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HMRC internal manual

Oil Taxation Manual

PRT: valuation of non-arm's length disposals and appropriations - gas - valuation of light gases from 1 January 1994 - general principles

LB Oil & Gas’s constant guide is what happens in the arm’s length situation. This will change over time and the valuation methodology is inevitably (and intentionally) dynamic. When the legislation was introduced the market was still mainly a long term one. Since then, the market has changed considerably with sales of between one day’s duration and many years duration. The LB Oil & Gas’s thinking has evolved with the market and we intend to continue to develop and consider methodologies appropriate to prevailing market conditions and practices. LB Oil & Gas’s view will therefore continue to change with the market and the practices described here reflect a snap-shot of the current approaches to the valuation of gas.

In an arm’s length situation a participator will attempt to obtain the best deal he can. He will want to sell to a reliable buyer under the best terms and prices he can negotiate and he will want to minimise his risks. In valuing gas disposed of non-arm’s length it is assumed that the participator is motivated by the same considerations. If therefore in a non-arm’s length disposal the participator puts himself in a disadvantageous position (e.g. as regards the identity or nature of the buyer, the timing of the disposal, the terms or the length of the contract, the risk undertaken etc) LB Oil & Gas will compensate for this in calculating the price to be assessed for tax purposes. The LB Oil & Gas does not of course seek to dictate to companies when, to whom and under what terms they must sell but it takes these factors into account in the valuation. The argument is that a seller in an arm’s length situation would only accept disadvantageous positions on these points if he was compensated with a higher sale price. For example:

  1. A participator disposes of gas to a petrochemical affiliate even though the fuel value is higher: the gas is valued as a fuel as under the gas election legislation.
  2. A participator decides to sell non-arm’s length but delays entering into a contract until just before the gas comes on stream: LB Oil & Gas does not accept an argument that this is a distress sale. See OT05390 on the date of the valuation.
  3. A participator sells to an affiliate under a contract in which he agrees to abnormally long credit terms and unusually harsh penalty provisions for failure of the supply: LB Oil & Gas looks for a correspondingly higher prevailing contract price.

What LB Oil & Gas seeks to do here is to ensure that the framework in which the valuation is considered (i.e. as regards such factors as the timing of disposal, risk allocation and contract scope) is reasonable and commercial from the seller’s point of view having regard to market conditions and normal industry practice. It is assumed that the producer aims to optimise the value of his gas and LB Oil & Gas obviously objects to a marketing approach which is apparently not in his interests. It is recognised however that there is likely to be more than one way of structuring a particular sale. LB Oil & Gas does not object to one commercial approach simply because there is an alternative of substantially equal value.