Changes to Energy Profits Levy

Yesterday the new Labour government published a policy paper with changes it intends to make to the energy profits levy, commonly referred to as ‘EPL’. These include extending the period for which the levy applies, increasing the rate, and denying the use of tax reliefs for the purposes of the levy. The announcement suggests that the last of these would involve not only the removal of investment allowances, but also a restriction on the use of general capital allowances against the levy, which would represent a significant departure from the UK upstream regime to date.

Rate change to 38%

The energy profits levy was introduced as a ‘windfall tax’ in May 2022, and is charged on profits from oil and gas in the UK in addition to the existing ring fence corporation tax (at a current rate of 30%) and supplementary charge (at 10%). When introduced, the levy was charged at 25%, but this was increased to 35% from 1 January 2023, meaning the aggregate headline rate is currently 75%. Various costs are also denied for the purposes of EPL – including financing costs, decommissioning costs and losses incurred prior to the introduction of EPL – which has meant the impact of EPL has varied significantly for those operating on the UK continental shelf depending on where in the field and investment lifecycle their assets happen to be.

Labour propose further increasing EPL to 38% with effect from 1 November 2024 – just after the proposed date of the Budget – giving a headline rate of 78%. It has previously been suggested that the rationale for this is that this it matches the headline rate in Norway: the Norwegian regime, though, does not have the same restrictions on reliefs as those applying to EPL, and this difference seems likely to be exacerbated by yesterday’s proposal to further restrict reliefs.

Extension to 2030

The levy will also be extended to 31 March 2030. This represents a two-year extension from the current legislative end date - although the previous Conservative government had announced it would extend it to 2029 - and pushing it beyond the end of the next parliament. The 'energy security investment mechanism' introduced earlier this year will remain. This mechanism provides that the levy will fall away early if market prices for both oil and gas fall below index-linked thresholds for two consecutive quarters: although when it was announced, it was stated that the Office of Budgetary Responsibility did not expect this to occur during the then-lifetime of the levy to March 2028. Assuming it does not fall away, the temporary windfall tax announced in 2022 will have been in place for nearly eight years.

Removal of allowances

The most significant aspect of the proposed changes seems likely to be the removal of allowances associated with EPL. When EPL was introduced, the government sought to avoid the dramatic increase in rate having an adverse impact on investment in the UK continental shelf by also introducing a new investment allowance, which provided an uplift on qualifying expenditure against the EPL. Following the increase to a 35% rate, this allowance gave a 29% uplift for general qualifying expenditure, and an 80% uplift for expenditure on decarbonisation. Yesterday's announcement states that the 29% allowance will be removed for any costs incurred after 1 November 2024: though given the long timeline for investment, companies are likely already to have committed to incurring costs after this date. The decarbonisation allowance will be retained.

More significant is the announcement that the government "will also reduce the extent to which capital allowance claims (including First Year Allowances) can be taken into account in calculating levy profits" with effect from 1 November. Given the capital-heavy nature of costs associated with oil and gas exploration, development and production, it has been a long-standing feature of the UK regime that capital expenditure is fully allowable in the year it is incurred. Introducing restrictions on general capital expenditure is a significant departure from this; as well as from the general corporation tax regime, following the introduction of 'full expensing' from April 2023. As a result, the current anomalies associated with decommissioning costs – which can see taxpayers with high decommissioning costs paying EPL at 35%, even where loss-making – could be further extended to general capital expenditure.

The extent of the restriction on capital allowances is not yet confirmed, which will mean further uncertainty between now and the Budget in October for an industry that has seen numerous fiscal changes in recent years. This uncertainty is also likely to be relevant to transactions taking place during the period, given that these often involve significant tax considerations.