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HMRC internal manual

Oil Taxation Manual

From
HM Revenue & Customs
Updated
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Capital gains: valuation of oil assets including shares: the discounted cash flow methodology of valuing fields - input assumptions

Oil price

HMRC may refer to Wood MacKenzie estimates of oil price. If differing values are being considered, then HMRC will accept a reasonable value. In determining a reasonable value it may be appropriate to recognise that a purchaser may have a cautious view.

Development and operating costs

Ideally these should be taken from contemporary plans. If there are none available, it may be questionable whether the field or prospect justifies being valued by a DCF.

Taxes

All relevant taxes should be covered in the assumptions and cash flows. For the North Sea, up to five different duties or taxes may need to be taken into account: royalty, supplementary petroleum duty, petroleum revenue tax, advance petroleum revenue tax and corporation tax, depending on the date of valuation (for 31 March 1982 it should be assumed that all fields are subject to royalty).

DCFs are calculated on a paid rather than accrued basis. On occasion it may be important to eliminate ‘tax overhang’, that is tax due, but which will not be paid until after the valuation date, and which may therefore fall into the DCF. With a company valuation, it may be reasonable to leave the entries in; they are after all ongoing liabilities of the company. However they should not be left in if they are also taken into account as balance sheet adjustments. For an asset valuation the tax for the prior period is unlikely to be a relevant deduction. The tax overhang adjustment will enhance the value of the asset where it is tax payable.

Purchasers assumptions

The DCF should reflect the purchaser’s assumptions. HMRC assume that in most cases the purchaser would obtain field data from the vendor and then apply their own views on the variables of discount rate, foreign exchange rate and oil price. A purchaser may be more conservative than the vendor, and, subject to a fixed ‘in house rate’, may use a higher discount rate than the vendor would.

Variations

It is sometimes thought that differences in variables and other inputs in the DCFs produce dramatic results. This is not necessarily the case. A decrease in sales value may be offset partially by a reduction in tax; less operating expenditure may mean more tax. Anticipation of income may also mean anticipation of expenditure.

Nevertheless the sensitivities of DCFs to differing assumptions and inputs may need to be considered and as companies may hold DCFs based on alternative assumptions these can be used to identify the key elements that make a difference to the net present value.

It is also important at the end to consider whether the asset would be a commercial project on a stand alone or on an incremental basis.

For example, in 1982 it was suggested within the industry that developments under 80m barrels would not be commercial. Again in 1998, when the oil price fell to $10 a barrel, a development or even a producing field might become uncommercial solely as a result of the price drop. It follows, therefore, that if at the date of valuation known reserves are below such a threshold, the open market value should not be attributed on the basis of NPV alone. These comments should be more relevant for prospects than fields, but the oil price can call into question the commerciality of producing fields.