New oil and gas windfall tax introduced

United KingdomScotland

The UK government has announced today the immediate introduction of a 25% windfall tax – described by the Chancellor as a “targeted, temporary energy profits levy” – on profits from UK oil and gas activities. Until recently the government position had been against the introduction of such a tax – primarily on the basis that it could impact investment in the UK – and the new tax was accompanied by the announcement of a new investment allowance for oil and gas activities.

Energy profits levy

The new levy will take the form of a 25% increase to the combined 40% rate of ring fence corporation tax and the supplementary charge, resulting in an overall headline rate of 65% applying to profits from oil and gas activities.

The levy will take effect from 26 May 2022 under standalone legislation to be introduced shortly (the bill is yet to be published). It has been described as being phased out once oil and gas prices return to “historically more normal levels”, though what this will constitute is not yet clear. The legislation will also include a so-called ‘sunset’ provision effective at the end of December 2025. This is in contrast to the residential property developer tax (another recently implemented sector-specific tax introduced in response to recent events), where the government resisted calls for the inclusion of a sunset clause despite their stated intention for the tax to be time-limited.

Crucially for companies that have made significant losses in recent years – or have assets that are either late life or being decommissioned – taxpayers will not be able to offset either previous losses or decommissioning expenditure against profits subject to the new levy. Companies that are not currently taxpaying – or would not be profit-making if viewed over a longer period of time - could therefore fall within the charge if currently profitable.

New investment allowance

The levy is accompanied by a new investment allowance, which is intended to operate in a similar manner to the ‘super-deduction’ introduced in relation to general corporation tax last year. This will not be subject to the activation requirements currently applicable to the investment allowances regime, but will instead be available in the period it is incurred.

Based on the information announced to date, the allowance will involve expenditure benefiting from an 80% uplift in deductibility against the new levy.

Expenditure can currently be used against ring fence corporation tax and the supplementary charge (at a total rate of 46.25%, where investment allowances are utilised).

Under the new regime, qualifying expenditure would also be immediately allowable against the new levy (at 25%), with an additional uplift of 80% against that levy (so an effective deduction of up to 80% of 25%, or 20%). This is stated as giving rise to an additional tax relief of 45% such that in combination with the previous position, 91p of every £1.00 of qualifying expenditure is recovered in tax.

There is no indication that the new allowance will depart from the existing ring-fence principle that prevents expenditure on non-oil and gas activities from being deductible against oil and gas profits; so previous suggestions that this may drive investment in renewables or the energy transition more generally may prove unfounded.

The announcement states that the combination of the levy and allowance is expected to lead to an overall increase in investment, and to raise around £5 billion in revenue over the next year.

Electricity generators

Until this week public discussions on a windfall tax had been in the context of profits from oil and gas activities, but it was indicated on Tuesday that the government was also considering extending a similar tax to profits of electricity generators.

While no such tax has been introduced, today’s announcement was accompanied by a comment that certain parts of this sector may also have generated extraordinary profits, and that the government will urgently evaluate the scale of these profits and the appropriate steps to take.

In the absence of a standalone tax regime such as that already applying to oil and gas activities, the introduction and scope of such a levy may involve significant planning.

We will continue to review the detail of the legislation once available and as it progresses through Parliament. If you have any questions, or it would be helpful to discuss this new tax, please do get in touch.