On 26 May 2022 the Chancellor, Rishi Sunak, unveiled the much speculated "windfall tax" in the form of a new Energy Profits Levy. This was introduced amongst a package of measures to deal with the increasing cost of living as well as finding a source of funding to support those measures. It is expected that the measures to alleviate cost of living increases will cost £15 billion, however there is still a shortfall as this new levy is expected to raise £5 billion in its first 12 months. The levy does come with quite a generous "super-deduction" which is designed to encourage investment during the lifetime of the levy.
Although trailed as a windfall tax, in reality it is a multi-year levy with an anticipated sunset clause effective at the end of December 2025. However, the levy could be phased out if oil and gas prices return to what HM Treasury describes as "historically more normal levels". This phrase, conveniently for HM Treasury, is not defined.
What is the levy
The Energy Profits Levy, in simple terms, is like an extension of the supplementary charge. It applies to profits arising from ring-fenced energy trades. At a rate of 25% it brings the overall tax rate on ring-fence activity to 65% (being 30% ring-fence corporation tax, 10% supplementary charge and 25% for the new levy). Like the supplementary charge, there is no deduction for finance costs against the levy.
How the levy works
The levy will exclude certain deductions. Decommissioning expenditure will not be allowable against profits subject to the levy, nor will ring-fence corporation tax losses be allowed to be set against such profits (essentially barring the use of historic losses). Losses arising during the period of the levy can be set against profits subject to the levy, which will allow carry back and carry forward. However, given the limited timescale of the levy (especially if it ends prior to December 2025) this may not be of significant use.
The aspect of the new levy which has attracted most attention is the investment allowance. It is actually more beneficial than the investment allowance available for the supplementary charge (being 80% of qualifying expenditure rather than 62.5%), and it will be available for use in the periods in which the expenditure is incurred rather than when the investment generates income. The availability of this relief and the timing of its availability is expected to have an accelerating effect on proposed investment expenditure as clearly deploying investment expenditure prior to December 2025 will generate additional tax saving (or mitigate the new tax cost introduced by the levy). Considering this relief, the investment allowance for the supplementary charge and first year allowances under ring fence corporation tax, the overall tax saving is 91p for every £1 of investment expenditure.
There had been some contradictory comments from industry sources from industry prior to the introduction of the levy, and in the wake of its introduction we have seen the well-publicised intent by BP to review its UK continental shelf operations. However, the majors have been exiting the North Sea for some time so the impact on other operators is of more significance to the ongoing viability and development of the UK oil and gas sector. The generous investment allowance will certainly mitigate the impact of the levy and indeed may provide a catalyst for accelerated investment activity. Indeed this has already led to criticism due to environmental concerns of encouraging oil and gas development which contradicts government ambitions in relation to net-zero.
In due course we will see if this levy is temporary as currently anticipated. It is always hard for a government to let go of lucrative revenue streams, and that may certainly be the case if other sectors of the economy remain sluggish while the oil and gas sector provides revenue to HM Treasury at a level not seen for some time.