Decommissioning Relief Deeds – a world first!

The publication yesterday by HM Treasury of the final form of Decommissioning Relief Deeds marks a milestone in a 30 month collaboration between government and industry to provide long-term certainty on decommissioning tax relief.

Under UK legislation, owners of offshore infrastructure at the end of its useful life are jointly and severally liable to decommission it. If the owners default, a wide range of people including former owners are also potentially liable to be brought back to pay for decommissioning. As a result, co-venturers in oil fields often enter into decommissioning security agreements (DSAs), under which each owner provides security to the others against the risk of defaulting on its decommissioning obligations. Oil companies selling interests in fields will also require such security from those purchasing their interest. Security is usually provided in the form of a letter of credit from a bank, and the bank will often require collateral from the party providing the security. This security therefore ties up a lot of capital which could be more usefully employed.

Tax relief is currently available for decommissioning costs when they are incurred but this relief could be withdrawn or amended at any time, and requires a party to have sufficient taxable profits against which to set the reliefs. Owners deciding whether to invest in a field where decommissioning may not happen for another twenty years will make cautious assumptions about the availability of relief, as they will when requiring security from their partners or from purchasers. DSAs typically therefore require security to be calculated “gross”, without any allowance for tax reliefs. This significantly increases (by a factor of 4 in some cases) the funds tied up in security which would otherwise have been available to invest, and prices some parties out of the market for assets.

Over the past two and a half years Oil & Gas UK has been working with HM Treasury to find a means of addressing this issue. The novel solution proposed by industry was the use of a contract which would be available to any party potentially liable for decommissioning in which the Government effectively guarantees the present rates of tax relief. Under these contracts, if the tax relief regime changed, the Government would make a compensating payment to the affected companies. However, if the tax relief regime remains unchanged, then except in the rare event of default (where minimum rates of tax relief are available to unrelated parties brought in to remedy the default) the Exchequer will pay no more in tax relief than it is expecting to pay today. The advantage of the contractual solution is that it is much harder for the Government to unilaterally alter the terms of a contract than to change tax rules. In a speech at Offshore Europe in September the Chancellor of the Exchequer, George Osborne, stated: “Never before has any government entered into legally binding contracts with individual companies to guarantee the tax relief they can expect decades into the future. No other place in the world provides such a guarantee.”

The Government has now introduced the necessary authorising legislation, and amendments to the tax code, to facilitate the contracts in the Finance Act 2013. The contracts, known as Decommissioning Relief Deeds (DRDs), are also now available to eligible companies and the first DRDs were signed last month. The effect of this change will be to encourage investment by existing owners of assets, increase asset trades and free up capital currently put aside to provide security, thereby extending the productive life of many fields – all at no cost to the Exchequer. Oil & Gas UK’s analysis suggests that decommissioning certainty will unlock new investment of about £40 billion, generate an additional 1.7 billion barrels of oil and gas and, over the next five years alone, the Exchequer could receive an extra £1 billion in tax revenue.

To achieve the full extent of these benefits, now the Government has put in place the statutory authority and begun to issue the new contracts, the final piece of the tapestry is for both existing and future DSAs to be amended to provide for security to be given net of tax relief. Oil & Gas UK has published suggested revised versions of its template DSA to take account of the introduction of DRDs. Oil companies are now beginning to address the significant task of amending existing DSAs (many of which predate the industry standard and are in many and various forms) to reflect the new guarantee.

To see the DRD, and information about applying for one, click here.

To see the amended Oil & Gas UK DSAs (there is a charge for non-members), click here.

Judith Aldersey-Williams has been advising Oil & Gas UK throughout this intensive period of discussion and negotiation with HM Treasury and HMRC. This work was rated as a standout entry in the Finance Category at the FT Innovative Lawyer Awards 2013.