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HMRC internal manual

Oil Taxation Manual

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HM Revenue & Customs
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PRT: unitisations and re-determinations - carried interest - PRT treatment

The particular taxation consequences of a development carry depend very much on what the arrangements actually achieve in that individual case. PRT cannot be considered purely in isolation and the CT consequences also need to be looked at.

Example 1 - Carrying Party becomes a participator

Originally company B has a 15% interest in a field in which company A does not have any interest. A then agrees to carry B in return for B relinquishing to A a 10% interest in the field with B retaining a 5% interest. Under the carry agreement, company A will be entitled to take company B’s production until such time as company A has recouped through the value of that production an amount equal to development costs, operating costs, field based taxes and an imputed interest factor. Once this payback is reached company B will be entitled to retain and sell production from its 5% interest.

Any agreement embodying such arrangements would be likely to grant to company A voting control over the additional 5% during the development phase. OTA75\S2 requires each participator to bring into account for PRT purposes either the price received for deliveries of oil within a chargeable period or the market value of oil where it is either sold otherwise than at arm’s length or appropriated.

Example 2 - Carrying party not participator; financing carry

If, instead of the facts in example 1, company A did not acquire an interest in the field (i.e. B’s interest at payback was 15%) and the carry was comprised purely of financing arrangements then company A, the person in favour of whom B chooses in the pre-payback period to forego title to the oil, will not be a participator. OTA75\Sch3\Para6 applies and B remains chargeable to PRT in respect of the oil which is regarded as being disposed of otherwise than at arm’s length. Expenditure is similarly allowed in the normal way.

Carrying party already a field participator

Where the carrying party is already a participator in the field, the PRT treatment depends very much on the facts and substance of the arrangements. The first question to be answered, normally by Valuation Section, is which of A or B should account for PRT on the crude oil taken by A under the carry arrangements. It will be a question of fact normally to be gleaned from the joint operating agreement and the carry agreements whether the oil in question is part of B’s share and whether he has delivered it to A. A subsidiary point is how ICTA88\S493 will apply for CT purposes.

ICTA88\S493 causes problems in that it would require that whatever figure is agreed for PRT in a non-arm’s length sale be used for CT purposes. This section may in certain circumstances prevent the allocation of revenue for CT purposes differing from that taken for PRT purposes which will be, both during and after payback, allocated on the basis of OTA75\Sch2\Para5(2) and by reference to the respective interests of the participators in the field in that oil. The view of LBS Oil & Gas is, therefore, that if, on a proper construction of the governing documentation, the carrying party is entitled not only to his own equity share in the oil but also to the whole or part share of the carried party, in the sense that the latter does not win the oil as well as not lifting, selling or appropriating it for the period until payback, the carrying party is liable to PRT and CT on the whole of that entitlement, not just his equity share. The carried party will not be assessed on the transferred share at all.

If, on the other hand, the carried party retains his entitlement to oil won and saved during the carry period, any lifting of his entitlement taken by him or others with his authority will contribute to his PRT gross profit. This will be so whether or not any payment as such is made and regardless of ownership or whether the oil was transferred before oil was won.

The exploration and development expenditure incurred by the increasing interest party will, in the normal course of events, be included in the field Schedule 5 claim. It will be allocated between the participators by reference not to their equity interests in accordance with OTA75\Sch5\Para2(4) and OTA75\Sch5\Para3(1) but on a disproportionate basis by reference to the actual share of production of A and B (see OT18290).

Payback in carry - Schedule 17 FA 1980

At the point of payback in respect of the carry there will be an event which transfers from company A part of its share in the oil i.e. the part relating to company B’s 5% interest.

Accordingly the provisions of Schedule 17 FA 1980 (see OT18000) will apply with a consequent transfer of reliefs, safeguard capital base, etc. in respect of this 5% interest from company A to company B.

Clearance applications

The treatment of carries can give rise to technical problems. As a result tax clearances are often sought by companies before agreements are completed. Copies of the agreements should be obtained together with a detailed note from the companies as to how they see the tax consequences.