1.

0 INTRODUCTION

Hydrocarbons have become one of the most essential natural resources for the
development of a countrys financial standing. This is also the story for the UK
during the last 40 years as the discovery of oil and gas has provided energy for
homes, industry, and the transport system, as well as yielding valuable export
and tax revenues to support its economy.1

Different administrations have developed a fiscal regime under a concession,

which provides taxation incentives to oil and gas companies to explore and
develop the UK oil and gas reserves while at the same time securing an
appropriate share of these resources for the nation.2

This essay is divided into two parts: the first part analyses the development of
the tax regime in the UKSC since 1975; the second part of the work compares
the regulatory and tax regime of the Indonesia oil and gas with that of the UK.

2.0 ANALYSIS OF THE DEVELOPMENT OF THE UKCS TAX REGIME UKCS

SINCE 1975

Over the last 40 years, the UK North Sea oil has become an important source of
world energy supply.3 The UK oil and gas fiscal regime is currently administered
by HM Revenue & Customs, Large Business Service Oil & Gas Sector.

A statement by the Prime Minister opined that UK oil industry enjoys an

enormously favourable tax regime and that Changes to the petroleum tax
regime were intended to simplify the regime whilst making the UK an attractive
investment province for international oil and gas companies.4

1
R. Mabro and others, The Market for North Sea Crude Oil, Oxford: University Press (1986)

2
H. Abdo. 'The Story of the UK Oil and Gas Taxation Policy: History and Trends', (2010) 8(4) Oil Gas & Energy
Law Journal (OGEL)

3
London, The Petroleum Economist Ltd., CHASE Oil & Gas Group (1995)

4
R. Corzine, National news offshore oil sector keen to know what's in the pipeline: uncertainty over taxation
may hit investment, Financial Times 16, 19th May 1998.

1
It is apt to note that the tax regime applicable to any oil field depends on the
year its approval was granted.5

2.1. FROM 1975 TO 1999

In 1973, there was a drastic increase in oil price arising from the Arab-Israeli
conflict and it became obvious that the tax regime was not doing justice to the
citizenry of the UK in terms of generating a fair share of the rapidly escalating oil
revenue.6

This brought about the introduction of a new tax; the Petroleum Revenue Tax
(PRT) in 1975 charged on cash flow, at a rate of 40%7 and was further increased
to 60% and 70% in 1975 and 1980 respectively resulting in an Annual Tax
Return from 83.2% to 87.4% and 58% for non-PRT-paying fields.8

The Oil Taxation Act also introduced a safeguard concept to encourage the
development of explored marginal fields by providing some form of relief that
would benefit less profitable fields.9 The benefiting party would pay PRT when
his adjusted profits for a period exceeded 15% of his accumulated capital
expenditure, provided the total payment of PRT did not exceed 80% of his total
gross profits.10

Furthermore, there was the creation of a state body called British National Oil
Corporation (BNOC) which enjoyed benefits such as obtaining licences outside
the normal licensing rounds; exemption from paying PRT; a seat on the licence
operating committee making it powerful amongst the companies operating
within the UKCS. 11
The aim of the BNOC was to represent the state in all
operating fields and securing national ownership and rent of produced oil and

5
H. Abdo, Evaluating the Usefulness of the Interventionist Approach as a Policy Tool to Influence Oil and Gas
Investment Activities: the Case of the UK , Vol. 10, Issue 2 International Energy Journal 1-9 (June 2009)
6
H. Abdo, 'Investigating the effectiveness of different forms of mineral resources governance in meeting the
objectives of the UK petroleum fiscal regime', (2014) 65(0) Energy Policy 48
7
The Oil Taxation Act, 1975
8
See H. Abdo (n 4) Pg. 3
9
D. Nigg and P. Keeling, Accounting for United Kingdom Taxes on Oil and Gas Producing Activities, Petroleum
Accounting and Financial Management Journal 59-84 (Winter 1983)
10
ibid
11
C. Robinson and E. Marshall, Oils Contribution to UK Self-Sufficiency, London: Policy Studies Institute and
the Royal Institute of International Affairs (1984)

2
gas.12 The BNOC was also given the option to buy 51% of the oil at the market
through a purchase agreement to help the Government control fluctuation in oil
prices in the short term.13

Still in 1975, a concept called Ring Fence Capital Tax (RFCT) was introduced
to ensure that losses from abroad or from other activities could no longer be set
against profits from North Sea production to reduce tax liabilities therefore more
revenue was capture from the high profits earned by oil and gas companies
during this period.14 Under the RFCT, profits arising from each field are charged
to tax separately from other fields profits therefore, losses in one field cannot be
deducted from profits in other fields. 15

This meant that the oil tax was now a combination of royalty at 12.5%, PRT at
45% and RFCT at 52% resulting to a marginal tax rate of 76.9% and 58% for
PRT non- paying fields.16

In March 1978, a White Paper was presented to Parliament stating the

benefits of North Sea oil suggesting ambitious plans for the income from
the extra oil and gas revenues which included investing in industry;
improving industrial performance; investing in energy and an increase in
essential services thereby increasing the Governments take by about 4
billion a year by 1980.17

This brought about major fiscal changes in 1979 to reduce the uplift for
allowable expenditure from 75% to 35% and oil allowance for the purpose of
PRT profits calculations from 500,000 to 250,000 metric tonnes a year.18
Another change was an increase in the rate of PRT from 45% to 60% raising the

12
R. Garnaut and A. R. Clunies, Taxation of Mineral Resources, Oxford: Clarendon press (1983).
13
T. N. Machmud, the Indonesian Production Sharing Contract, The Hague: Kluwer Law International (2000).
14
KPMG, A Guide to UK Oil and Gas Taxation, 10th Edition UK, Summerhouse Communications (2000)
15
ibid
16
ibid
17
A White Paper entitled The Challenge of North Sea Oil March 1978.
18
Finance (NO.2) Act 1975, Ch. 45 in the Taxes Acts, 1997 Ed. Great Britain. Norwich: The Stationery Office
(1975)

3
Government marginal tax revenue rate from petroleum resources from 76.9% to
83.2% and 58% for non PRT paying fields.19

As a result of the change in policy of the new Government (Conservative)which

favoured the private sector by mid- 1979 and the increased rate of PRT to 70%
raising the Government marginal tax rate from 83.2% to 87.4% and 58 % for
non-paying PRT fields there was a decline in new oil and gas projects. 20

Similarly, the BNOC purchased very large volumes of oil without major storage
facilities and could not operate actively in the forward market resulting in losses
when oil prices decreased since Oil and gas companies refused to buy back the
oil which had been previously sold to the BNOC to fulfil the 51% requirement
especially since they could purchase oil from other suppliers for cheaper prices.21

On 17th December 1981, a bill known as the Oil and Gas (Enterprise) Bill was
published proposing the disposal of the BNOC oil-production business to the
private sector by transferring the BNOCs oil-producing assets into a subsidiary
named Britoil with 51% of Britoils shares offered for sale to the public.22 The
remainder of the BNOC, which was the trading sector kept its original name with
the role of taking 51% of North Sea oil production at market price and royalty oil
for the state. 23

The Thatcher Government did not welcome any kind of state interference,
eventually leading to the winding of the BNOC and the selling of Britoil with UK
no longer having a state oil company.24

19
S. 1 Oil Taxation Act 1975, Ch. 22 in the Taxes Acts, 1997 Ed. Norwich: The Stationery Office (1975).
20
J. G. Liverman, Without Precedent: The Development of North Sea Oil Policy, 60 Public Administration 451-
469 (1982)
21
J. A. Fleites Melo, Development in the World Oil Industry, Profiles of Major Non-United State Oil Companies
and State Contractual Frameworks Report Commissioned (1991)
22
HC, 4th Report from the Committee of Public Accounts on Financial Control of BNOC; Advances to the British
Gas Corporation HC (30), London, HMSO (Session 1981-82)
23
Department of Energy, Development of the Oil and Gas Resources of the United Kingdom, London, HMSO
(1982)
24
See J. A. Fleites Melo (n23)

4
A resultant effect of the increase in oil prices in 1979/80 was the
introduction of a new tax Supplementary Petroleum Duty (SPD) in
1981 chargedon the gross profit accruing from the field in any chargeable
period to which this section applies. 25

The SPD Charge at a rate of 20% was introduced for temporary period of 18
months to give the oil industry an opportunity to find alternative ways of raising
a high level of revenue from a better structure but it was extended to two years
ending period on 31st December 1982.26

Following changes in tax rates over the period of 1975-1982, the fiscal regime of
the UK North Sea oil taxation became extremely complex and unstable with the
application of a combination of four separate taxes at the same time; Royalties
at 12.5 %, Petroleum Revenue Tax at 70%, Supplementary Petroleum Duty at
20% and Corporation Tax at 52% and exemptions of taxes27 leading to a total
marginal take of the UK Government from final revenues of the oil and gas
resources during that period at 89.9 % and 66.4% from non-PRT paying fields.28

With a marginal take of 89.9 % the Government decided that exploration and
the development activities of North Sea oil were affected by the high marginal
tax rate and the frequency of changes.29 Therefore, the Government decided to
relax the tax burden on the oil companies as a necessary corrective action to
maintain exploration and development activities.30

The SPD was dropped in favour of a higher rate of PRT at 75% With effect from
31st December 1982, bringing the marginal take to 91.6% and 66.4% for non-
PRT paying field and a new tax Advance Petroleum Revenue Tax (APRT)
introduced in order to accelerate revenue collection and was scheduled to phase

25
Section 122 (5) Finance Act, 1981
26
RT Hon. N. Lawson, MP, Minutes of Evidence Taken Before the Energy Committee on Oil Prices at 8,
Parliamentary Papers, HC 332, vol. XXXI. London, HMSO (Session 1982-83)
27
Petroleum Revenue Tax Act 1980
28
See H. Abdo (n3) Pg. 18
29
See J. G. Liverman (n 22)
30
H. Abdo, Evaluating the Usefulness of the Interventionist Approach as a Policy Tool to Influence Oil and Gas
Investment Activities: the Case of the UK, Vol. 10 Issue 2 International Energy Journal 1-9 (June 2009).

5
out in four stages with reducing rates following which it was to be completely
abolished.31

The replacement of SPD by APRT on 31st December 1982 brought the Annual
Tax Return of oil companies down to 89.5% and 58% for non-PRT-paying
fields.32

Long before 1975, there was a charge on the value of production which was not
a profit related duty known as Royalty. It was charged at 12.5% of the landed
value of petroleum production with an allowance for cost associated with
conveying, treating and initial storage of the product between the well head and
the point of valuation.33

However, after the allowances, the actual rate was usually lower than 12.5%
and the royalties were charged on the licence which usually covered more than
one field.34 The royalties were payable to the Secretary of State for Energy who
had the powers to require royalties to be paid in kind.35

1983 saw a major turning point in the UK tax regime, first was the news of the
abolition of royalties by Petroleum Royalties (Relief) Act 1983 for qualifying fields
receiving development approval from the Secretary of State for Energy on or
after 1st April 1982 by Chancellors Budget Statement.36

Next were the abolition of the APRT and the doubling of PRT allowance for new
fields developed after March 1982.37

Another was an Immediate PRT relief against any field for expenditure incurred
after 15th March 1983 on searching for oil or appraising reserves discovered.

31
Section 132 Finance Act 1982: Advance Petroleum Revenue Tax, Ch. 39, in the Taxes Acts, 1997 Ed. Great
Britain. Norwich: The Stationery Office (1982).
32
Section 139 Finance Act 1982: Advance Petroleum Revenue Tax, Ch. 39, in the Taxes Acts, 1997 Ed. Great
Britain. Norwich: The Stationery Office (1982).
33
S. Bond et all, North Sea Taxation for the 1990s, IFS, Report Series No. 27 (1987)
34
C. Nakhle, Petroleum Taxation: A Critical Evaluation with Special Application to the UK Continental Shelf ,
PhD Thesis, Surry University (2004)
35
See KPMG 2000 (n13)
36
D. Bland, UK Oil Taxation, 3rd Ed. UK: Longman (1991)
37
Finance Act 1983, Ch. 28, in the Taxes Acts, 1997 Ed. Great Britain. Norwich: The Stationery Office (1983)

6
The RFCT rate was reduced in this year to 50 %; leaving the marginal tax rate
for old fields at 89.062 % and 87.5% for new fields.38

The rate of the RFCT was further reduced to 45% in 1984, 40% in 1985 and
35% in 1986; these changes brought the petroleum marginal tax rate down
from 87.97% to 86.25%; 86.87% to 86.25%; 85.78% to 83.75% in new fields
respectively costing the Government 800 million of revenue from 1983 to
1987.39

To ensure stability, there were no major changes in the taxation of the industry
between 1985 and 1986.40 One of the minor changes was the transfer of the
property rights and liabilities of the British Gas Corporation to a public limited
company (British Gas plc) on 25th July 1986, making it one of the private
companies in upstream operations subject to the same controls and restrictions
as private companies.41

Another was the immediate withdrawal of PRT relief from exploration and
appraisal expenditure in 198542 and finally in 1986 The Advance Petroleum
Revenue Tax Act provided for a tax refund of APRT to operators who had never
won a profit from UK oil and gas fields but paid APRT for a chargeable period
before 31st December 1986.43

In 1987, the concept of Cross Field Allowance which allowed 10 % of the

development expenditure of offshore fields outside the Southern Basin of the
North Sea approved for development after 17th March 1987 was introduced by
the Finance Act. This allowance was to be deducted from income in other fields
for the purpose of calculating PRT.44

38
Department of Energy, Development of the Oil and Gas Resources of United Kingdom, London HMSO (1983)
39
ibid
40
Department of Energy, Development of the Oil and Gas Resources of United Kingdom, London HMSO
(1986)
41
Department of Energy, Development of the Oil and Gas Resources of United Kingdom, London, HMSO
(1987)
42
See (n 44)
43
Section 1 Advanced Petroleum Revenue Tax Act, Ch. 68, in the Taxes Acts, 1997 Ed. Great Britain Norwich:
The Stationery Office (1986)
44
Section 65 Finance Act 1987, Ch. 16, in the Taxes Act, 1997 Ed. Great Britain Norwich: The Stationery Office
(1987)

7
Again, in 1988 the Chancellor of the Exchequer announced the exemption from
royalties with effect from 1st July 1988 of all Southern Basin and onshore fields
for which a development permit was given after 31st March 1982.45

In the same year, it was provided that interest payments to a participator on the
extra payment of PRT to the Government should not be considered when
calculating the operators profits for corporation tax purposes.46 Also, royalties
were now to be taken in cash other than in kind after 31st December 1988 and
the PRT oil allowances were reduced.47 All these reduction on the tax burdens on
oil and gas production was an investment incentive for companies.

By early 1990s, the Government had a new relaxation package to reduce taxes
within the UK petroleum fiscal regime to address the issue of: high marginal tax
rate of PRT paying fields who were now trying to avoid their tax liabilities by
shifting income into fields that did not pay PRT and shift expenditure into PRT
paying fields to benefit from tax reliefs available for PRT paying fields for
expenditure; and the decline in Government tax take resulting from the low oil
prices during that period of time.48

These package included allowances for expenditure on scientific research of a

capital nature and payments to research associations to be written off when
computing the profits or gains of the trade for the purpose of tax.49

The package also lowered the rate of RFCT to 34% bringing the marginal tax
rate to 85.56 % for old fields and 83.5% for fields developed after March 1982.
This was further reduced to 33% in 1991 with a marginal tax rate to 85.34% for
old fields and to 83.25 % for new fields.50

45
Section 1, Petroleum Royalties (Relief) and Continental Shelf Act 1989.
46
Section 501 Income and Corporation Taxes Act 1988: Petroleum Extraction Activities (Ch. V), Ch. 1, in the
Taxes Acts, 1997 Ed. Great Britain. Norwich: The Stationery Office (1988)
47
Department of Energy, Development of the Oil and Gas Resources of United Kingdom, London, HMSO
(1989)
48
See H. Abdo (n 3) 23
49
Section 136 Capital Allowances Act 1990 Ch. 1, in the Taxes Acts, 1997 Ed. Great Britain, Norwich: The
Stationery Office (1990)
50
Section 185 Finance Act 1993 Ch. 34 in the Taxes Acts, 1997 Ed. Great Britain, Norwich: The Stationery
Office (1993)

8
In 1993, PRT was reduced for oil fields that had development consent before
16th March from 75% to 50% and abolished for oil fields with development
consent on or after 16th March 1993.51

With new fields developed post March 1993 only subject to RFCT rate of 33%
and the abolition of oil allowance for PRT purposes, the marginal tax rate for old
fields was now 70.69%; 66.5% for PRT paying fields and 41.4% for non PRT
paying fields developed pre March 1993.52

In 1997 and 1999 the rates of RFCT were reduced to 31% with a marginal tax
rates of 69.81 % for old fields; 65.5 % for fields developed post March 1982 but
pre March 1993; 31% for fields developed post March 1993 and 30% with a
marginal tax rates 69.38 % for old fields and 65 % for fields developed post
March 1982 but pre March 1993 respectively.53

2.2 2000 to 2010

on 17th April 2002, the Chancellor of the Exchequer in the budget announced
that companies producing oil and gas in the UK or UKCS would pay a
Supplementary charge (SC) of 10% on the profits from companies ring
fenced trades in addition to the 30% corporation tax already payable on these
profits with special rules for instalment payments during the transitional period
to ensure that there was no underpayment of instalments.54

The introduction of SC changed the marginal tax rate of the UKCS to 73.75% for
old fields, 70% for fields developed post March 1982 but pre March 1993 and
40% for the post March 1993 fields.55

To stimulate investment in the North Sea, the Budget also introduced 100% First
Year Capital Allowances to be available to virtually all ring fenced capital

51
ibid
52
L. Zhang, Taxing Economic Rents in oil production: An assessment of UK PRT Warwick Economic Research
Papers no. 445, University of Warwick October 1995.
53
ibid
54
HMRC (2010b)
55
ibid

9
expenditure and the intention to abolish the royalty completely effective from
1st January 2003.56

Furthermore, the SC was raised to 20% effective from 1st January 2006
increasing the marginal tax rate for the areas of the UKCS to 75% and 50% for
non PRT paying fields pre- 16 March 1993 subject to PRT, RFCT and SC; and a
marginal tax rate of 50% for post- 16 March 1993 fields subject only to RFCT
and SC.57

In 2009, to encourage investment in small or technically challenging fields to

realise the estimated 2 billion barrels of the remaining UK oil and gas reserves,
the Government introduced a Field Allowance set at 75 million for small
fields and 800 for ultra- heavy oil fields and ultra-high pressure/high
temperature fields.58

2.3 2011 TO DATE

The upstream oil and gas taxation contributed about 20% of the corporate tax
revenue in 2011 to the Uk Exchequer. The fiscal regime which currently applies
to companies exploring for or producing oil and gas in the UKCS consists of
Petroleum Revenue Tax; Ring Fence Corporation Tax and the Supplementary
Charge.59

CORPORATION TAX (CT)

UK tax resident companies are subject to CT on their worldwide profits, including

chargeable gains, with credit for any creditable foreign taxes. However,
exemptions apply to certain dividends, profits or losses from overseas branches
and gains or losses on disposals of substantial shareholdings. The taxable profits

56
Great Britain 2002 <http://www.england- legislation.hmso.gov.uk/acts/acts2002/ukpga_20020023_en_1.>
accessed on 24th December, 2013
57
D. P. Cameron, Property Rights and Sovereign Rights: The Case of North Sea Oil , New York: Academic Press
Inc. (1983)
58
HMRC, North Sea Fiscal Regime: Incentivising Production, available at:
<http://www.hmrc.gov.uk/budget2009/bn10.pdf (2009)> accessed on 27 th
December, 2013
59
ibid

10
of a UK company are based on its accounting profits as adjusted for a number of
statutory provisions.60

Non-UK tax-resident companies are subject to CT only if they carry on a trade in

the UK through a permanent establishment (PE). The rate of CT was reduced
from 30% to 28% in April 2008 and 28% to 26% in April 2011 however; the
industry was exempted from this reduction.

The current rate of corporation tax is 30% for ring-fence profits and 24% for
non-ring-fence profits. The UK has a transfer pricing regime to ensure that, for
corporation tax purposes, transactions between connected parties take place on
arms length terms.61

Petroleum Revenue Tax

The PRT is charged on oil and gas production and seeks to obtain for the
Government a share of the economic rent arising from oil and gas production;
allow a project to rapidly recover its costs; ensure that tax due is payable as
early as possible and ensure that projects where no economic rent was likely are
protected from tax.62 It is charged at field level on the profits arising from
individual oil fields at the rate of PRT 50%.63
PRT was abolished for fields that have previously been decommissioned and are
then re-commissioned from 1st July 2007 and effect from 21st July 2008 for fields
in respect of which the responsible person has elected and HM Revenue &
Customs agreed that the field is to be non-taxable on the basis that no
assessable profit will accrue to participators, or any assessable profit will be less
than the oil allowance.64

The fields that are within the charge to PRT are known as taxable fields and
those outside it are known as non-taxable fields. PRT is assessed on each

60
<http://www.hmrc.gov.uk/oilandgas/guide/intro.htm> accessed 22nd December, 2013
61
ibid
62
UK Economic Report, 2011 available at <http://www.oilandgasuk.co.uk/economic_report/ukcs_regime.cfm>
63
ibid
64
Department of Energy and Climate Change, Oil and gas: taxation available < https://www.gov.uk/oil-and-
gas-taxation> accessed on 23rd December, 2013

11
participator in each field and assessments are raised for six-month chargeable
periods ending on 30th June and 31st December each year.65

The responsible person for each taxable field must submit a return showing the
total amount of oil and gas produced from the field within one month of the end
of each chargeable period. This return gives details of each participator's
percentage interest in the field and the amount of each participator's share of
the total oil and gas produced. Each participator must submit two months after
the end of each chargeable period a return of their own incomes from each
taxable field in which they have an interest.66

Ring Fence Corporation Tax (RFCT)

Ring Fence Corporation Tax (RFCT) is calculated in the same way as the
Corporation Tax but with the addition of a 'ring fence' which prevents taxable
profits from oil and gas extraction in the UK and UK Continental Shelf (UKCS)
being reduced by losses from other activities or by excessive interest payments.
Such oil extraction activities are treated as a separate trade, distinct from all
other activities carried out by the company and the current rate of RFCT is
30%.67

Any cross ring fence transactions within a single company are treated as if they
were transactions between associates and are subject to the normal transfer
pricing rules. PRT paid by a company is an allowable deduction in computing ring
fence profits. Expenditure on the decommissioning of fields and assets which is
capital in nature normally qualifies for immediate 100% relief within the Capital
Allowances code. 68

RFCT only apply to companies involved in oil and gas exploration and production
and are payable in three equal instalments each year:69

65
ibid
66
The taxation of the Uk oil industry : an overview: the current fiscal regime for oil and gas available at
<http://www.hmrc.gov.uk/manuals/otmanual/ot00020.htm> accessed on 23rd December, 2013
67
ibid
68
ibid
69
Guide to the North sea fiscal regime: Ring Fence Corporation Tax available at
<http://www.hmrc.gov.uk/oilandgas/guide/rfct.htm> accessed on 23rd December,2013

12
 first instalment - 6 months and 13 days from the start of the accounting
period
second instalment - 3 months from the first instalment due date
third instalment - 14 days from the end of the accounting period

Supplementary Charge

The Supplementary Charge is paid on the ring fence profits together with the
RFCT liability. The profits chargeable for Supplementary Charge are calculated in
the same way as for Ring Fence Corporation Tax (RFCT) but with no deduction
for financing costs.70

Section 330 CTA 2010 provides, in addition to ring fence corporation tax, profits
derived from upstream activities are subject to an additional tax and the
supplementary charge. The Finance Bill 2011, effective from 24th March 2011
sought to impose on Oil and gas companies that operate in the UK or on the UK
Continental Shelf (UKCS) an increase in the SC from 20% to 32%.71

The rationale for an increase at a time of high oil prices was for the Government
to strike the right balance between oil producers and consumers, and to ensure
fairness to taxpayers. To attain this balance, if in future years the oil price falls
below a set trigger price of trigger price of US $75 per barrel on a sustained
basis, the Government will reduce the supplementary charge back towards 20%
on a staged and affordable basis while prices remain low.72

The bill also sought to change the rate at which companies obtain relief for
decommissioning expenses with effect from 2012 by restricting tax relief for
decommissioning expenses to 20% rate of supplementary charge. This bill was
passed into law on the 17th July 2012 and is now known as the Finance Act,
2012 hence the current SC rate is 32%.73

The Government announced that it will work with the industry with the aim of
announcing further, longer-term certainty on decommissioning at Budget 2012.

70
UK oil and gas fiscal regime: new onshore allowance available at
https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/263643/shale_gas.pdfaccess
ed on 24th December, 2013
71
ibid
72
Tax Information and Impact Note 23rd March 2011
73
ibid

13
Furthermore, that there will be no restrictions to decommissioning relief beyond
this level for the lifetime of this Parliament. The policy is kept under review
through regular communication with the business sector affected by the
measure.

The SC will likely reduce the post-tax profits of companies producing oil and gas
thereby affecting the commercial viability of some investments and may cause
Government to consider the introduction of a new field allowance to support
continuous investment in the North Sea. 74

Decommissioning Expenditure

Decommissioning expenditure is considered to be capital in nature for tax

purposes and qualifies for a special 100% capital allowance. This includes
expenditure on demolition, preservation pending re-use or demolition and
preparing or arranging for reuse (including removal). Specifically, this may
include mothballing installations, plugging wells, dumping or toppling rigs, and
restoring sites.75

The rate of relief for decommissioning expenditure for supplementary charge

purposes is restricted to 20% for decommissioning carried out on or after 21
March 2012.

Indirect Taxes

The standard rate of VAT in the UK is 20%, with reduced rates of 5% and 0%.
VAT is potentially chargeable on all supplies of goods and services made in the
UK and its territorial waters.

74
ibid
75
ibid

14
3.0 COMPARISM OF THE DEVELOPMENT OF THE REGULATORY AND TAX
REGIME OF UK OIL AND GAS WITH THAT OF INDONESIA (USING THE EY
GLOBAL GUIDE 2013)

3.1 THE REGULATORY REGIME OF UK OIL AND GAS

Concessions date back to early 20th century and were the popular form of
petroleum agreement between host governments and international oil and gas
companies.76 The UK has been using the concession type of oil and gas
agreements to regulate its oil and gas operations. The law grants the
concessionaire the right only to obtain the products from the concession area of
the UK land or sea and gives him a title to these products only. Hence, it gives
the concessionaire a title to the production but not to the minerals in situ.77

The Petroleum Act 1998 is the main regulatory legal framework for exploration,
exploitation and production of oil and gas in the UK. The Act vests all rights to
petroleum in the Crown, including the rights to search, bore for and get the
petroleum and empowers the Secretary of State to grant licenses to search and
bore for and get petroleum to such persons as he thinks fit and the Licenses are
issued within licensing rounds.78

Therefore any company wishing to undertake oil and gas activities in the UK has
to apply for a license during the licensing rounds. However, licenses could be
granted by the Department outside regular licensing rounds the applicant show
grounds of urgency already there have been 27 of such licensing rounds on the
UKCS and next will be announced in January 2014 the 28th Licensing Round.79

An application may be made by a single company or by a group of companies

and the company must be registered in the UK, either as a company or as a
branch of a foreign company.

76
https://www.gov.uk/government/organisations/department-of-energy-climate-change
77
See H. Abdo (n3)
78
Section 3(1) of the Petroleum Act 1998
79
Providing regulation and Licensing of energy industries and infrastructure available at
https://www.gov.uk/government/policies/providing-regulation-and-licensing-of-energy-industries-and-
infrastructure accessed 6th January,2014

15
 Department of Energy and Climate Change (DECC) entrusted with the
regulation of the industry and tasked with the development of guidance that set
out the information concerning licenses in the UK 80

3.2 THE DEVELOPMENT OF THE REGULATORY AND TAX REGIME OF

INDONESIAN OIL AND GAS INDUSTRY.

3.2.1 REGULATORY REGIME

The Indonesian Constitution provides how natural resources within the

jurisdiction of the country should be dealt with. It stipulates that all the natural
wealth on land and in the water is under the jurisdiction of the State and should
be used for the greatest benefit and welfare of the people.81

Accordingly, the authority to administer, control and carry out mining operations
in the field of oil, natural gas and geothermal energy is vested in PERTAMINA.
PERTAMINA is authorized to cooperate with other parties through contractual
arrangements in carrying out its regulatory duties and functions.82

With the introduction of Oil and Gas Law, Law No. 22 of 2001which revoked Law
No. 8 of 1971, the upstream (exploration and exploitation) and downstream
(refining, transport, storage and trading) activities are differentiated and are to
be undertaken by separate legal entities.

The Law provides the authority for the Government to establish BPMIGAS, an
executive agency for upstream activities, and BPHMIGAS, a regulatory agency
for downstream activities, to assume PERTAMINAs regulatory functions.

Consequently, BPMIGAS replaced PERTAMINA as the contractual party

representing the Indonesian Government while PERTAMINA was transformed
from a state owned enterprise governed by Law No. 8 of 1971 into a state-
owned limited liability company PT PERTAMINA now similar to other oil and gas
companies in Indonesia with the authority to supply for domestic consumption.83

80
ibid
81
Article 33 of the 1945 Indonesian Constitution
82
Article 12 of Law No. 8 of 1971 of Indonesia
83
ibid

16
BPMIGAS is now known as SKK MIGAS (Special Task Force for Upstream Oil and
Gas Business Activities)

The existing contractual arrangements between foreign oil and gas contractors
and SKK MIGAS are mainly in the form of a PSC, joint operating contracts (JOC),
technical assistance agreements (TAA) and enhanced oil recovery (EOR).

Previous contractual agreements entered into with the Indonesian Government

have also changed and are now structured as co-operation contracts and the
contractor may now enter into cooperation or service agreements under similar
terms and conditions to those of the previous PSCs.

Government Regulation No. 79, issued 20 December 2010, provides rules on

cost recovery claims and Indonesian tax relating to the oil and gas industry
effective from the date of issuance and applies to cooperation contracts signed
or extended after that date.84

Upon signing the agreement, the contractor pays a bonus is not cost recoverable
and not tax deductible and agrees to a work program with minimum exploration
expenditures for a 3- to 10-year period. The availability of the incentives
depends on the agreement with the Indonesian Government.85

3.2.2 FISCAL REGIME

The operator of the every work area has to register with the Indonesian tax
office from the moment it obtains an interest in the work area. The income tax
rates, consisting of the corporate income tax (CIT) and the dividend tax or
branch profits tax (BPT) for branch operations, vary depending on the year the
contract was entered into.86

84
Regulation, GR 79/2010,
85
Legal Guide to Oil and Gas Regulation in Indonesia: Development of Oil and Natural Gas available at <
http://blog.ssek.com/index.php/2013/02/legal-guide-to-oil-and-gas-regulation-in-indonesia/> accessed on 5th
January, 2014
86
Ernst & Young, 2013 Global oil and gas tax guide

17
Ring-fencing

The Government applies the tax ring-fencing rule, meaning that costs incurred
by the contractor in one working interest are not allowed to be offset by income
of another working area and provides rules on how to offset and recover the
costs from the different products therefore there are no tax consolidation or
other group relief facilities available in Indonesia.87

First tranche production

The FTP is taxable income equal to 20% of the production each year (before any
deduction of cost recovery) and is split between the Government and the
contractor according to their equity oil share as stipulated in the agreement with
the Indonesian Government.

Domestic Obligation

After commencement of commercial production a contractor is required to

supply a specific portion of the crude oil ranging from 15% to 25%. GR 79/2010
their production to the domestic market in Indonesia from its equity share and
the contractor is compensated by SKK MIGAS for the DMO at the prevailing
market price for the initial five years of commercial production. The difference
between the DMO costs and the DMO fee received is subject to tax.88

Cost recovery

Cost recovery is usually stipulated in Exhibit C of the agreement; it is the

reimbursement of cost (through cost oil) prior to the determination of the profit
oil. Costs that are recoverable are deductible for tax purposes and are limited to
costs incurred to earn, collect and maintain income; cost connected with the
operation of the production block of the respective contractor; costs at arms
length relationship and in accordance with a work program and budget approved
by the Indonesian regulatory body.89

87
GR 79/2010 specifically requires costs relating to gas activities and oil activities in the contract area to be
separated.
88
See (n 84)
89
ibid

18
GR 79/2010 provides that direct and indirect allocation of expenses from a head
office can only be charged to an Indonesian project and is cost recoverable and
tax deductible if certain conditions are met.

Capital allowances

In accordance with Exhibit C of the agreement all equipment purchased by

contractors becomes the property of SKK MIGAS once the equipment is in
Indonesia. The contractors have the rights to use and depreciate such property
until it is abandoned or for the life of the work area, subject to approval by
BPMIGAS. Depreciation will be calculated at the beginning of the calendar year in
which the asset is placed into service, with a full years depreciation allowed for
the initial calendar year. 90

Investment credit

Usually, the contractor will be permitted an investment credit of 8.8% net after
tax on the capital investment cost directly required for developing production
facilities out of new oil fields and the investment credit must be claimed in the
first or second production year after the expenditure has been incurred. The
credit is treated as taxable income and the applicable rule can depend on the
year the agreement and the types of fields. 91

Interest recovery

Based on GR 79/2010, interest costs or interest cost recovery is not a cost

recoverable expense and is not tax deductible. However, Subject to tax treaty
relief, the interest is subject to withholding tax of 20% of the gross amount if it
is provided by a non-Indonesian lender.

Contractors are allowed to carry forward for tax purposes the pre-production
expenses to offset against production revenues. 92

90
ibid
91
ibid
92
ibid

19
 Withholding taxes

The rate of dividend withholding tax and the rate of branch profits tax depend on
the year that the PSC was entered into. Withholding tax on all other amounts
follows the general tax law. 93

Indirect taxes

For PSCs that are signed under the law prior to Law No. 22/2001, the import
duty, VAT on importation and import withholding tax on importation of capital
goods and equipment are exempted by the Indonesian Government while for
PSCs that are signed under Law No. 22/2001, the import duty and VAT on
importation is borne by the Indonesian Government relating to import of capital
goods and equipment used in exploration activities.

3.3 COMPARISM OF BOTH REGIMES

Having discussed both regimes, the writer will now compare both regimes as
gathered from the discussions above.

First, both regimes operate different forms of agreement; concession for the UK
and the PSA for Indonesia. The implication of this is that under the PSAs with
the Indonesian government, the government is involved in the oil and gas
production through its national companies for (upstream and downstream
activities), shares the profit from production; reimburses the company for cost of
production where oil is discovered in commercial quantity and generates revenue
through imposition of taxes and duties on the companys take. In the case of
the UK on the other hand, the company alone bears the cost of production and
profit from production is not shared with the government but only subject to
taxes and duties.94

With regards to the tax systems of both jurisdictions, whilst the UK system has
gone through a plethora of changes, making its tax regime complex, the
Indonesian regime has enjoyed a relatively stable system since 2010. Similarly,

93
ibid
94
Knowing more about Indonesian Upstream Oil and Gas Contract available at
http://www.skkmigas.go.id/en/mengenal-kontrak-hulu-migas-indonesia

20
the Laws providing for Taxation in the UK are quite numerous these may create
difficulties on intending investors who may try to familiarise themselves with the
tax system. For Indonesian, most of her tax provisions are embodied in
Regulation No. 79, issued 20 December 2010.95

The Indonesian government bears the import duty and VAT on importation
relating to capital goods and equipment used in exploration activities this
reduces the take of the government. Under the UK, there is no exemption on
VAT in fact the threshold for non-resident companies was removed on 1st of
December, 2012. 96

Under Indonesian regime, after commencement of commercial production a

contractor is required to supply a specific portion of the crude oil ranging from
15% to 25% of their production to the domestic market in Indonesia from its
equity share and the contractor is compensated by SKK MIGAS at the prevailing
market price for the initial five years of commercial production; this ensure
availability of supply to its citizen; in the UK on the other hand, upon the
winding of BNOC this may not be achievable.97

Although both regimes operate different regulatory framework, they share some
similarities such as; under both regimes, the oil fields are charged to tax based
on the year of approval and both applies the arms length rule to taxation.
Another similarity is the concept of ring fencing to ensure that costs incurred by
the contractor in one working area or field are not allowed to be offset by
income of another working area or fields to escape tax liabilities.

4.0 CONCLUSION

Given the probabilities associated with the oil and gas industry, UK tax regime
has been flexible enough to cope with changes in oil prices providing the
industry with the necessary stability for future planning and in the light of recent

95
H. Abdo, The taxation of UK oil and gas production: Why the windfalls got away, Energy Policy vol.38, issue
10 October 2010 Pg. 5625-5635
96
Investment and Taxation Guide May 2012 5th Ed. Updated for GR79/2010 and its implementing regulations
97
Indonesia oil and gas laws: A legal Introduction available at < http://www.oentoengsuria.com/wp-
content/uploads/2010/11/Indonesias-oil-and-gas-laws.pdf> accessed on 6th January, 2014

21
developments and latest budget, investors can be confident of stability.98 That
notwithstanding, UK has one of the highest tax rate on oil and gas profits with a
combined rate of 81% and 63% and various tax reliefs and allowances the
interests of oil majors are turning towards the tax havens.

Indonesia on the other hand, is economically attractive for oil investors but the
fiscal regime for gas needs to be review to attract more investments.99

In all the fact still remains that in the current years, there will continue to be
changes in the regulation and fiscal regimes of the oil and gas industry of
different countries to fit the current global economy.

98
International Tax Review <http://www.internationaltaxreview.com/Article/3057698/UK-Recent-
developments-in-the-taxation-of-oil-and-gas-activities-in-the-UK.html> accessed on 24th October, 2013
99
H. Zianofa, Evaluation of Indonesian Production Sharing contract: A sensitivity Analysis Approach.

22
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