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6 August 2009
Oil and gas tax changes in a challenging economic environment
Ernst & Young has recently released the first Global oil and gas tax guide,
summarizing the 40 most important tax jurisdictions from an oil and gas perspective.
The purpose of this article is to provide a high-level overview of the key issues related
to oil and gas taxes and of the tax changes enacted by Australia, the United Kingdom,
Kazakhstan, Russia and the United States in response to the global economic
downturn.
The global economic downturn and instability in the financial markets have created
new challenges and opportunities for oil and gas companies. However, the impact on
different components of the sector is highly variable. Major implications for the oil and
gas industry are:
 Due to a lack of readily available and affordable financing, many smaller,
independent companies have announced significant reductions in their planned
investment for 2009 compared with the previous year. Cutbacks in spending by
independent players could impact the longer-term viability of oil and gas production
from less developed regions.

Sub-sectors of the industry that require a higher oil price to be economically viable
are likely to suffer from a reduced level of capital investment. Forward investment
plans on renewables and oil sands projects are being delayed or scaled back as
high costs and lower oil prices force developers to reassess the economics.

In the short term, merger and acquisition activities are impacted, as companies are
finding it difficult to raise funds from the debt and equity market. However, the
market turmoil has opened up new acquisition opportunities for cash-rich players,
particularly reserve-seeking national oil companies (NOCs).
In considering what measures can be further taken by countries to support long-term
oil and gas investment, the following are examples of actions related to tax that may be
appropriate:
Reduction of royalty rates
In jurisdictions that charge royalties on gross sales revenue, without a sliding scale that
reduces the royalty percentage on a reduction in oil price, a reduction in the royalty rate
may bring significant relief to companies in distress.
Increase of capital allowances
Many tax regimes will provide for capital allowances to be claimed by oil and gas
companies. Although some of these allowances may be generous, the increase of
allowances on capital expenditure during the economic downturn should be considered
to encourage continued investment in, and development of, oil fields.
Production sharing contracts
Many oil and gas jurisdictions tax oil and gas revenues in accordance with production
sharing contracts (PSCs) entered into between a company and host government.
PSCs typically provide for the participating company to recover their costs at a prespecified percentage of production. Most PSCs have limits on the percentage in a
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particular year. With the onset of the economic crisis and the resultant collapse of the
oil price, many previously profitable fields have become marginal. Under these
circumstances, it may be appropriate for governments to offer to increase the
percentage rates as set by the PSC.
Tax rates
A decrease in tax rates on profits may encourage investment in the oil and gas sector
in general and specifically during the economic downturn. However, unless the benefit
of a reduced tax rate is granted over the long term, it is unlikely to provide a short-term
advantage for companies looking to invest in the sector.
Incentives
To encourage continued oil and gas exploration, governments may consider granting
special incentives.
Given the scope of the changes in the market and the fluctuations in the price of oil,
many countries are reviewing their oil and gas tax regimes in order to determine the
relevance in the current economic climate. Recent tax changes in the following
countries are of significance and briefly explained below. A more detailed explanation
can be found in the Global oil and gas tax guide.
Australia
Australia introduced a temporary additional corporate income tax deduction in the form
of an investment allowance, which covers new investment in tangible assets between
the period 13 December 2008 and 31 December 2010.
The investment allowance is aimed at boosting investment and building confidence in
the face of the global economic downturn and is a welcome development in the current
environment. It will hopefully encourage companies operating in Australia to continue
with and even increase their capital expenditure programs during the economic
downturn. In order to secure an additional 30% allowance the expenditure had to be
committed to by 30 June 2009. An additional 10% allowance may still be available if
the asset’s commitment time is by 31 December 2009. This timeframe is very short in
the context of large scale oil and gas developments.
United Kingdom
After an extended period of consultation, certain changes to the UK oil and gas fiscal
regime were included in the 2009 Finance Bill aimed at supporting investment in the
UK North Sea. The proposed changes include:

A new “Field Allowance”: intended to support investment in specific projects where
the supplementary charge makes the project return marginal or uneconomic.
Specifically targeted are small fields (less than 3.5m tonnes), heavy oil fields and
high-pressure, high-temperature fields. A defined level of income from each
qualifying project will be exempted from supplementary charge, resulting in a
reduction in the overall tax liability suffered on the profits arising from the project.

Removal of tax barriers to “change of use” activities: oil and gas tax legislation has
evolved in a manner not conducive to allowing infrastructure to be reused for nonoil activity, such as wind power, carbon capture and gas storage activities, and the
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chancellor has confirmed that changes will be made to remedy this. Changes to the
Petroleum Revenue Tax (PRT) rules on decommissioning relief, tariff receipts and
deemed disposal receipts, and to the Corporation Tax (CT) rules on
decommissioning relief, will be made to remove tax disincentives to change of use
projects. In addition, HM Revenue and Customs (HMRC) has given confirmation
that they agree “cushion gas” required for gas storage activities can be treated as
plant for capital allowance purposes.

Chargeable gains changes: ring-fence asset disposals will be exempt from Capital
Gains Tax (CGT) if the proceeds are reinvested in acquiring new ring-fence assets,
and swaps of developed licenses where no consideration changes hands will not
give rise to chargeable gains. The reinvestment relief extends the “hold-over relief”
currently available on license disposals to a full exemption, and the relief for
developed license swaps extends the relief currently available for swaps of
undeveloped licenses.

Some PRT simplification measures and technical changes to PRT relief for
decommissioning costs have also been proposed.
Kazakhstan
Kazakhstan introduced a new tax code with effect from 1 January 2009. This code
included a radically revised tax regime for oil, gas and mining operations. However, the
regime was written while oil prices were at their peak in 2008 and consequently it is
primarily targeted on capturing for the state most of the gross revenue of high oil
prices. The result is a regime that is a modest relaxation of state take, compared with
the previous regime in the lower part of the price range (below US$60 per barrel), but
which captures for the state almost all of the added value when oil prices exceed
US$100 per barrel.
Russia
In Russia, a set of initiatives undertaken with respect to profits tax include, in particular,
the decrease in the headline profits tax rate from 24% to 20%; the increase in the
accelerated capital allowance for fixed assets from 10% to 30%; and the reduction in
the statutory useful life of certain oil and gas related assets. During 2009, the maximum
deductible interest rate was increased from 110% of the Central Bank refinancing rate
for ruble loans and 15% for loans in a foreign currency, to 150% and 22% respectively.
The mineral extraction tax rate has been somewhat reduced. In addition, oil extracted
from new fields located north of the Arctic Circle, in the Sea of Azov, the Caspian Sea,
the Nenets Autonomous District and the Yamal peninsula may be exempt from mineral
extraction tax during a certain period until production reaches a certain level.
All of the above countries have taken steps intentionally or unintentionally to lessen the
tax burden on oil and gas companies during the economic downturn. While the
changes will provide marginal relief in some form, they are not comprehensive and
some companies may benefit more than others.
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Interestingly, in contrast to the steps taken by the countries above, the United States
has enacted the Emergency Economic Stabilization Act of 2008, which added to the
tax burden on the oil and gas industry. The Act changed the way the foreign tax credit
rules apply to the oil and gas industry, reducing the amount of foreign tax credits
available. It froze the deduction for domestic manufacturing at 6% for the oil and gas
industry, while permitting that deduction to rise to 9% for all other industries. Finally, it
extended and increased the excise tax for the Oil Spill Liability Trust Fund. According
to industry experts, these changes are estimated to cost the oil and gas industry
US$10 billion over the next 10 years. There are also proposals in the 2010 Budget that
will substantially increase taxes on the industry.
Clearly, such actions do not assist American oil and gas companies in an era of low oil
prices, and should be viewed in the context of United States’ endeavors to move from
a reliance on oil to renewable energy sources.
Oil and gas companies are going to continue to be unevenly impacted by the global
economic downturn. During the downturn and beyond, companies should consider all
the tax implications of their investment decisions and be vigilant in monitoring changes
in tax regimes that will impact their current business operations. Governments that
create a stable and beneficial investment environment will preserve the viability of the
local oil and gas industry and encourage further development. This is particularly
important for the emerging markets, but not exclusively.