OT21564A - Investment Allowance: Operating and leasing expenditure – Operating expenditure
To ensure that the allowance is only generated where operating expenditure represents a genuine investment in UK Continental Shelf oil and gas activity, the following conditions must be met:
Condition A (Regulation 3(2))
The expenditure must be incurred for the purposes of increasing any of the following:
(a) the rate at which oil is extracted from a qualifying oil field or a cluster area;
(b) the reserves of oil of a qualifying oil field or a cluster area;
(c) the number of years for which it is economically viable to carry out oil extraction activities in relation to a qualifying oil field or a cluster area;
(d) the number of years for which a facility can be used for the purposes of oil extraction activities in relation to a qualifying oil field or a cluster area; or
(e) the amount of tariff receipts or tax-exempt tariffing receipts that are earned by the company in respect of upstream petroleum infrastructure.
Companies should have detailed information about the field’s recoverable reserves, the current rate of oil extraction, and tariff receipts at present, as well as forecasts for the future life of the field and any facilities therein. We would expect that to meet Condition A the company would be able to demonstrate that the expected impact of the expenditure was to increase one or more of (a) to (e) compared with if the expenditure was not incurred.
In the context of (b), reserves means economically recoverable reserves.
Where only part of the expenditure incurred gives rise to an increase in (a) to (e), only that part of the expenditure which gives rise to the increase will be capable of generating the allowance. Note that Condition A is a ‘purpose test’. This means that it is the company’s purpose in incurring the expenditure which is crucial. So allowance could still be generated, even if the expenditure did not ultimately result in an increase in any of (a) to (e), as long as the company’s purpose in incurring the expenditure was that it would do so. The company should have clear evidence of the purpose of the expenditure. Contemporaneous evidence such as records of discussion with the North Sea Transition Authority (NSTA) or with field partners would normally provide sufficient evidence. Project planning documents, such as field development plans, together with projections and internal records of meetings or other communication, could also provide useful evidence. This evidence would not need to be submitted with the company’s tax return but should be retained in case of HMRC enquiry.
Condition B (Regulation 3(3))
Condition B is that the expenditure is not routine repair or maintenance expenditure. The legislation does not define “routine repair or maintenance expenditure” so these words take their normal meaning. HMRC provides guidance in the Business Income Manual at BIM35430 et seq. on what we interpret as a repair.
HMRC would likely consider expenditure to be routine if it did not represent any genuine new investment but was more akin to a day-to-day running cost.
We would not normally take the view that the regularity with which the activity occurs affects whether or not it is routine. It would not matter whether the activity needed to be (and indeed was) undertaken weekly, monthly, yearly, or even more rarely. The allowances are designed to encourage investment in UK oil and gas activity, so the activity being undertaken should represent a genuine investment. Maintaining the current condition of the asset, or returning it to its original state, where regular maintenance was neglected, is unlikely to represent any new investment and instead will likely be viewed as routine maintenance.
In cases of doubt, it may be useful to consider whether a company has discussed the work being undertaken with the NSTA. Where the company has not done so, it is likely that the work would be routine. Equally, where the NSTA has been consulted, it is more likely that the work would not be routine. However, consulting the NSTA is in no way decisive and all the facts must be considered.
Condition C (Regulation 3(4))
This condition sets out what expenditure must be incurred on. To qualify, expenditure must be incurred in relation to a facility or an oil well. Facility and upstream petroleum infrastructure was initially defined at regulation 3(6). However, the definition meant that some facilities located onshore and in Northern Ireland waters would not be in scope and that was not the intention of the legislation. The Investment Allowance and Cluster Area Allowance (Investment Expenditure) (Amendment) Regulations 2024 (Link) (SI 2024/395) amended the 2017 Regulations by incorporating the definitions of facility and upstream petroleum infrastructure in the Energy Profits Levy to ensure the allowance applies as intended. Facility is defined in EPLA22\S18(1) as a platform , an oil well, a platform well, an oil well head or upstream petroleum infrastructure. Upstream petroleum infrastructure means any upstream petroleum pipeline, oil processing facility or gas processing facility (as defined by the Energy Act 2011\S90 but as if that section also applied, with the appropriate modifications, to Northern Ireland. This is an exhaustive list. Expenditure must fall within the definitions provided at regulation 3(4)(a) in relation to a facility, and regulation 3(4)(b) in relation to an oil well to generate the allowances. Expenditure on items which are not listed cannot generate the allowances.
If expenditure is incurred on the replacement of equipment, then to meet Condition C the existing equipment must be no longer capable of being used for the purposes of oil extraction activities. The meaning of ‘no longer capable’ is not restricted to cases where the physical condition of the asset, due to damage or wear and tear, means that it can no longer be used for oil extraction activities. It could also include cases where, due to regulatory changes, health and safety issues, environmental requirements or other reasons, the asset is no longer capable of being used. Note that ‘no longer capable’ means that upgrading to a newer or better model would not generate the allowances, where the existing asset was still capable of being used.
Where a company incurs expenditure, only part of which meets the conditions outlined above to qualify as operating expenditure, only that part of the expenditure which meets the conditions may generate the allowance. In accordance with regulation 3(5) any apportionment should be on a just and reasonable basis.
For example, if a company were to replace a damaged pump, and the contract for the new pump included maintenance of that pump for the next 5 years, only the amount relating to the replacement of the pump, and not its maintenance could generate allowance, assuming all other conditions were met. If the contract did not split out the costs of maintenance and acquisition, then any apportionment should be on a just and reasonable basis, having full regard to the relevant facts and circumstances.