The oil and gas sector - a taxing business
The past year has been a turbulent one for the energy sector, with oil prices from June 2014 to the beginning of 2015 decreasing by more than half and brent crude oil dipping below USD 50 a barrel for the first time since May 2009. This volatility has caused longer term, widespread repercussions across the industry. An increase in merger and acquisition (M&A) activity, tax concessions instigated by governments and major oil companies announcing ravaged profits, are just some of the consequences afflicting the oil and gas sector – and this is without considering the gathering momentum of the OECD’s initiatives in respect of international tax planning under the rubric of “Base Erosion and Profit Shifting” or “BEPS.” The tax implications of these issues were outlined and discussed at the Taxand Global Conference in Milan.
The oil and gas sector has had a rough ride this year causing a tidal wave of change. Merger and acquisition activity has picked up as smaller oil and gas companies without the capital reserves to withstand the cash flow shortages, have been gobbled up by larger players or private equity houses. Governments have also been quick to act as they instigated tax incentives to stimulate continued production and exploration projects. We’ve also seen the various sanctions against Russia impacting the energy sector. On top of all this, the impending BEPS initiatives could cause an overhaul of the way oil and gas companies approach tax. Price stability in the energy sector may be hard to predict, but what is clear is that changes in global tax are unavoidable.
The M&A boom has been fuelled by companies with smaller cash reserves, unable to wait out the adverse impact of low prices. Deal activity has not just been reserved to oil extraction companies, but all businesses involved across the industry, for instance contractors and engineering companies which help design the platforms. The depreciation in paper value of these companies and their assets have attracted takeover bids from either larger companies, with bigger cash reserves who have been opportunistic in eradicating competition, and private equity houses looking for bargains. Acquiring companies have been reassessing both their own tax structure and that of the takeover target to see if any tax benefits available through the merger are maximised. In the US, the current environment has also thrown up a number of opportunities for Joint Ventures, particularly in the shale gas sector, as foreign companies look to get some exposure to the US fracking market, with the oil price so low.
Plummeting oil and gas prices have also led governments around the world to rethink their tax policy across the industry as a traditionally stable source of tax revenue can no longer be counted on to help shore up struggling economies. A number of governments have quite swiftly moved on from their previous policies, seen in the high energy price environment where, on the one side they looked to extract revenues from high Carbon taxation and on the other, introduced incentives, including some tax breaks, for renewable energy initiatives.
Many projects and contracts have been put on hold as the oil price could no longer justify the investment, which has led to governments wading in to protect the sector. In Canada, tax breaks have been given to liquefied natural gas projects in an effort to spur multibillion dollar investments that haven’t gone past proposal stage. In Norway, there have been calls for the government to reduce tax rates to prevent oil companies from cutting investment by 15% this year and in the UK, the British government announced cuts in effective tax rates on production in the North Sea oil and gas fields in March. This welcome trend will no doubt continue if price volatility should persist.
As companies within the energy sector are given some tax breathing space, however, the impending BEPS initiatives will no doubt cause further implications. Historically, many oil and gas companies have used offshore tax jurisdictions, but with the arrival of BEPS and the country-by-country reporting, these existing tax structures will come under scrutiny, and likely require a complete overhaul.
There are two main threats from BEPS. Firstly, it is likely oil and gas companies will be required to report their worldwide operations in their ‘home’ countries. Secondly, it is expected that there will also be automatic exchange of information between all countries in which a group is active, raising questions over where the value of an energy company really lies. Therein lies the danger, as countries scramble to claw back what they perceive is their fair share of tax, raising the risk of double taxation. Finally, companies will have to spend more time and capital on internal and external compliance particularly given the likely impact of the BEPS transfer pricing requirements on the Oil and Gas sector.
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The effects of price volatility across the sector will be long term, regardless of recent signs that prices are starting to stabilise, particularly as company tax policies were not engineered to cope with such unpredictability and internal tax functions did not have enough time to respond to falling prices. In many cases the damage has already been done with some companies announcing that their value has more than halved or that they are facing insolvency as a consequence. Although tax concessions instigated by governments will come as a welcome relief to the ailing industry, the implementation of BEPS presents an upcoming hurdle to companies, particularly those which operate in multiple jurisdictions, as profits could be hit harder and deeper through taxation. This raises the issue that both legislators and the OECD will have to tread carefully not to damage a sector which is battling to recover.
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