Revenue Note for Guidance

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Revenue Note for Guidance

CHAPTER 2

Petroleum taxation

Overview

This Chapter provides a comprehensive code of taxation for Irish oil and gas exploration and production.

The tax provisions apply to “relevant fields” only, that is, fields discovered by virtue of the 1975 or 1992 licensing terms or subsequent licensing terms. However, there is an exception for reliefs discovered under a “non-licensing terms” lease so long as that lease had expired before the issue of the petroleum lease under which the petroleum is recovered. The terms do not apply to activities conducted within what is commonly referred to as “Marathon lease acreage”.

The principal feature of the tax package is a corporation tax rate of 25 per cent. This rate applies to production of oil and gas under leases granted before cut-off dates listed in section 686. The cut-off dates for granting of leases qualifying for the 25 per cent rate vary with the difficulty of exploring the waters for which the lease is granted. The 25 per cent rate will only apply to production profits or royalty income earned under a lease granted before the cut-off dates. Accordingly, the advantageous tax terms will only be available for a limited period.

The provisions extend the period for write-off of unsuccessful exploration expenditure against subsequent oil or gas profits to 25 years. The terms also provide for a 100 per cent write-off for tax purposes of capital expenditure on development of fields discovered under the 1975 or 1992 or subsequent licensing terms. Development expenditure incurred in respect of a field will not be written off against the oil or gas profits of the company until production of oil or gas in commercial quantities from the field begins.

In addition to allowing full write-offs against oil and gas profits for exploration and development expenditure, the terms also make provision for expenditure which companies may incur in withdrawing from or shutting down an oil or gas field. A 100 per cent write-off of abandonment expenditure against oil and gas profits is provided for. If allowances for abandonment expenditure create or increase a loss for tax purposes, a company may carry back the loss attributable to its abandonment expenditure against the profits of the preceding 3 years. If a company ceases trading before incurring abandonment expenditure, that expenditure will be treated as expenditure of its last period of trading. If there is then an abandonment loss in that last period of trading, it may be carried back through the 3 years preceding that last period, as mentioned above. If at that stage any allowance for abandonment expenditure remains unused, it may be deducted from the profits of a subsequent oil or gas trade carried on by the company.

The terms also facilitate disposals and acquisitions of interests in licensed areas. The Minister for Communications, Energy and Natural Resources must be satisfied that the sole purpose for the disposal of an interest in a licensed area is the proper exploration and development of the area. If the Minister is satisfied in that regard, tax will not be payable so long as the proceeds of the disposal of an interest are applied to exploration and development activities, or so long as the interest is disposed of in exchange for an interest in another licensed area. To the extent that the disposal of the interest does not involve a farm-out or an exchange of interests, capital gains tax or corporation tax will be charged on any capital gains on the disposal at the normal rate.

A person acquiring an interest in a licensed area will be entitled to a write-off of the exploration expenditure incurred in connection with the area when the person begins to work the area under a petroleum lease. The write-off of exploration expenditure will be limited to the cost of acquiring the interest in the area.

The terms recognise that the scale of costs associated with oil and gas exploration and production requires special measures to protect tax revenues. The tax yield to the Exchequer from other sectors of the economy is protected by confining relief for oil and gas exploration and production costs to set-off against income and profits of oil and gas production. Accordingly, the terms include extensive “ring-fencing” measures restricting relief for oil and gas losses, group relief, charges on income and advance corporation tax.

In addition, to protect the State’s tax take from oil and gas profits chargeable under the provisions, the “ring-fence” also prevents losses from other sectors of the economy being set against oil and gas profits. The fence set up around a company’s oil and gas activities therefore protects, for example, both against oil and gas losses being taken out and against losses from other activities being brought in. This ring-fence recognises the unique potential of the oil and gas exploration and production industry for exceptionally large costs and losses and also for exceptionally large profits. The ring-fence protects the tax payable by other sectors and also ensures a tax yield from profitable oil and gas production.

The terms also provide against the reduction of the Irish tax yield from oil and gas production by the payment of charges on income, such as royalties, or excessive interest by a producer to a connected person. For example, excessive interest paid by an Irish oil producing company to a foreign company, both companies being members of the same multinational group, would reduce the Irish company’s profits and Ireland’s tax take – if the relief for the interest were not restricted.

Provision is also made against artificial pricing arrangements between connected persons which would have the effect of reducing the profits, and therefore the tax, from Irish oil and gas production. For tax purposes, all transactions in Irish oil or gas between parties who are not dealing with each other at arm’s length will be recomputed on the basis of market prices for oil and gas at the time.

The central thrust of the provisions is clearly to provide a favourable tax regime for the development of an Irish oil and gas industry. At the same time, care has been taken to protect the State’s interests as respects revenues from other sectors and future revenues from an oil and gas industry.

684 Interpretation (Chapter 2)

Definitions

(1) Some of the following notes on the definitions are arranged in terms of connectedness – which may not conform to alphabetical order.

“abandonment activities” are defined as activities required under a petroleum lease in relation to withdrawal from a relevant field or part of a relevant field and the removal of pipelines to shore. The activities must be undertaken by the holder of the lease or on the holder’s behalf. In the case of a company the lease may be held by a company “associated” with the company undertaking the abandonment activities. The meaning of companies being associated is set out in subsection (2).

“abandonment expenditure” is expenditure on abandonment activities.

“development expenditure” is capital expenditure incurred in connection with a relevant field on the provision for use in carrying on petroleum extraction activities of —

  • machinery or plant (This covers assets provided for use in drilling, production or transportation (pipe-line or tanker) of petroleum in or from a relevant field, where such assets would be regarded as machinery or plant under normal tax rules. This will operate only in respect to non-Marathon fields and will cover persons carrying on a petroleum trade and lessors of equipment to such traders.),
  • works (such as fixed platforms, pipe-lines, storage tanks or jetties) or buildings (such as on-shore structures for initial storage or initial treatment of oil or gas), and
  • any other assets – such as intangible assets – which are of such a nature as to have no more than a minimal value at the end of the field’s life.

Certain expenditure is excluded from qualification as “development expenditure”, namely —

  • expenditure on road vehicles,
  • expenditure on certain buildings and structures,
  • expenditure on drilling, etc at the pre-trading stage or where exploration is being carried on in a separate licensed area by a company also producing in a field (Such searching is captured by the definition of “exploration expenditure” which can normally be relieved fully as soon as a petroleum trade commences.),
  • expenditure site costs, particularly in relation to on-shore wells or ancillary buildings,
  • licence costs or capital sums paid on a farm-in,
  • expenditure on machinery, plant, works, buildings or structures for processing petroleum (other than the initial treatment thereof as defined) or storing petroleum (other than initial storage thereof as defined), and
  • interest payments.

“exploration expenditure” is intended to embrace only pure exploration expenditure. If expenditure qualifies as development expenditure it cannot also be exploration expenditure.

“relevant field” is defined for the purposes of describing a petroleum field other than a Marathon area. It confines the field to an area covered by a petroleum lease by narrowing the meaning of “licence”. Accordingly, capital allowances in relation to Marathon fields will not benefit from, or be affected in any way by, the special rules in section 692.

“designated area” means an area designated by order of the Government under section 2 of the Continental Shelf Act 1968. Section 2 of that Act vests in the Minister for Communications, Energy and Natural Resources any rights of the State over the seabed and subsoil outside the territorial waters of the State. Section 4 of the Petroleum and Other Minerals Development Act, 1960 vests all State petroleum in the Minister for Communications, Energy and Natural Resources and petroleum in a designated area is also so vested by virtue of section 4 of the Continental Shelf Act, 1968.

Areas in respect of which petroleum licences or leases are granted under the Petroleum and Other Minerals Development Act, 1960 are either in the State (which includes the territorial seas, that is, the 3 mile limit) or a designated area.

A number of definitions are connected. These are “petroleum activities” which include “petroleum extraction activities” which, in turn, include “initial treatment and storage”. The purpose of these definitions is to define the scope of the activities embraced by the “ring-fence” provisions. Broadly, these activities are any activities related to the exploration for and exploitation of petroleum resources in the State or a designated area (other than in areas covered by a Marathon licence) up to the point where crude oil is available for supply to a refinery.

The purpose of the “ring-fence” is to segregate all receipts and expenditure (and, therefore, all profits and losses) of petroleum activities from receipts and expenditure (and profits and losses) of other activities, so that the tax on profits from petroleum activities is not diluted by losses from other activities and losses incurred in relation to petroleum activities are not available for offset against profits of other activities for tax purposes.

The “ring-fence” isolates trading profits, non-trading profits or income, chargeable gains and the corresponding losses.

As regards petroleum activities carried on in the course of a trade together with other activities, section 685 provides that the petroleum activities are to be treated for tax purposes as being carried on as a separate trade distinct from the other activities. This will require a separation of the receipts and expenses related to the petroleum activities from the receipts and expenses related to the other activities so that the profit or loss from the petroleum activities can be isolated. That profit or loss will be calculated, firstly, according to ordinary accounting principles and then adjusted by reference to the principles (statute and case law) applied in computing trading profits for tax purposes. The result will show the profit or loss of the “petroleum trade”.

“petroleum activities” means one or more of the following activities —

  • “petroleum exploration activities”,
  • “petroleum extraction activities”, and
  • the acquisition, enjoyment or exploitation of “petroleum rights”.

Activities covered by the separate definition of “petroleum extraction activities” are searching for, extraction of, and the initial treatment or storage of petroleum.

The enjoyment or exploitation of petroleum rights, that is, rights to petroleum or to interests in or to the benefit of petroleum would include, for example, royalties from a petroleum interest.

It is to these activities, trading and non-trading, that the ring-fence applies. The central purpose of the ring-fence is to prevent the dilution of the tax payable on the exploitation of petroleum resources and to prevent the erosion of the corporation tax yield from non-petroleum activities by the set-off of the inevitable early losses incurred in oil production. It does not extend the scope of the charge to corporation tax or income tax but merely restricts the availability of certain reliefs and allowances.

“petroleum extraction activities” means activities of a person carried on under a petroleum lease which involve searching for and extracting, transporting to shore, and the initial treatment or storage of petroleum.

The petroleum lease may be held by an associated company (this principally covers “pass-through” arrangements).

The activities cover exploration for, development of and extraction of petroleum and such initial treatment as is necessary to put it in a condition ready for disposal to a refinery in the case of oil or for distribution in the case of gas.

“initial treatment and storage” includes —

  • those processes necessary to permit the safe storage or loading on to a tanker of petroleum, or its acceptance in a safe form by a refinery,
  • separating oil from gas,
  • separating saleable gas from non-saleable gas,
  • liquefying gas for transportation purposes,
  • other processes necessary to bring crude petroleum to a saleable condition, and
  • storing oil or gas before its disposal or appropriation to refining,

but does not include any activity connected with refining.

“licence” means a licence or lease granted under the Petroleum and Other Minerals Development Act, 1960 in respect of an onshore area or of an offshore area but subject to the Exclusive Offshore Licensing Terms published in April, 1975 or any subsequent Licensing Terms.

A licence or a lease issued under the 1960 Act may be any of the following (references to sections are references to sections of the 1960 Act), namely, an exploration licence (section 8), a petroleum prospecting licence (section 9), a petroleum lease (section 13), or a reserved area licence (section 13).

Only a petroleum lease confers a right to extract petroleum. An exploration licence and a petroleum prospecting licence confer rights to search for and ascertain the extent and character of petroleum deposits. A reserved area licence is in effect an exploration licence but issued to a holder of a petroleum lease in respect of an area adjacent to the area covered by the lease.

Activities carried on under the authority of a licence or lease will come within the ambit of the activities defined to be “petroleum extraction activities”; interests and rights to petroleum deriving from a licence or lease will be “petroleum rights”, as defined; and interests and rights under a licence or lease will be “petroleum-related assets”, as defined.

A licence or lease in respect of an offshore area must be one which was issued subject to the Exclusive Offshore Licensing Terms Published in April, 1975 or subsequent Licensing Terms. This is so as to exclude any licence or lease granted under an agreement in 1959 with the Ambassador Oil Company and now held by Marathon Petroleum Ireland Ltd. Activities carried out under a Marathon licence or lease are not “petroleum activities” for the purpose of this Chapter and no profits, losses or gains from such activities are covered by the special tax terms provided for. This is in line with the policy decision to exclude any activities covered by the 1959 Agreement. That Agreement contains particular clauses as to the maximum amount of Irish tax and royalties to which receipts from petroleum covered by the Agreement should be subjected.

“licensed area” means an area covered by a licence, that is, exclusive of areas covered by an extant Marathon licence.

“petroleum” means petroleum won or capable of being won under a licence which, therefore, excludes petroleum won under a Marathon licence or lease.

“petroleum profits” are defined for the purposes of corporation tax. The definition is derived from the definition of “profits” in section 4. Petroleum profits means all of a company’s income deriving from petroleum activities (for example, income of its petroleum trade, income from petroleum rights) and chargeable gains from disposals of petroleum-related assets.

“petroleum-related asset” means —

  • petroleum rights which includes any interest in a licence,
  • any asset representing exploration expenditure, or development expenditure, that is, tangible and intangible assets deriving from exploration and development expenditure such as the results of seismic and exploration work and physical assets such as rigs, pipelines or wells, and
  • shares, other than quoted shares, deriving their value from petroleum activities.

“petroleum trade” means a trade consisting only of petroleum activities or the part of a trade consisting of such activities which is treated as a separate trade under section 685.

Associated companies

(2) Rules are provided for determining whether or not one company is associated with another for the purposes of the definition of “petroleum extraction activities”. A company may be regarded as carrying on petroleum extraction activities under rights held by an associated company. This is to facilitate use of “pass-through” arrangements.

Relevant Date: Finance Act 2021