 31 December 2025 unless oil and gas prices revert to more “normal levels” in the coming years, in which case the levy will be phased out.
Oil and gas companies in the UK are taxed under a regime that is separate to the regimes for other taxes on profits earned by companies. A “ring fencing” system prevents taxable profits of companies from the production of oil and gas in the UK and on the UK Continental Shelf from being reduced by losses incurred on other activities or by excessive payments of interest. Oil and gas companies currently pay a 40% headline tax rate on profits, consisting of a ring fence corporation tax of 30% and a 10% supplementary charge. The new energy profits levy will apply at a rate of 25% to companies within the UK’s ring fence corporation tax regime and will apply in addition to mainstream corporation tax and supplementary surcharge. Taking into account the energy profits levy, the headline rate for affected companies will increase from 40% to 65%.
The tax base for the levy will be computed in a manner similar to the ring fence and supplementary tax regimes and will apply to relevant profits. A company’s profits (or losses) for an accounting period are the amount that, based on certain assumptions set out in the legislation, would be determined for corporation tax purposes to be the company’s ring fence profits (or losses) for the period.
As noted above, the UK government would like companies in the oil and gas sector to reinvest their profits to help support the economy and jobs. To encourage such investment, the legislation provides for an investment allowance under which oil and gas companies that make qualifying investments for oil-related activities (capital expenditure and some operating and leasing expenditure, but not financing or decommissioning costs) in the relevant accounting periods can immediately claim 80% of those costs as a deduction against profits liable to the levy. The legislation also contains relief provisions for qualifying losses.
No significant new compliance obligations should arise as the energy profits levy will apply to ring-fenced profits, which are already calculated by affected companies. However, companies making a payment of the levy must provide information about the payment to the UK tax authorities so that receipts can be monitored.
Although the windfall profits tax has been enacted, considerable uncertainty on this new tax remains given the ongoing Conservative leadership contest: one candidate has announced she would repeal the levy if elected. Whichever candidate becomes the new Prime Minister on 5 September, it is expected that there will be an Emergency Budget in September or October.