EXPLANATORY NOTE

1. This clause ensures that capital allowances will be available for companies incurring expenditure on plant and machinery for use under an oil production sharing contract (PSC). The measure will apply to expenditure incurred on or after 21 March 2000.

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3. Subsection (1) inserts new section 64A into the Capital Allowances Act 1990 (CAA).

4. Subsection (1) of 64A sets out the conditions to be met for subsection (2) to apply. These are that a contract exists between a ‘contractor’ and a government or government representative; the contractor incurs capital expenditure,

commensurate with the value of his interest under the contract, on plant and machinery which is used for his trade of oil extraction for qualifying purposes (as defined in subsection 11 of 64A); and ownership of these assets at some point passes, in accordance with the contract, to the government or government representative.

5. Subsection (2) of 64A provides that, for the purposes of Part II CAA, which deals with machinery and plant capital allowances, the machinery or plant shall be deemed to belong to the contractor until it either ceases to belong to the government or ceases to be used or held for use under the contract. By ensuring that the ‘belonging’ condition in section 22 or 24 CAA is satisfied, this allows the contractor to claim capital allowances on capital expenditure incurred on the provision of machinery or plant under the contract.

6. Where an interest in the contract is sold and the purchaser (referred to in the section as the ‘participator’) incurs capital expenditure on the provision of machinery or plant under the contract, subsections (3) and (4) of 64A similarly treat the machinery or plant as belonging to the participator and thus ensure that he can claim capital allowances. Subsections (3) and (4) apply whether the sale is the first or a subsequent sale of the interest in the contract.

7. Where an interest in a contract is sold, whether for the first time or subsequently, and part of the sale price relates to machinery or plant that is deemed under section 64A to belong to the seller, subsections (5) to (8) of section 64A treat the machinery or plant as sold by the seller to the purchaser for the part of the sale price that relates to the machinery or plant. The seller is thereby required to bring in a disposal value equal to the lower of that amount and the amount on which he has previously claimed capital allowances.

8. Subsection (9) of 64A restricts, in some circumstances, the amount of the purchaser’s expenditure that can qualify for capital allowances. The purchaser can claim allowances only on the lower of the sale price that relates to the machinery or plant or the disposal value, if any, brought in by the seller. Where no disposal value is brought in by the seller (for instance, where the seller was not liable to tax in the UK) this rule allows the purchaser to claim allowances on the part of the sale price that relates to the machinery or plant.

9. Subsection (10) of 64A provides for a just and reasonable apportionment to arrive at the expenditure referred to in subsection (5) (i.e. the element of any sale price that relates to the interest in plant and machinery).

11. Subsection (12) of 64A provides a definition of ‘oil’ for the purposes of 64A.

12. Subsection (2) inserts two new paragraphs in section 26(1) of CAA. These set out the way in which the disposal value is to be calculated if there is a deemed disposal under 64A arising only because the relevant assets have either ceased to belong to the government or government representative or have ceased to be used or held for use under the contract. In such circumstances, the disposal value is equal to the compensation, if any, received by the contractor or participator, or to nil otherwise.

13. Subsection (3) provides for the clause to have effect in respect of expenditure that is incurred on or after Budget Day or is treated as incurred on or after Budget Day by virtue of a person’s bringing into use plant and machinery for the purposes of a trade.

14. A PSC is a contract negotiated between an oil-producing country and an oil company. PSCs are frequently used by developing countries that wish to exploit their oil and gas reserves, while retaining control of their natural resources. Under a typical PSC, all oil rights continue to be owned by the state, while a foreign oil company becomes the contractor for a designated area. The oil company generally carries out all exploration, production and marketing in respect of the oil in the designated area.

15. UK oil companies operating overseas under PSCs often incur significant capital expenditure on plant and machinery. However, machinery and plant capital allowances are generally available only to the owner of the relevant assets. It is a feature of most PSCs that ownership of the assets used for oil exploration or production passes from the oil company to the host country at some point for example, when the assets enter the host country. Before Budget day, therefore, an oil company operating under a PSC may have had no, or only a limited, entitlement to capital allowances because at some point it failed the ‘ownership’ test.

16. The Inland Revenue has in the past generally managed to ensure that companies operating under PSCs do get effective relief for their expenditure on machinery or plant. It has achieved this by ensuring, on a case-by-case basis, that companies’ tax liabilities are no higher than they would have been if machinery and plant allowances had been available. But both the oil industry and the Inland Revenue take the view that it is no longer appropriate to continue this non-statutory practice. The oil industry has been consulted on the clause in draft and has welcomed the measure.

17 Because the Inland Revenue has in the past sought to give relief broadly equivalent to the value of the capital allowances that would ‘normally’ have been available for the plant and machinery, the cost of this measure, which simply puts relief on a firm statutory footing, is negligible.

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