OT20300 - Corporation tax general: take or pay gas sales contracts

To secure an adequate supply of natural gas in the early years of exploiting North Sea reserves, a purchaser will often have entered into a long term sales contract and agreed to pay the producer for a specified minimum quantity of gas even if that gas was not taken. Although the details of contracts vary, a typical one may specify that the purchaser is required to pay the seller for a certain quantity of gas each year, whether or not the purchaser can take delivery of that quantity in the year. If it cannot take delivery, the purchaser may be allowed credit in future years for any payments in respect of gas not taken. There may be circumstances where payments are refundable.

For accounting purposes, it is usual for payments by the purchaser for gas not delivered at an accounting date to be dealt with as deferred income in the balance sheet of the seller. They are regarded as payments in advance for gas to be delivered, and are released to the income statement when the criteria for revenue recognition are met. This would normally be upon delivery.

In accordance with general tax law, the earliest chargeable period in which trading profits can be recognised for tax purposes is that in which the item sold to the customer has been substantially rendered to him. Take or pay contracts are considered to be contracts for the sale and delivery of gas. The purchaser is paying for gas and its delivery. It therefore follows that until the gas has been delivered, the service the customer is paying for has not been rendered. It is when the gas is delivered that the profit arises. It does not arise when payment is made.

The above paragraph is based on legal advice.

As noted in OT02003, IFRS15 Revenue from contracts with customers is effective for accounting periods beginning on or after 1 January 2018. The standard applies to contracts with customers and entities in the oil and gas sector will be within the scope. Early adoption is permitted. Any complex contractual arrangements relating to the sale of products or services will require careful consideration in light of the new requirements. Depending on the arrangements in place there could be an impact on when to recognise revenue and how to measure it.