EXPLANATORY NOTE

1. This clause provides for restrictions to the expenditure that can be allowed for petroleum revenue tax (PRT) purposes when a company sells a North Sea asset and then leases it back. The measure is intended to prevent companies from minimising their tax liabilities either by exploiting safeguard relief to shelter sales proceeds from a PRT charge or by claiming PRT relief on the interest element of lease rental payments. The clause will apply to the sale of North Sea assets on or after 9 March 1999, unless the sale takes place under an unconditional contract entered into before that date.

_____________________________

2. Subsection (1) provides for the clause to apply where a participator disposes of an asset used in a North Sea oil field, and the seller or a connected person leases the asset for use in a North Sea field within two years of the disposal.

3. Subsection (2) places a cap on the total amount of PRT relief allowable on expenditure related to the asset.

4. Subsection (3) defines the expenditure in relation to which relief will be capped. This expenditure consists of all the lease rental payments - other than amounts attributable to operating costs - and any expenditure incurred in re-acquiring the asset. All this expenditure is referred to as lease payments in these notes.

5. Subsection (4) explains how the cap will be calculated. Where the PRT liability for the disposal period has been reduced by safeguard relief, the cap is the marginal amount of PRT payable on the disposal proceeds divided by the PRT rate for that period, or the disposal proceeds if less. Thus, if no PRT is paid on the disposal proceeds because of the operation of safeguard, then none of the lease payments will be allowable; if PRT is paid on only a proportion of the disposal proceeds because of the operation of safeguard, relief will be given on a proportion of the lease payments. Where safeguard relief does not apply, relief will not be given for lease payments in excess of the disposal receipts, thus preventing any relief being given for the interest element of the lease payments.

6. Subsection (5) covers sale and leaseback deals where the asset is leased under more than one lease. The subsection apportions the cap, calculated in accordance with subsection (4), between the various leases.

7. Subsection (6) gives the formula for apportionment when subsection (5) applies.

8. Subsection (7) covers sale and leaseback deals where the asset is used in connection with more than one field. In these cases, the cap on the allowable lease payments for an individual field will be a proportion of the overall cap, based on the proportionate expected usage of the asset in that field, including use to generate tariffs which will be taxable in the field.

9. Subsection (8) provides that where new information leads to a recalculation of the cap and the new cap is lower than the lease rental payments already allowed, the excess relief will not be recovered by the Inland Revenue. This will avoid the administration and compliance costs which could be incurred in cases, which are expected to be rare, where a re-calculated cap could lead to changes in the amount of lease payments already allowed in assessments many years earlier.

10. Subsections (9) and (10) provide for clauses 86, 87 and 88 to apply to assets sold on or after Budget day.

_______________________

11. This clause and clauses 87 and 88 close two loopholes in the PRT legislation that companies have been able to exploit by selling an asset used in a North Sea field - for example, a pipeline or a platform - and leasing it back. The clauses remove the potential for abuse in the current rules, but do not hinder sale and leaseback deals undertaken for commercial reasons.

12. The first loophole relates to the operation of ‘safeguard’ relief. The PRT regime includes a number of reliefs and allowances which are designed to ensure that the tax does not impact unfairly on smaller or more marginal oil and gas fields, and ‘safeguard’ is one of these reliefs. It allows fields to achieve a certain level of return on investment before they incur any PRT liability. The relief applies in all half-yearly chargeable periods from the first production of oil or gas until payback and then for half as many again. When safeguard applies, profits in the period are compared with a threshold level which is 15% of cumulative capital expenditure up to payback. If profits are below the threshold, no PRT is payable. If profits are above the threshold, PRT payable is the lower of 80% of the excess and the amount of PRT payable under normal rules.

13. Where a company sells a North Sea asset in a period where safeguard relief applies, the sales proceeds may be sheltered from a PRT charge by safeguard relief. The extent to which the proceeds are sheltered depends on how much of the rest of the field income is covered by safeguard relief. In broad terms, if a field’s income is relatively low safeguard relief can be used to shelter a significant amount from the sale of an asset which is then leased back. Before Budget day, companies were able to claim effective PRT relief on the lease payments made for the continuing use of the asset when safeguard relief ended. PRT relief would thus have been given twice on expenditure on the asset - when the asset was originally acquired and on the rental payments without an effective PRT charge on the sales proceeds. These clauses close this loophole, by ensuring that relief is not given for lease payments where the sales proceeds of a sale and leaseback deal have not been subject to an effective PRT charge.

14. The second loophole relates to the use of sale and leaseback to obtain PRT relief for interest payments. Interest payments are not, in general, an allowable expense for PRT purposes. But before Budget day, companies were able to use sale and leaseback deals to raise finance and effectively claim PRT relief on the interest payments element of lease payments. These clauses stop the use of sale and leaseback to obtain PRT relief for interest by denying relief for lease payments that exceed the sale proceeds.

15. The clauses also ensure that the restrictions operate effectively where, after a sale and leaseback, the company that has leased back the asset transfers its interest in the field to another company and the asset continues to be used in the field, and where there is a series of transfers and leases.