Taxation of Oil Industry – UK experience N. Kornienko Currently the Ministry of Finance of the Russian Federation has prepared and submitted for public discussion improved bill on transfer pricing14. One of the main addressees for the application of new bill’s statements will be oil industry enterprises. Practically simultaneously the Government of the Russian Federation announced its plans to make some changes to chapter 26 of the Tax Code of the Russian Federation “Mineral resource recovery tax”. The suggested changes to the Russian system of oil industry taxation and encouraged to consider international experience on this sector of economy taxation. It was the UK that was chosen as an example – being one of the oil producing countries it successfully administers a special system of this branch of industry taxation and at the same time applies the rules for transfer pricing according to the scheme similar to that which Russian authors of the law suggest introducing in the territory of the Russian Federation.
In the UK (insular part) gas and oil production started in 1930ies, however at that time there was only one special tax – royalty at the rate of 12.5% for the license for oil and gas production, which gave its holder the right for exploration and exploitation of the licensed oil field. In 1964 gas production started to develop in the Southern part of the North Sea, and there was no special tax regime introduced at that period. In fact in 1960ies there was only one monopolistic gas purchaser – British Petroleum (BP)15– a government corporation, correspondingly, the government’s interested in receipt of economic rent for gas fields development was secured with negotiations of gas producing companies with BP on the optimum price for it.
However, when in the mid-1970s oil production started to develop in Northern parts of the North Sea, the situation changed dramatically. First, the government did not buy crude oil by big volumes, crude oil, however, was not sold at open markets but was transferred through a number of affiliated companies of an oil producing enterprise for further processing and sale in the form of oil products. In order to levy oil producing companies correctly with profit tax it was necessary to establish market price at the open market of crude oil transferred to affiliated companies for processing instead of the price established by a group of affiliated enterprises for the deals among each other.
Second, since the price for crude oil starting with med-1970s had been growing rapidly, profit taxation with the ordinary tax rate for corporation incomes was insufficient for the budget to receive an adequate part of rent from oil fields exploitation. It became necessary to develop additional tax or increase the tax rate for corporation incomes, which would guarantee transfer of a part of additional incomes received by oil companies to the state budget.
Third, at that period leading oil companies were suffering big taxable losses from oil production in the Middle East. These losses, however, were not real, but created “artificially”, since they were the result of the practice to sell crude oil to affiliated companies in one corporation at reduced prices, which were set by oil producing countries. These prices did not reflect real cost of oil production for oil producing companies and certainly could not be constant when crude oil had been sold at open market. That is why it was necessary to prevent somehow oil-producing companies developing oil field in the North Sea from reckoning losses from oil production in other countries with profit received from oil production in the North Sea.
And, finally, there was an issue on introduction of administrative measures that would enable the Her Majesty’s Revenue and Customs (tax service) of the UK to create necessary expert potential which would http://www1.minfin.ru/ru/tax_relations/policy/use_regulation/ http://en.wikipedia.org/wiki/BP#Origins_and_history http://www.bp.com/sectiongenericarticle.docategoryId=2010123&contentId= enable to understand clearly structure and production activity of the oil processing industry and to interact with the representatives of oil producing companies on equal terms while conducting tax examinations16.
Transfer Pricing It is obvious that notwithstanding which decision is made concerning additional profits of oil-producing companies, the main issue, which requires intent attention of the tax service, is the issue of transfer pricing.
In 1975 the issue if transfer pricing for crude oil was rather complex.17 It was also clear for everybody that prices for Middle East oil, reflected in accounts, do not correspond to the real market price for crude oil.
There was a spot market in Rotterdam to which individual supplies of crude oil were made but it was not regarded as prices’ standard, whose value would then be the result of guaranteed long-term supply of oil processing affiliated enterprise of oil producing company18.
Currently, 1975 problems that mainly concerned the formation of crude oil prices still exist. For instance, nowadays there exists a considerable volume of market of oil grade Brent, prices for which are daily give in official press, cost disputes mainly concern differences in quality of standard and estimated oil Brent.
Thus, disputes on the application of the main principle of control over transfer pricing has always been there – comparison of the price applied by the sides of the deal with the price at arm’s length.The UN legislation adopted in 1975 contains the definition of the deal by the arm’s length principle, which is used both to calculate corporation incomes tax and taxes for additional incomes (or economic rent) adopted at the same time.
The deal on crude oil sale is considered to be arm’s length deal only if it meets three conditions:
1. Contract price is the only remuneration for the deal.
2. Commercial relations between the seller and any other person, connected with the seller, and buyer or any other person connected with buyer, excluding those stated in the contract, do not affect the conditions of the deal 3. Neither the seller nor any other party connected with the former does not have direct or indirect interests in further realization or use of the oil or any product, obtained from the oil.
In accordance with this definition two companies are considered to be interdependent if, broadly speaking, they are under the common control or one company is in control of the other either on its own or together with others.
Tax on Additional Income from Oil Production Main aspects of the tax, which has not been introduced for oil industry in the Russian Federation so far, are of special interest – it is successfully applied in other countries, being considered as one of the main tax tools. In 1975 the UK introduced tax on additional profit (or economic rent), which was called petroleum revenue tax (PRT), was levied on the volume of oil and gas produced and was calculated by the methodology, envisaged by the corresponding Law. There were three goals for the government to follow:
1) Provide companies, developing oil fields, quick defrayal of the corresponding expenditures with further taxation of profit at higher rate.
2) Secure tax payment.
3) Grant privileged taxation regime for those oil fields that hardly will be able to pay economic rate.
There was also the fourth aim for this tax:
4) Stimulate further development of oil fields and investments in oil industry in the areas belonging to the UK jurisdiction.
PRT is levied locally on the profit of the oil company, received from each particular oilfield, operated by the company. This means that it is prohibited to deduce expenditures for the development of one oil field from the profit received from another. As to losses, this rule does not apply, and losses can be transferred “back and forth” regarding one oil field for indefinite time, at the same time the oil field will be granted different privileges up to the moment when it becomes profitable and will be levied with economic rent. An objection can be made that since PRT is levied on individual oil field, which prevents companies from investing profit from oil production into works on further exploration and development of oil fields in the North Sea and the fact that PRT was abolished for all the oil fields, consent to whose development was re http://www.hmrc.gov.uk/international/ns-fiscal3.htm http://www.hmrc.gov.uk/manuals/otmanual/OT00010.htm http://www.portofrotterdam.com/en/news/pressreleases/2007/20070112_01.jsp http://www.hmrc.gov.uk/pbr2007/lb-review-of-links.pdf ceived after 6 March 1993, is the argument for the objection mentioned. The tax was abolished because new oil fields were worse, did not give super-profits, but at the oil fields in exploitation the tax was still applied.
Nevertheless, PRT recovery, when it is supposed that crude oil transfer proceeds, according to the arm’s length principle, at market price is a distinct criterion for any regime of oil profits taxation. This does not mean that all the system of UK taxation should be applied as a whole, but it should be acknowledge that this model has some elements that require intent consideration.
Losses taxation Considerable losses of companies up to 1975 that were taken into account for taxation purposes prevented correct taxation of profits that these companies received from oil production in the North Sea. Two methods were developed to solve this problem.
First, co-called “ring fence” was created round the profit from oil production levied with the corporation incomes tax. It meant that corporation incomes (profit) tax on oil production was to be paid fully everywhere where this profit was reported, and it was forbidden to account for losses or any privileges in the territory of the UK or out of its borders by this profit. In accordance with the approach applied oil production profit was regarded completely independently from other kinds of activity carried out by the company. In other words, it was prohibited to deduce losses from other kinds of activities from oil production profit (“ring fence”) and any transfer of crude oil to other branches of the company, for example, oil processing or affiliated company, was considered to be the deal not complying with the arm’s length principle. Crude oil, transferred in such a way, would be considered to be sold at price, established for economic rent.
Second, it was allowed to transfer losses calculated by 31 December 1972 losses, excluding losses from activities in the “ring fence”, to next taxation period, the following requirement being fulfilled :
1. Losses to be deduced from the future profit from other kinds of activities, excluding activities in “ring fence”, should not exceed 50 millions pounds or the amount of profit gained from such kinds of activities before introduction of “ring fence” on 1 January 1973.
2. It was prohibited to deduce losses or a part of losses from the profit, gained after 1 January 1973 from the activities in “ring fence” (or from those that would be “behind” this fence, if it was introduced at that moment).
So, as to losses, ring fence acts only in one direction. Losses from the activity behind the ring fence can be deduced from the profit received from other kinds of activities outside the fence, but losses outside the fence could not be deduced from the profit received from the activities behind the fence.
One more point should be noted: while calculating the profit from the operations behind the fence, it is allowed to deduce both from royalty and petroleum revenue tax.
Administrative measures While introduction of PRT and “ring fence” in the UK, an important decision was made – to make single department, which would look into all the issues and aspects of direct taxation of oil companies20. The activity of oil companies is one of the most complex commercial activities and the division of pertroleum taxation was the most important instrument in the UK’s HM Revenues and Customs to control taxation of this sphere. This division – petroleum taxation department – deals with the estimation of crude oil costs for PRT and corporations’ taxation “behind” the ring fence, it is also responsible for relations with the Trade and industry department concerning all the issues connected with the estimation of oil cost for royalty levy, calculated the tax liabilities for PRT and corporation profit tax by all kinds of activities – both inside and outside of the ring fence.
All declarations arte submitted to this department, which defines the amount of tax liabilities as to corporation profit tax and petrol revenue taxes, as well as for all kinds of activities at different levels of production chain. The department is also responsible for estimation of market price for the purposes of petroleum revenue tax and for other purposes of transfer pricing.*** http://www.hmrc.gov.uk/international/ns-fiscal2.htm http://www.hmrc.gov.uk/lbo/index.htm Отдел имеет около 20 налоговых инспекторов, специализирующихся по различным вопросам. Почти половина из них занимается оценкой стоимости, а вторая половина - проверкой счетов и расчетом налогов.
This paper presents some examples from successful foreign practice to serve as ideas for Russian taxation policy’s development, which could contribute into simplification of oil industry taxation system in the Russian Federation. For instance, petrol revenue tax is similar to the tax on monetary flows but it is levied only in case the calculated balance is positive. Small and not efficient oil fields can be protected by granting them reductions and privileges for payment of this tax.
Though the petroleum revenue tax can be applied as one of the elements of taxation system in oil production industry, it should not be the main tax in this system.
Tax information exchange in foreign trade regulation:
international experience A. Levashenko So far the issues relating to the exchange of information with the tax agencies of other countries have not been properly elaborated. This is especially true with regard to the development of special agreements on cooperation and exchange of information concerning the compliance with RF tax legislation. In this connection it would be interesting to discuss international experience in the sphere of tax information exchange.
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