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HMRC internal manual

Oil Taxation Manual

Capital gains: non residents: illustrative agreements

A condition of the award of UK and UK Continental Shelf production licences before 1976 was that the company holding the licence had to be incorporated and resident in the UK. Non-resident oil groups (primarily US) therefore set up UK companies to apply for licences.

If successful and with the sanction of the Secretary of State and HMRC, the non-resident company (referred to below as the ‘X-company’) would enter into an agreement with the UK licensee company called an ‘Illustrative Agreement’ on, or shortly after, the grant of a licence.

When the licensing requirements were changed in 1976, a licence holder no longer had to be incorporated in the UK and so the rationale for Illustrative Agreements diminished and a number of them were collapsed.

The terms of an Illustrative Agreement normally provide that the X-company:

  • will provide all funds and equipment required for operations under the licence and in return shall own and receive all of the oil or gas won and saved to which the licensee company is entitled after all costs are recovered (possibly with a royalty payable to the licensee company),
  • will ensure that the licence conditions are fulfilled so that the licensee company’s obligations are discharged,
  • will either have its central management and control exercised from within the UK so that it is resident for UK tax purposes, or
  • will carry out its activities under the agreement through a UK branch or agency which is regarded as a permanent establishment for the purposes of the relevant Double Taxation Agreement.

As a consequence, the X-company is treated for UK tax purposes as if it were the licence holder.