BSM 151: COMPARATIVE INTERNATIONAL TAX LAW

FRANCISCA O. DAWODU
ST1217523
10/01/2014.
 Table of Content
1. Introduction
2. Development of Tax regime in the UKCS
3. Tax regime in Brazil
4. Comparative and critical analysis of the development of the
regulatory and taxation regime in U.K. and Russia.
5. Conclusion ..
6. Bibliography.

COMPARATIVE ANALYSIS OF THE REGULATORY AND TAX

REGIME OF THE UNITED KINGDOM AND RUSSIA

1.0. Introduction

The equality of tax levied on a society does not depend on the wealth it possesses but on
the equality of debt owed to the country.1 Governments merely impose tax to enable it
contribute towards the running of services required in its economy. The exploration of oil and
gas in the North Sea has emerged as the great boost in the UK economy. Oil and gas being
a highly taxable commodity is subject to vigorous tax laws. Petroleum taxation are imposed
by the government as a means of earning revenues from the international oil companies
(IOCs). From the United Kingdoms perspective, natural resources are owned and controlled
by the government and as such, the government is obliged to apply the appropriate tax to
appease its own people and attract foreign investors.

The discovery of oil and gas in the North Sea has prompted the need for a regime change
as to taxation of oil companies. The government gets its share of benefits and companies
are rewarded for their heavy investments in the exploration and production of petroleum. In
the early era, the only mechanism available for the government in generating revenue from
the exploration and production of oil and gas was by means of royalties and licensing. In
1974, the Petroleum Revenue Tax and Corporate Tax ring fence was proposed by the

1
Professor Thomas Hobbes Levitan 1651
government to strike a fair balance between the nation and oil companies by giving a fairer
share of profit to the nation and maximised the balance of payment and rewarding the IOCs
in taking a risk in the exploration and production of petroleum resources.2

The writer of this essay aims at examining the development of the tax regime in the United
Kingdom from 1975 as the Oil Taxation Act 1975 became the structure of the now current
fiscal regime and the regime has been a subject of constant change. It also aims at
examining the tax regime of another oil and gas producing country (Brazil) using Ernest and
Young global tax guide 2013 to draw a comparative analysis of the regulatory and fiscal
regime of both nations for the sole purpose of arriving at the conclusion that whatever
taxation regime a government intends to implement, it must strive hard to strike a balance
between its take and that of the international oil companys so as not to prevent investment
and maximum recovery.

2.0. Development of the tax regime in the UKCS.

Oil and gas was discovered in the United Kingdom in the early 1960s. In 1975, the Oil
Taxation Act of 1975 formed the basis and gamut of the incumbent tax regime.3 The 1975
Act was made for the first time and introduced in 1974 through a white paper. The incumbent
structure is radically different from what obtained in 1975 as several changes has occurred
to the regime ever since then.4 Prior to 1993, governments take in the North Sea was very
high. In our modern economy, it ranks as one of the most attractive regimes globally.
Whatever taxation the United Kingdom government intends to implement, it must take into
consideration the maturity of the UKCS and that there are other regions seeking the
attention of the international oil companies.

In light of this, it is mandatory for the United Kingdom to adapt to changes as it is said that
the only constant thing in life is change. In the case of the UK with little petroleum potential,
great hazard exploration and high cost of development, it is advised that reduced take
should be resorted to.

The United Kingdom operates a petroleum concession fiscal regime and the basic fiscal
regimes employed in the country are Petroleum Revenue Tax (PRT), Corporation Tax (TX)

2
The Taxation of the UK Oil Industry: An Overview: Public Accounts Committee Report 1973 and the 1974
White Paper
3
Carole Nakhle, Petroleum Taxation: A Critical Evaluation with Special Application to the UK Continental Shelf
available at <http://epubs.surrey.ac.uk/2790/1/410990.pdf> accessed on 15th December 2013
4
Ibid
and royalties. At the creation of the UK tax regime, the Inland Revenue service (IRS) aimed
at ensuring a just take of the IOCs returns for the nation and the international oil companies
had a fair income/returns on their capital investment.

The United Kingdoms tax regime has on several occasions been reviewed although its roots
dates back to 1975. Andrew et al in 2011 opined that the worst place to produce oil was not
Russia or Venezuela but the United Kingdom due to its constant tinkering with its tax rates.5
In 1987, Rowland et al was also of the opinion that the fiscal instability experienced in the oil
and gas sector of the United Kingdom economy had never been experienced by any other
industry.6 In the 1980s, 87 per cent of the governments take in the oil and gas sector
plummeted to 30% through the introduction of 10% supplementary charge on corporate tax
generated profits.7 For the very first time in 2002 ever since 1983, the government increased
its take. The introduction of the supplementary charge was heavily criticised by the United
Kingdom offshore operations associations (UKOOA now called OGUK) as it argued that it
was introduced in the wrong time in the North Seas life. The government through the
Chancellor had an opposing view and claimed that the introduction will boost lasting
investment in the North Sea. There is bound to be disagreement amongst the interest
groups involved in the oil and gas sector due to lack of objective criteria for fixing a particular
fiscal regime. Mutual agreement is required for the takes decisions because it can hinder
investments and most host countries lack the resources to develop the resources
unilaterally. Arguments has been made that a small sacrifice from one side may be a big
gain for the other.8 This is further reinforced by the subtle financial, technical, legal and
political brouhaha; hence striking a balance will be apposite. A nations long- term
sustainability universal competitiveness can be argued to be premised on the states fiscal
regime. Sequel to bigger fields such as Brent, Ninian and Forties, corollary fields has
become consistently marginal.9 As Crowson puts it, it is important not to frighten away the
geese so that they no lay any eggs, golden or otherwise, let alone present themselves for
plucking. Colbert allegedly also commented that the art of taxation consists in so plucking

5
Andrew Inkpen etal, The Global Oil and Gas Industry:Management, Strategy and Finance, (Tulsa, Oklahoma
2011) 248
6
Chris Rowland and others, The Economics of North Sea Oil Taxation (Macmillian London, 1987)
7
Ibid.
8
Carole Nakhle, Petroleum Taxation: A Critical Evaluation with Special Application to the UK Continental Shelf
available at <http://epubs.surrey.ac.uk/2790/1/410990.pdf> accessed on 15th December 2013
9
Emre Usenmez, The UKCS Fiscal Regime in Greg Gordon, John Paterson, Emre Usenmez (eds), Oil and Gas
Law: Current Practice and Emerging Trends (2nd edn, Dundee University Press 2011)
the goose as to obtain the largest amount of feathers with the least possible amount of
hissing.10

The long-term sustainability universal competitiveness of any nation can be argued to be

premised on the states fiscal regime. Sequel to bigger fields such as Ninian, Brent and
Forties, corollary fields has become consistently marginal.11

Critically speaking, an objective and open minded thinking must be given to the fact that
what is important is the choice of an appropriate evaluation technique and not just the per
cent take of each party. Disagreement still clouds the issue of an appropriate financial
evaluation technique and the impact of the tax on profitability. Generally speaking, the
volatility in the global oil and gas price over the last 30years requires the flexibility of fiscal
policy of the UK to keep with any major price change.12

2.1. Royalty Payment and the UK Fiscal Regime.

Arguments has been made that the story of the United Kingdoms petroleum concession and
fiscal regime appears to be unique due to the employment of a unique concession type of
agreement which no longer includes a royalty charge as a key element of its fiscal regime.

To what extent can this arguments be approved as it relates to the removal on the payment
of royalties?

In January 1 2003, the payment of royalties was abolished in its entirety.13 Prior to this date,
only fields which got development consent on or prior to March 31st 1982 paid royalties.
Alleviation in global oil prices lead to the abolishment of the payment of royalties for fields
obtaining development consent after the 31st of March 1982.14

10
James Morton, The Poverty of Nations: The Aid Dilemma at the Heart of Africa (paperback edn, I.B. Tauris
& Co. Ltd, London 1996)
11
Emre enmez, The UKCS Fiscal Regime in Greg Gordon, John Paterson, Emre Usenmez (eds), Oil and Gas
Law: Current Practice and Emerging Trends (2nd edn, Dundee University Press 2011)
12
HM Revenue & Custom, A Guide to UK and UK Continental Shelf:Oil and Gas Taxation (January 2008)
<http://www.hmrc.gov.uk/international/ns-fiscal3.htm> accessed on 8th January 2014
13
HM Revenue and Custom, A Guide to UK and UK Continental Shelf: Oil and Gas Taxation (January 2008)
available at <http://www.hmrc.gov.uk/international/ns-fiscal3.htm> accessed on 15th December 2013
14
Emre Usenmaz, The UKCS Fiscal Regime in Greg Gordon and others (eds) Oil and Gas Law Current
Practice and Emerging Trends (2nd edn Dundee University Press 2011) 138
Arguments has also been made that the United Kingdoms concession model
accommodates private interest under public control. This is true to an extent as the
authorities to grant licences and to deny consent for development plans provides the
government with some control over the manner in which and the speed at which the
countrys hydrocarbon resources are exploited.15 Notwithstanding the above, the recourse to
the North Sea model which has the characteristics to wit:

Unique petroleum taxation and state participation being used as vehicle for garnering
experience and also profiting from the oil and gas income.
Reliance on Foreign Oil Company was mandatory for the UK owing to inadequate
and experience in the oil and gas sector and,
Unlike varying oil producing nations, licences were approved in line with
administrative allocation in smaller areas.

The North Sea Model gave room for oil and gas production licenses to be granted to private
and multinational oil and gas companies and to be controlled under royalties and unique
taxation to be paid in addition to conventional corporation taxes. This was the reason behind
Abdos argument when he quoted Norengs statement that it accommodates private interest
under public control.

EVOLUTION OF THE UK NORTH SEEA TAX SYSTEM

Despite the Oil Taxation Act 1975 establishing the petroleum fiscal regime for the UKCS, it
has occasionally been reviewed and amended. This was mainly caused due to the
combination of factors such as the volatility of oil prices, the international competitiveness of
the United Kingdom as an oil producing province and the maturity of the UKCS.16 The UK
government enjoyed the greatest intake of revenue from oil companies during the early

15
HM Revenue & Custom, A Guide to UK and UK Continental Shelf:Oil and Gas Taxation (January 2008)
available at <http://www.hmrc.gov.uk/international/ns-fiscal3.htm> accessed on 20th December 2013
16
Carol Nakhle, Evolution of the UK Fiscal Regime, Vol 4 Issue 1, OGEL May 2006
1980s and this was mainly under the oil companies pressure to ease the tax burden even at
this point in time. In april 2002, the government increased its take for the first time sicne
1983 through the imposition of a 10% supplementary charge on the Corporate Tax based
income.

FOUNDATIONS OF THE CURRENT REGIME

The United Kingdom government in 1974 published a white paper setting out two principal
objectives with respect to the taxation of exploration and production activities on the UKCS.17
The first objective was to secure a fairer share of profit for the nation and the second being
to assert greater public control. The white paper also established the basic structure of the
current oil taxation system and this was later legislated for in the Oil Taxation Act in 1975. 18
The system was based on three elements: Royalty, PRT and CT.19

Royalty

Royalties are payments to a landowner for the right granted under the license to extract oil
and gas. In the United Kingdom, the royalty rate was fixed at 12.5% on the gross revenues
of each field with a deduction for conveying and treating costs. Royalties are based on a six
month period and is administered by the department of trade and industry rather than the
inland revenue who have responsibility for the other tax instruments.

Petroleum Revenue Tax (PRT)

These are special petroleum profit taxes. They are assessed on field basis hence a
company with taxable losses in one field cannot offset them against profit in another field.20
PRTs are charged on a half year basis at an initial rate of 45% on the value of oil and gas
produced. This equates to receipts less the expenditure incurred in developing and operating
the field. PRTs are mainly introduced to capture economic rent from the more profitable
fields. Less profitable projects are shielded from the tax as a result of various allowances
and reliefs. Three main reliefs are identified under PRTs

17
Entitiled United Kingdom Offshore Oil & Gas Policy (Inland Revenue, 2003)
18
Before 1975, there were two elements of the UK North Sea fiscal regime: Royalty charges at 12.5% and
Corporate Tax charges at 50%. The Oil Taxation Act 1975 established the Petroleum Revenue Tax and the main
regulations governing the administration of the tax (National Audit Office, 2000)
19
Ibid (n, 16)
20
Ibid (n.16)
 Uplift: An additional allowance of 75% to capital expenditures. PRTs are not to be
paid by companies until they have at least recovered 175% of their capital
expenditure.
Oil allowance: This allows one million tonnes of oil per annum to be exempt from
PRT up to a cumulative maximum of ten million tonnes. As a result, PRT are unlikely
to be payable on fields with reserves of less than 100 mmbbls. The Oil allowance
was introduced to help the development of marginal fields.
Safeguard: Safeguards limits the PRT liability in any chargeable period to 80% of the
amount by which gross profit exceeds 15% of cumulative expenditure. They were
mainly introduced to ensure that while it applies, PRT calculated after taking account
of all other reliefs do not reduce a participators return on capital in any chargeable
period to 15% or less. The safeguards limits PRT liability for a part of the fields life
and allows fields to achieve a certain level of return on investment before they incur
any PRT liability.

PRTs are similar to resource rent tax (RPT). RRTs are taxes designed to capture
economic rent. The two taxes however differ in their respective treatment of expenditure
carried forward for offset against future profits. RRTs allows such expenditure to be
carried forward in real terms together with an interest mark up while PRT compensates
for the absence of this relief by allowing Uplift to apply to most development
expenditures.

Corporation Tax (CT)

CTs were set at 52% on company gross profits. Exploration costs were deemed fully
deductible while development costs were made subject to various tax depreciation
allowances. CTs are standard company taxes on profits that applies to all companies
operating in the UK and companies can offset losses generated by one activity against
income generated by its other activities.

In the UKCSs exploration and production perspective, ring fence prohibits the use of
losses from other activities to reduce the profits originating from within the UKCS ring
fence and losses and capital allowances inside the ring fence may be set against
income outside the ring fence.
TIGHTENING OF THE SYSTEM (1978 - 1982)

The government implemented measures to increase the level of total tax take on the
United Kingdoms continental shelf following the increase in the oil price in the mid
1970s. In 1978, it increased the oil allowance from one MT to 500,000 mt per year with a
maximum allowance of 5 Mt. In 1980, the PRT rate was raised to 70% thereby
increasing the combined marginal rate to some 87%. A new tax supplementary
petroleum duty (SPD) was introduced. SPD was charged on a field by field basis by
reference to 20% of gross revenues less an oil allowance of one MT per annum. SPD
was applied in the early producing life of field and was payable on monthly basis.

Abolition of Royalties (1983)

In 1981/ 1982, the government started considering some adjustments to the fiscal
regime by reducing both oil prices and declining levels of development activity combined
with continuing industry pressure. For the very first time in 1983, relaxation in the system
were introduced to encourage exploration and appraisal activity and to encourage the
development of new fields.

In 1983, SPD was abolished and replaced by advance petroleum revenue tax. It was
mainly imposed on gross revenues less an allowance of one MT per year. The rate
applied was 20% and payments were to be made on monthly basis. APRTs are not new
tax but rather an instrument for accelerating the payment of PRTs. It consisted of an
advance payment of PRTs that would be offset against the actual PRT payments due
later in the life of a field. Additionally, the PRT rates were increased to 75%. The
government further amended the regime in the same year by abolishing royalty on fields
receiving development consent after April 1982

Oil allowance against PRT was restored to one MT per year for a maximum of ten years.
Cross field allowances in addition to this was introduced with respect to PRTs and it
allowed up to 10% of the development costs of a new field to be offset against the PRT
liabilities of another field. At the end of 1986, APRTs were abolished and CTs reduced
to 35%.
SUPPLEMENTARY CHARGE (2002)

After the increase in oil prices in 1996/1997, the government in 1998 proposed two
alternative fiscal reforms. The first was the application of a supplementary corporate tax
on upstream activity profits and the other was on the re- introduction of PRT on fields
receiving development consents after March 1993.

The government in 2002 introduced new changes to oil taxation in the UKCS. Changes
were very close to one of the reform packages proposed in 1998. A 10% supplementary
charge on profit subject to CT was applied in addition to the 30% rate and the charges
were to be calculated on the same basis as normal CTs. A 100% capital investment
allowance was introduced by the government against both general corporate tax and
supplementary charge. Royalties were abolished on older fields that had received
development consents before 1983 to encourage fuller exploitation of reserves from
those fields.

INCREASE IN THE SUPPLEMENRATY CHARGE (2005)

Changes were introduced by the governments to supplementary charges to strike the

balance between enabling oil and gas companies to receive a fair post tax return for their
investments in the North sea thereby providing the UK with a fair share of the revenues
from its natural resources in view of the recent significant increases in oil prices and the
upwards shift in expectations of the medium term outlook for future oil prices.

Increase in the supplementary charges were accompanied with the following:

New investment incentives : ring fence exploration supplement which allowed

companies to carry forward unrelated expenditure with an uplift of 6% per annum for
a maximum of 6 years and,
Companies are now able to elect to defer 100% first year allowance claims for
expenditure incurred.
 Comparative and critical analysis of the development of the
regulatory and taxation regime in the United Kingdom and Russia.

This writer will attempt a cursory and critical look at the development of
the regulatory and taxation regime in Russia and that of the UK with the
aim of recommending or suggesting the best practice that should have
been adopted. I will strive to recommend the best regime as this can be
argued to be the preoccupation of a tax lawyer, this writer being one.
Before proceeding, it may be apposite to know what a fiscal system
encapsulates. It is technically, the legislated taxation structure for a
country (including royalty payments). The term includes all aspect of
contractual and fiscal element that make up a given government- foreign
oil company relationship.21
The fiscal regime that applies in Russia to the petroleum industry consists
of a combination of royalties (called mineral extraction tax (MET)),
corporate profits tax and export duty. While in the United Kingdom, the
contractual element is concession which is often termed a unique type of
concession because ownership in the oil and gas in situ resides in the
crown as opposed to the IOC in other climes. Under the UK regime also
the PRT, RFCT and SC are the variants of tax system now extant with the
abolition of royalties in 200322 and others at differing times when they
seem to have achieved their aims. The Finance Act through the Finance
Bill is the legal instrument the UK uses in tinkering with all the taxation
species above.

The fiscal regime that applies to the petroleum industry in Russia consists
of a combination of royalties (MET), corporate profits tax and an export
duty on crude oil, oil products and natural gas.

Corporate profits tax

Russian resident corporations are subject to profits tax on their non-

exempt, worldwide profits at a rate of 20%. The 20% rate applies to
profits from oil and gas activities. Ring-fencing is not used determining an

21
Carole Nakhle, Petroleum Taxation: A Critical Evaluation with Special Application to the UK Continental Shelf
<http://epubs.surrey.ac.uk/2790/1/410990.pdf >Accessed on 10th December, 2013
22
HM Revenue & Custom, A Guide to UK and UK Continental Shelf:Oil and Gas Taxation (January 2008)
<http://www.hmrc.gov.uk/international/ns-fiscal3.htm> accessed on 8th January 2014
entitys corporate tax liability in relation to its oil and gas activities. Profit
from one project can be offset against the losses from another project
held by the same legal entity, and, similarly, profits and losses from
upstream activities can be offset against downstream activities
undertaken by the same entity (individual branches of foreign companies
are generally taxed as separate entities for profits tax purposes).
BIBLIOGRAPHY