Pressrelease from the Comission on the Petroleum Tax system 20.06.2000

Press release 20.06.2000

Commission on the Petroleum Tax system

On October 22, 1999 the Ministry of Finance commissioned an expert group to evaluate the Petroleum Taxation System. Today, the Commission submitted its report to the Minister of Finance, Mr. Karl Eirik Schjøtt-Pedersen. An important finding of the Commission is that the existing petroleum taxation system may discourage new entrants on the Norwegian Shelf, and it proposes to introduce new measures to increase the attractiveness of the Shelf for new companies.

The principal conclusions of the Commission are:

• There are deficiencies in the present taxation system for offshore oil and gas exploration and exploitation. These deficiencies will become more pronounced over time due to changing characteristics of the activities on the Shelf and due to increased oil company involvement internationally as well as on-shore domestically.

• The taxation system must be changed to prevent erosion of the tax base due to oil company economic activities outside the Norwegian Shelf.

• The deduction rules relating to investments must be adjusted to avoid excessive use of capital and to ensure that investments that are profitable before tax will also be profitable after tax.

• In connection with transfers of licences, the present system of individual rulings (section 10 rulings) should be replaced by a set of general approval conditions.

Background

The exploration of oil and gas gives rise to extraordinary returns (economic rents), over and above what are considered normal returns. Since natural resources are sovereign property, it has always been the intent of the Norwegian Government to secure a major part of these economic rents for the benefit of the Norwegian society.

The present petroleum taxation system consists of a general business tax, which is the same as for on-shore businesses (the Ordinary Tax), and a special tax for Norwegian Shelf activities (the Special Tax). The Commission is recommends that the two forms of taxation are maintained, but proposes to change somewhat the relevant bases for taxation. The Commission is underlining the importance of fixing the relevant base to ensure that the taxation of normal returns from petroleum exploration shall be the same as for on-shore activities, but that the economic rents, and exclusively these, shall be subject to the higher tax rate.

The Commission believes that the size of new finds as well as their profitability will vary considerably in the future. It will therefore be of importance to avoid levying the Special Tax in the absence of economic rents. Furthermore, new entrants should also take interest in the Norwegian Shelf without necessarily having expectations of extraordinary high returns before tax. The recommendations of the Commission will significantly improve the tax conditions for companies without current income from the Norwegian Shelf.

Significant weaknesses of the existing petroleum taxation system

In its mandate the Commission was requested to look into certain specific areas of the Petroleum Taxation System. In these areas the Commission has identified three principle weak points:

• It stimulates the incorporation of non-Norwegian Shelf activities in the entities subject to Norwegian Shelf petroleum taxation. Disproportionate allocations of net financial expenses and deductions for these against a 78% tax rate are giving significant tax benefits when engaging on-shore or in non-Norwegian jurisdictions. Such deductions erode the bases for taxation on the Shelf and are giving the relevant companies unintended competitive advantages when investing in other markets.

• It gives too strong incentives to invest in companies in a full tax paying position. In some cases, investments in exploration and exploitation with negative returns before tax become profitable after tax. This distortion may lead to excessive capital investments on the Norwegian Shelf.

• For companies without current Norwegian Shelf income, it gives too weak incentives to engage in exploration and exploitation. In this respect, new entrants are at disadvantage relative to established companies.

The recommendations of the Commission

The objectives of the recommendations are to make the tax system more targeted towards Norwegian Shelf income, to diminish distortions in company-level investment decisions and to encourage exploration and development irrespective of the tax position of the individual company. The recommendations, if adopted, will lead to the elimination, or a reduction, of the weaknesses of the existing petroleum taxation system.

The recommendations are:

• Today's deductions for net financial costs and uplift (friinntekt) in the base for the Special Tax to be replaced by an Allowance for Return on Capital Employed. This Allowance will shelter normal returns on capital from the Special Tax, irrespective of how the investments are financed. The Allowance to be computed on the basis of depreciable assets on the Norwegian Shelf, assessed at the written down value for tax purposes. The applicable return on capital shall be the risk free rate of interest, before tax.

• Actual net financial expenses related to ordinary Income to be allocated according to net asset values, basis written down values for tax purposes, in the two fiscal regimes, off and on-shore. The Petroleum taxation law, section 3 h on "thin capitalisation" no longer to be applicable.

• The depreciation rules to be changed so that the depreciation period for tax purposes becomes a closer approximation of the economic useful life of the assets. Depreciation may start only when assets are delivered or completed.

• It shall no longer be allowed to deduct up to 50 % of losses from Mainland Norway against Shelf Income.

• Future losses, in the bases for the Ordinary Income and the Special Tax, to be carried forward with interest using the after tax risk free rate. Future losses are defined as losses occurring after the implementation of the new rules.

• Future Losses in a company that ceases its activities on the Norwegian Shelf to be transferable in case the assets are sold or in case of a merger with another company.

• Transfers of licences between companies that do not have carry forward losses established prior to the introduction of the new rules no longer be subject to individual rulings by the Ministry of Finance. The principle of tax continuity to be applied in the case of sale of assets with associated licences.

• Sale and purchase of licences involving companies with losses established prior to the introduction of the new rules, to be subject to § 10 rulings by the Ministry of Finance as before. This will also be the case in transfers where SFDI (State Financial Direct Interest) is a party to either side of a transaction.

Actual net financial expenses, including expenses arising from non-shelf related activities, shall no longer be taken into account when arriving at the base for the Special Tax. Furthermore, the Commission recommends introducing a new set of allocation rules for net financial expenses permitted to be included in the Ordinary Income base. These measures combined will reduce the erosion of the Shelf Taxation base. Regarding onshore investments, they will also put Shelf and non-Shelf companies on a level competitive ground. The adoption of these recommendations will effectively end the present practice of sheltering other investments through the petroleum taxation system.

New depreciation rules will contribute to a more equal taxation of normal returns on Shelf investments compared to returns on-shore investments.

Normal returns will be sheltered from Special Taxation through the Allowance for Return on Capital Employed. This shelter is however smaller than today’s aggregate allowances for actual net financial expenses, uplift (friinntekt) and the effects of generous depreciation allowances for Shelf investments. Redefining the deductions is necessary to prevent tax- induced excessive capital investments on the Norwegian Shelf.

The recommendations regarding loss-carry-forward will in particular improve the economic conditions for new entrants and may enhance exploration and exploitation. They will also benefit existing companies to the extent that they from time to time are not in a tax paying position. The recommendation regarding a new set of general tax rules for transfers of licences has been made in consideration of facilitating the acquisition of such licences for smaller companies

Consequences for taxation revenues

Some of the recommendations will serve to expand the base for Petroleum Taxation. This follows from the objective of securing neutrality in the taxation system. If adopted, the changes will reduce incentives for investments that are unprofitable on a before tax basis. All other things being equal, an expanded tax base will lead to an increase in government taxation revenues.

The recommendation to allow loss-carry-forward, compounded with interest, trading in tax-loss positions for exiting entities, the deletion of paragraph 3 h in the Law on Petroleum Taxation, all other things being equal, serve to reduce government taxation revenues.

The Commission was requested to estimate the effects of its recommendations on Shelf Taxation Income. The estimates have chiefly been made on the basis of the a-continuation-of-existing-plan-principle for companies currently active on the Norwegian shelf. It has not been possible to properly evaluate the net effects of those recommendations that lead to a more lenient taxation, in particular for the new entrants.

According to the calculations carried out by the Commission, the net present value of the taxation proceeds for the period 2001-2030 will remain unchanged if the present level of Special Tax is reduced by about 4 percentage points and the CO ₂-tax is reduced to the same level as for mineral oils. In its calculations, the Commission has assumed non-compensation of today’s misallocation of financial items.

If the Special Tax was to remain unchanged the net present value of the increase in Shelf Taxation Income caused by the proposed changes would amount to about NOK 30 billion for the period 2001-2030. Such an increase equals about 2% of the aggregate Norwegian government income from the petroleum sector in the corresponding period

The Commission underlines that its estimates of the effects on Shelf Taxation Income are associated with a high degree of uncertainty. The Commission was not requested to evaluate the level of the Special Tax and has therefore decided not to express a recommendation on this issue.