What does the energy profits levy mean for the UK energy sector?
How the tax will be levied – and what might be in store for electricity generators.
The UK chancellor announced, on 26 May 2022, a temporary windfall tax on oil and gas companies to help fund government measures to ease the impact of high energy bills on consumers, alongside an investment allowance to be introduced within the levy. The announcement comes after sustained political pressure on the government to act.
How will the tax work?
The new energy profits levy will be charged on the profits of oil and gas companies operating in the UK and the UK continental shelf at a rate of 25%.
Currently, the oil and gas sector pay a 40% headline rate tax on profits consisting of 30% ring fence corporation tax and 10% supplementary charge. The energy profits levy is an additional 25% tax on UK oil and gas profits on top of the existing 40% headline rate of tax, taking the combined rate of tax on profits to 65%.
The tax will take effect from 26 May 2022 and will be legislated for via a standalone bill to be introduced shortly. Companies who have an accounting period that straddles that date will be required to apportion their profits. The tax base will be computed in a similar manner to the existing taxes on the sector and will be charged and be payable as if it were an amount of corporation tax.
The levy is expected to raise £5bn in its first year and the levy will be phased out when oil and gas prices return to historically normal levels. However, there will be a sunset clause in the legislation which will remove the tax after 31 December 2025.
What about the investment allowance?
To encourage investment in the sector, a ‘super-deduction’ style investment allowance will be introduced within the levy to provide an immediate incentive for the oil and gas sector to invest in UK extraction.
This 80% investment allowance will be available to companies at the point of investment. By contrast, the current investment allowance as part of the 10% supplementary charge can only be claimed once income is received from the field subject to the investment (which can take several years).
Prior to the announcements, there had been reports that the allowance would be linked to renewable investments but that was not part of the chancellor’s statement. Instead, the technical papers released with the announcement indicate that the allowance will be generated on any investment expenditure (capital expenditure and some operating and leasing expenditure) at 80%, which can immediately be used to reduce profits subject to the levy. There will, however, be restrictions on generating an allowance on the acquisition of an asset which has already been in receipt of allowances so that new expenditure is encouraged.
What impact will electricity generators feel?
The levy does not apply to the electricity generation sector. However, the chancellor acknowledged that extraordinary profits are also being made there due to the impact that rising gas prices have on the price paid for electricity in the UK market.
As a long-term measure, the government is already consulting with the power generation sector and investors as part of energy market reforms to make the price paid for electricity more reflective of the costs of production.
But rather ominously, the chancellor announced that the Treasury will be urgently evaluating the scale of these extraordinary profits and the appropriate steps to take. It may be that a levy on electricity generator profits may come in the autumn.
Prior to the announcement, the oil and gas industry remarked that a windfall tax would discourage investment in the sector, and have knock-on implications for its supply chain and the broader manufacturing sector. To the extent that renewable energy generators rely on similar elements of the oil and gas supply chain, the cost of developing renewable energy projects may see increases of its own, such that the windfall tax may have ramifications for industry at large.
Comment
While this tax is aimed at the oil and gas industry, it is clear that electricity generators are within the government’s sights and this may well capture some renewable generators.
The government has not taken the opportunity to design a more targeted allowance scheme aimed at investments in decarbonisation of the sector. There was no mention of other fiscal measures that would have benefitted taxpayers such as reducing the VAT charged on supplies of fuel and energy.
It is possible that other proposals may be developed in the next few months and further measures will be announced as part of another package in the Autumn Budget, when typical household energy bills are expected to rise again by £800 a year to £2,800 a year.
Matthew Lewis, Simon Hobday, Dipika Keen & Veronica McMahon, Osborne Clarke
Home >Articles > What does the energy profits levy mean for the UK energy sector?
What does the energy profits levy mean for the UK energy sector?
How the tax will be levied – and what might be in store for electricity generators.
The UK chancellor announced, on 26 May 2022, a temporary windfall tax on oil and gas companies to help fund government measures to ease the impact of high energy bills on consumers, alongside an investment allowance to be introduced within the levy. The announcement comes after sustained political pressure on the government to act.
How will the tax work?
The new energy profits levy will be charged on the profits of oil and gas companies operating in the UK and the UK continental shelf at a rate of 25%.
Currently, the oil and gas sector pay a 40% headline rate tax on profits consisting of 30% ring fence corporation tax and 10% supplementary charge. The energy profits levy is an additional 25% tax on UK oil and gas profits on top of the existing 40% headline rate of tax, taking the combined rate of tax on profits to 65%.
The tax will take effect from 26 May 2022 and will be legislated for via a standalone bill to be introduced shortly. Companies who have an accounting period that straddles that date will be required to apportion their profits. The tax base will be computed in a similar manner to the existing taxes on the sector and will be charged and be payable as if it were an amount of corporation tax.
The levy is expected to raise £5bn in its first year and the levy will be phased out when oil and gas prices return to historically normal levels. However, there will be a sunset clause in the legislation which will remove the tax after 31 December 2025.
What about the investment allowance?
To encourage investment in the sector, a ‘super-deduction’ style investment allowance will be introduced within the levy to provide an immediate incentive for the oil and gas sector to invest in UK extraction.
This 80% investment allowance will be available to companies at the point of investment. By contrast, the current investment allowance as part of the 10% supplementary charge can only be claimed once income is received from the field subject to the investment (which can take several years).
Prior to the announcements, there had been reports that the allowance would be linked to renewable investments but that was not part of the chancellor’s statement. Instead, the technical papers released with the announcement indicate that the allowance will be generated on any investment expenditure (capital expenditure and some operating and leasing expenditure) at 80%, which can immediately be used to reduce profits subject to the levy. There will, however, be restrictions on generating an allowance on the acquisition of an asset which has already been in receipt of allowances so that new expenditure is encouraged.
What impact will electricity generators feel?
The levy does not apply to the electricity generation sector. However, the chancellor acknowledged that extraordinary profits are also being made there due to the impact that rising gas prices have on the price paid for electricity in the UK market.
As a long-term measure, the government is already consulting with the power generation sector and investors as part of energy market reforms to make the price paid for electricity more reflective of the costs of production.
But rather ominously, the chancellor announced that the Treasury will be urgently evaluating the scale of these extraordinary profits and the appropriate steps to take. It may be that a levy on electricity generator profits may come in the autumn.
Prior to the announcement, the oil and gas industry remarked that a windfall tax would discourage investment in the sector, and have knock-on implications for its supply chain and the broader manufacturing sector. To the extent that renewable energy generators rely on similar elements of the oil and gas supply chain, the cost of developing renewable energy projects may see increases of its own, such that the windfall tax may have ramifications for industry at large.
Comment
While this tax is aimed at the oil and gas industry, it is clear that electricity generators are within the government’s sights and this may well capture some renewable generators.
The government has not taken the opportunity to design a more targeted allowance scheme aimed at investments in decarbonisation of the sector. There was no mention of other fiscal measures that would have benefitted taxpayers such as reducing the VAT charged on supplies of fuel and energy.
It is possible that other proposals may be developed in the next few months and further measures will be announced as part of another package in the Autumn Budget, when typical household energy bills are expected to rise again by £800 a year to £2,800 a year.
Matthew Lewis, Simon Hobday, Dipika Keen & Veronica McMahon, Osborne Clarke
