The retention by a seller of part or all of the decommissioning liability associated with a licence interest being sold immediately mitigates or removes the issue of any lack of buyer capacity to enable it to obtain tax relief for decommissioning expenditure. To the extent the seller, not the buyer, is bearing decommissioning costs, tax relief for those costs is an issue for the seller not the buyer. It will have been a key feature for both Shell and BP that their transactions are structured in a way that preserves their ability to claim the relevant tax reliefs when they start to incur costs relating to the decommissioning expenditure. From a tax rules perspective the important point is that the seller is paying for the decommissioning of plant and machinery which comprises an offshore installation or pipeline which has been brought into use for the purpose of a ring-fence trade, broadly carrying on upstream oil and gas operations. For this, as well as other plain commercial reasons, retention of decommissioning liability is generally limited to those installations in place at the time of the sale transaction and does not extend to the decommissioning of installations added by the buyer after such date. The expenditure must be incurred in complying with an approved abandonment programme or in compliance with a condition imposed by the Secretary of State prior to agreement of an abandonment programme. Where Petroleum Revenue Tax (PRT) fields are involved the seller will have to retain an interest in the field licence at the time of decommissioning in order to be eligible for decommissioning relief. This is not the case for non-PRT fields. There has been some uncertainty whether a seller would be entitled to the tax relief where the buyer bears the primary liability for decommissioning expenditures and then is indemnified or reimbursed by the seller. At the time of the 2016 budget, HMRC provided guidance that a seller needed to be directly incurring decommissioning expenditures to qualify for the relief. Clearly this still leaves plenty of ambiguity and on any given transaction structure confirmation from HMRC may be desirable that reliefs will be available.
Notwithstanding this, where a buyer does take on liability for decommissioning, the issue of the ability of a buyer to have access to tax relief for decommissioning expenditures where they do not have a tax history in the UKCS remains. Although for PRT purposes relief for decommissioning costs can be carried back and met against PRT liabilities of former participants, for Ring Fence Corporation Tax and Supplementary Charge purposes losses arising from decommissioning costs can only be carried back against the ring fence profits of the company incurring the loss. On March 20, 2017 HM Treasury issued a discussion paper asking for comments on possible changes to the tax treatment of the sale of late life assets to, amongst other things, allow for the transfer of the tax history of a seller to a buyer to address this issue. The consideration of such changes had been previously flagged in the 2016 budget. The discussion paper illustrates the desire of the Government to support M&A activity in the UKCS in relation to late-life assets in the interests of MER but it is also clear that the Government has not yet decided what changes, if any, to make. Comments are due on the paper by June 30, 2017 and it is expected that any proposed changes will be announced in the Autumn Budget.
Structuring a transaction around the retention of decommissioning liability is not just a question of tax relief. Where the buyer takes ownership of the assets and will perform decommissioning obligations but the seller will pay all or a significant part of the costs then governance also becomes a key concern where the sums involved are material. How much involvement does the seller need in decisions made by the buyer and, where relevant, its co-venturers in relation to decommissioning? Where part of the commercial rationale of the transaction is the potential for the buyer to decommission for less than the seller, undue oversight or interference from the seller may prejudice that outcome. On the other hand, few organisations are happy for another to spend tens or hundreds of millions of their dollars without a reasonable degree of involvement. Sellers will also be concerned that the way in which the assets are operated may in fact increase decommissioning liabilities and their reputational exposure if something goes wrong during decommissioning operations. In drawing the appropriate line the seller will also have in mind its objective to release the organisational capability that has hitherto been dedicated to the relevant assets, something that may be compromised if substantial ongoing involvement is needed. Finally, putting a ring-fence around those installations that the seller will retain decommissioning liability for requires careful thought and definition. Whilst in many cases it may be clear what constitutes a new installation, what about modifications to or replacements of existing installations?
We have advised on a number of UKCS transactions over the past 24 to 36 months where a proposal for the seller to retain all or part of the decommissioning liability associated with the relevant licence interests has been tabled. In a number of these cases the proposal was not entertained whilst in others it was not the preferred option. Significantly, so far as we are aware, no alternative deal materialised. What is clear from this experience is that it is not in the interests of MER. Whilst Shell had previously retained decommissioning liabilities when it sold its interest in the Greater Kittiwake Area to Venture and Dana in 2003 and BP had done the same when it sold its interest in the Thistle /Deveron fields to DNO in 2002 and its interest in the Erskine field to Serica in 2015, there is a sense that the recent Chrysaor and Enquest deals reflect a coming of age of the notion that the “clean-break” is not the only way forward and that retention of decommissioning liabilities is now an acceptable and accepted feature of the UKCS M&A landscape. If this is the case, if the oil price stays at least within its more recent range and if HMRC can deliver some good news on the fiscal aspects of decommissioning relief later this year, then predictions of improved M&A activity on the UKCS may well come to pass.