The Chancellor Rishi Sunak has announced that the Treasury will introduce a windfall tax on North Sea oil and gas producers.
The temporary 25% tax on profits should raise around £5bn of revenue over the next year, set to be phased out when prices return to more normal levels.
Speaking earlier today, he stated: “The oil and gas sector is making extraordinary profits, not as the result of recent changes to risk-taking or innovation or efficiency, but as the result of surging global commodity prices driven in part by Russia’s war.
“For that reason I am sympathetic to the argument to tax those profits fairly.”
Sunak also said: “It is possible to both tax extraordinary profits fairly and incentivise investment.”
Oil and gas prices have risen substantially, with oil prices nearly doubling since early last year, and gas prices more than doubling, resulting in significant increases in profits earned from UK oil and gas extraction.
The new Energy Profits Levy will go towards supporting people struggling with the increased cost of living.
A new 80% Investment Allowance will mean businesses will overall get a 91p tax saving for every £1 they invest – providing an additional, immediate incentive to invest. This nearly doubles the tax relief available and means the more investment a firm makes, the less tax they will pay.
The levy does not apply to the electricity generation sector. However, certain parts of it have also seen extraordinary profits partly due to record gas prices.
As set out in the Energy Security Strategy, the UK Government is consulting with the power generation sector and investors to drive forward energy market reforms and ensure that the price paid for electricity is more reflective of the costs of production.
"Those reforms will take time to implement," read a Treasury statement. "In the meantime, the government will urgently evaluate the scale of these extraordinary profits and the appropriate steps to take."
How will the Energy Profits Levy work?
- Currently, the oil and gas sector pay a 40% headline rate tax on profits consisting of 30% Ring Fence Corporation Tax and 10% Supplementary Charge.
- In recent years, under the existing regime, fewer than 35 groups have made tax payments each year. In 2021, the top seven groups accounted for around 95% of payments.
- The Energy Profits Levy is an additional 25% tax on UK oil and gas profits on top of the existing 40% headline rate of tax, taking the combined rate of tax on profits to 65%.
- To appropriately tax the extraordinary profits, companies will not be able to offset previous losses or decommissioning expenditure against profits subject to the levy.
- It is expected to raise around £5bn in its first 12 months.
- The tax will take effect from today, 26 May, and will be legislated for via a standalone Bill to be introduced shortly.
- In future years, if oil and gas prices return to historically more normal levels, the UK Government will phase out the Energy Profits Levy, and also the legislation will include a sunset clause, effective at the end of December 2025.
How the new Investment Allowance will work?
- To encourage reinvestment, a ‘super-deduction’ style investment allowance will be introduced within the levy to provide an immediate incentive for the oil and gas sector to invest in UK extraction.
- The new investment allowance rate is 80% and means the total tax relief on investment nearly doubles - for every £1 businesses invest they will overall get a 91p tax saving.
- The current 10% Supplementary Charge provides companies with an investment allowance that can only be claimed once income is received from the field subject to the investment (which can take several years).
- In contrast, the new 80% Investment Allowance for the Energy Profits Levy will be available to companies at the point of investment, making it both more immediate and more generous.
- The government expects the combination of the levy and this investment allowance to lead to an overall increase in investment, and the OBR will take account of this policy in their next forecast.
Overall, the tax relief companies receive from qualifying expenditure will nearly double, from 46p for every £1 of extra investment to 91p.
There is precedent for taxes on exceptional profits. For example, in 1981, a one-off tax on certain bank deposits was introduced via a 2.5% levy on deposits of banking businesses, who were benefiting from high interest rates.
The permanent 40% headline tax rate for oil and gas producers is competitive globally against similar operating environments, and is lower than Norway, the Netherlands and Denmark.
The UK oil and gas fiscal regime taxes profits earned by companies from the production of oil and gas on the UK Continental Shelf.
The regime is kept separate to other taxes on commercial profit by the operation of a 'ring fence', which prevents losses from other activities being imported into the regime. The current headline rate of tax is 40%, made up of the following taxes:
- 30% Ring Fence Corporation Tax – this is a tax on profits from exploration and production in the UK, largely on the same basis as normal corporation tax rules. This has not changed since the Supplementary Charge was introduced in 2002.
- 10% Supplementary Charge – this is an additional charge of 10% on adjusted ring-fence profits, excluding finance costs. It has remained unchanged since 2016 (when it was reduced from 20% to 10%). The rate peaked at 32% between 2011 and 2014.
- 0% Petroleum Revenue Tax – a field-based tax charged on profits arising from fields given development consent before 16 March 1993. It has been zero-rated from 2016 but not abolished to allow companies to carry back losses arising from trading and decommissioning.
Ryan Crighton, policy director at Aberdeen & Grampian Chamber of Commerce, said: “In the short-term, taking an additional £5bn from a sector already taxed at 40% will achieve very little apart from making the North Sea - already one of the world’s most mature basins - less attractive to investors.
“It is clear that the Treasury has benefited enormously already from higher energy prices, to the tune of £19m per day so far this year, and therefore offering targeted support to consumers and businesses was already within its gift, without this damaging additional tax raid.
“It needlessly puts obstacles in our path to net zero and will increase our reliance on imported energy, which comes at a greater environmental and financial cost.”
Susannah Streeter, senior investment analyst at Hargreaves Lansdown, commented: ‘’As Sunak perfected his u-turn on a windfall tax, the share prices of BP and Shell also looped lower, before climbing back up, as investors shrugged off its impact given that it is expected to be a short lived hit.
‘’It may mean dividends are pushed lower temporarily, but given that tax will reduce if companies invest more, it’s likely to mean an acceleration of investment by BP and Shell, a strategy which will be welcomed by many investors who see environmental progress and not just shareholder pay-outs as crucial for their long term growth prospects.”
A barrel of Brent crude, the international benchmark, edged higher to just shy of $115 - around double what it was at the start of the year, pushed higher by the outbreak of war in Ukraine.
Elsewhere in the announcement, a new £15bn package of targeted UK Government support was announced.
The intervention includes a new, one-off £650 payment to more than eight million low-income households on Universal Credit, Tax Credits and legacy benefits to be made in two tranches starting in the summer, with separate one-off payments of £300 to pensioner households and £150 to individuals receiving disability benefits.
Sunak also announced that the energy bills discount due to come in from October is being doubled from £200 to £400, while the requirement to pay it back will be scrapped. This means the vast majority of households will receive a £400 discount on their energy bills from October.
The new Cost of Living Support package will mean that the most vulnerable households in Scotland will receive more than £1,000 of extra support this year.
Sunak also announced a £500m increase for the Household Support Fund. This brings the total Household Support Fund to £1.5bn.
This will all be paid for by the Energy Profits Levy, with Sunak stating: “I know that people in Scotland are anxious about keeping up with rising energy bills, which is why today we have introduced measures which will take the support for millions of the lowest income households over £1,000.
“It is right that companies making extraordinary windfall profits from rising energy prices should contribute, and I’m introducing a temporary energy profits levy to help pay for this support, while still encouraging the investment that generates jobs in Scotland.”
During the announcement, the Chancellor also set out Westminster's strategy to control inflation through independent monetary policy, fiscal responsibility and supply side activism – a plan he said that should see inflation come down and returning to its target over time.
The total cost of all the measures announced this year is now estimated by Treasury to be £37bn, which is equal to the total income tax paid through self-assessment tax returns for 2021/22.
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