The Special Commissioners

Spc00624

PETROLEUM REVENUE TAX – legislation provides an exemption from tax for gas sold to British Gas under a contract made before the end of June 1975 - Appellant entered into a contract with British Gas on 27 June 1975 and Revenue agreed that gas sold under that contract was exempt from tax –the period of the 1975 contract ended on 31 October 2002 – in March 2002 the Appellant and British Gas entered into an agreement which took the form of amendments to the 1975 contract and which extended its term by ten years – whether gas sold after 31 October 2002 was sold under “a contract made before the end of June 1975” – no – appeal dismissed – OTA 1975 s 10(1)(a)

THE SPECIAL COMMISSIONERS

SHELL UK LIMITED

Appellant

- and -

THE COMMISSIONERS FOR HER MAJESTY’S

REVENUE AND CUSTOMS

Respondents

Special Commissioners: DR A N BRICE

JOHN WALTERS QC

Sitting in London on 16 – 24 May 2007

Graham Aaronson QC with Michael Bools, instructed by Herbert Smith Solicitors, for the Appellant

Sean Wilken with Jess Connors, instructed by the Solicitor for HM Revenue and Customs, for the Respondents

DECISION

The appeal

1.Shell UK Limited (the Appellant) appeals against assessments to petroleum revenue tax for the six chargeable periods between 31 December 2002 and 30 June 2005 inclusive. The assessments were made by the predecessors of the Commissioners for Her Majesty’s Revenue and Customs (the Revenue) because they were of the view that gas sold after 1 November 2002 by the Appellant to British Gas was not exempt from petroleum revenue tax because it was not gas sold under a contract made before the end of June 1975 within the meaning of section 10(1)(a) of the Oil Taxation Act 1975. We were informed that the amount of tax in issue was about £150M.

The legislation

2.The Oil Taxation Act 1975 (the 1975 Act) imposed a new tax in respect of profits from substances won under the authority of licences under the Petroleum (Production) Act 1934 (the 1934 Act). Section 1(1) of the 1975 Act provided that petroleum revenue tax was charged in respect of profits from oil. Oil was defined as meaning any substance won under the authority of a licence under the 1934 Act. Thus oil includes natural gas. Section 1(2) of the 1975 Act provided that for each oil field the tax was to be charged at the rate of 45 per cent on the assessable profit accruing in any chargeable period from that field. Section 1(3) provided that a chargeable period was half a year. Section 2 contained provisions about the calculation of assessable profits and allowable losses for the purposes of the tax.

3.The relevant parts of section 10 provided:

“10 (1)In computing under section 2 of this Act the gross profit or loss (if any) accruing to a participator in any chargeable period from an oil field –

(a)any oil consisting of gas sold to the British Gas Corporation under a contract made before the end of June 1975 shall be disregarded; …

and in the following provisions of this section any oil which falls to be disregarded under this subsection is referred to as “excluded oil”.

4.Thus the scheme of the legislation is to charge tax on assessable profits from oil fields. In computing those profits any gas sold to the British Gas Corporation under a contract made before the end of June 1975 is disregarded. We refer to this provision as an exemption from tax as it is referred to in that way in subsequent legislation (namely, in the Gas Levy Act 1981).

5.Since the enactment of section 10(1)(a) the British Gas Corporation has changed its name twice. Throughout this Decision we refer to it as British Gas.

The issue

6.The Appellant entered into a contract with British Gas on 27 June 1975 (the 1975 contract). The contract had a fixed term of twenty years beginning with a first delivery date. The first delivery date was 1 November 1982 and so the term of the contract ended on 31 October 2002. The Revenue agreed that all gas sold under the 1975 contract before the end of October 2002 was exempt from petroleum revenue tax. Towards the end of 1999 the Appellant and British Gas entered into negotiations about sales of gas after October 2002 and reached an agreement in March 2002 (the 2002 agreement). The 2002 agreement took the form of amendments to the 1975 contract; in particular, it changed the provisions about price and the quantities of gas to be sold and it extended the term of the contract from twenty to thirty years.

7.The Appellant argued that gas sold to British Gas after October 2002 was gas sold under the 1975 contract and so was exempt from petroleum revenue tax. The Revenue argued that, as a matter of statutory construction, the purpose of the 1975 Act was to exempt from tax gas sold under contracts which were being negotiated at the time of the passing of the Act. In their view the 2002 agreement was not the same contract as the 1975 contract because its terms were fundamentally different; accordingly gas sold to British Gas after October 2002 was not gas sold under the 1975 contract and so was not exempt from petroleum revenue tax.

8.Thus the issue for determination in the appeal was whether gas sold to British Gas after October 2002 was “sold under a contract made before the end of June 1975” within the meaning of section 10(1)(a) of the 1975 Act and so was exempt from tax (as argued by the Appellant) or was not “sold under a contract made before the end of June 1975” and so was not exempt (as argued by the Revenue).

The evidence

9.There was an agreed statement of facts. Twenty-two bundles of documents were produced by the parties. At the hearing reference was made to many of the documents in bundles A1, A2 and A3 and C1, C2, C3 and C4. Very little reference was made to the other bundles.

10.A witness statement prepared by Mr Philip Lowery, the General Manager of Shell Gas Direct Limited, was admitted in evidence on behalf of the Appellant. Oral evidence was given on behalf of the Revenue by Mr Tony Chanter, a petroleum revenue tax technical specialist employed by the Revenue and by Mr Malcolm Phelps who was also employed by the Revenue.

11.Expert evidence on behalf of the Appellant was given by Ms Gay Wenban-Smith, B.Sc, M.Sc. Since 1995 Ms Wenban-Smith has been a Managing Consultant and Senior Associate with Gas Strategies Consulting. Before 1995 she spent twelve years with British Gas. Her main report was signed on 14 March 2007 and a supplementary report was signed on 4 April 2007.

12.Expert evidence on behalf of the Revenue was given by Mr Niall Fitzgibbon Trimble, Managing Director of the Energy Contract Company. Mr Trimble is the author of The Energy Company’s UK Gas Market Review and before 1983 he spent some time with British Gas. His main report was dated 28 February 2007 and his supplementary report was dated 4 April 2007.

The facts

13.From the evidence before us we find the following facts. We have also found it convenient to refer to some relevant legislation within the context of the events at the time when it was enacted.

1964 – The Continental Shelf Act and natural gas

14.The Continental Shelf Act 1964 (the 1964 Act) contained provisions dealing with the exploration and exploitation of the continental shelf. Section 9(1) contained provisions about the use and supply of natural gas “gotten” in pursuance of a licence under the 1934 Act. Section 9(2) provided that the holder of the licence should not, without the consent of the Minister of Power, use the gas in Great Britain or supply it to any other person at premises in Great Britain. Section 9(3) provided that the Minister of Power should not give such consent unless satisfied that the Area Board (of British Gas) had been given an opportunity of purchasing the gas at a reasonable price.

15.Although section 9(3) gave British Gas the right of first refusal, in practice the effect of these provisions was that the only purchaser of natural gas in the United Kingdom was British Gas and that natural gas had to be sold to British Gas at a “reasonable price”. These provisions were not repealed until the Gas Act 1986. Thus until 1986 the whole British market for natural gas was effectively controlled by British Gas who was the monopsony buyer for the wholesale market, the transporter of natural gas within the United Kingdom, and the distributor and seller of natural gas. As British Gas was owned by the government until privatisation in 1986, the wholesale price of gas was heavily influenced by the government. There was then no spot market for gas and traded wholesale prices for gas were not available.

1968 - the Leman and Indefatigable contract

16.On 14 December 1968 the Appellant entered into two contracts with British Gas to sell natural gas from the Leman and Indefatigable fields. The Leman contract provided that it was to continue in force up to and including 30 September 1993 “and thereafter until terminated by either party by two years’ prior written notice given to the other and timed to expire either on or after 30 September 1993”. The Indefatigable contract had a similar provision save that termination was to be on 30 September 1994. Both contracts were subsequently amended and extended.

1970 - the Brent oil field

17.The Brent oil field is located in the United Kingdom North Sea and is about 150 miles north east of Aberdeen. It was discovered in about 1969 and on 29 July 1970 the Appellant, together with Esso Exploration and Production UK Limited (Esso), became joint licensees of the Brent field under a production licence. Each of the Appellant and Esso hold a 50% working interest in the Brent field. The Brent field is primarily an oil field but natural gas is produced in association with the oil.

1972 – 74 – negotiations leading to the 1975 contract

18.In October 1972 negotiations began for the sale of natural gas from the Brent field by the Appellant to British Gas. Separate negotiations were conducted between Esso and British Gas with which we were not concerned. During the negotiations with the Appellant, British Gas indicated that it wanted to buy all of the gas from the Brent field which could economically be brought to the mainland and the Appellant indicated that it also wanted the option of selling to British Gas gas from other small fields near the Brent field.

19.The duration of the contract was also discussed. British Gas wanted a contract for twenty-five years and the Appellant wanted a contract for fifteen years. One provision of the contract was to be that the Appellant would construct a very expensive pipeline to transport the gas from the Brent field to the mainland, and dedicate the use of that pipeline solely to gas sold to British Gas. The Appellant was reluctant to commit to the exclusive use of the pipeline by British Gas for a long period, especially as the price which British Gas was prepared to pay was low by market standards. At that time it was thought that the Brent reserves would justify dedication of the pipeline for about fifteen years. Ultimately a term of twenty years was agreed commencing on a date called the first delivery date.

20.At that time the Appellant wanted the price and its escalation to be indexed to a mixture of competitive fuels, and to that extent, market-related. However, British Gas pointed out that the “reasonable price” payable under the 1964 Act was not market-related nor cost-related but was a reasonable price which would give the Appellant a good return on its investment and that was all that was required to be reasonable. In the view of British Gas a reasonable price lay somewhere in the low end of the margin between bare cost and market value. It was appreciated that, even if there were to be an escalation provision related to oil or wholesale prices, the price payable would increasingly fall short of the market value of the gas.

21.We saw a gas production forecast for the Brent field prepared in June 1974 which showed that it was then expected that sales would start in 1978, that production volumes would peak in 1980 and that thereafter volumes would decline until 1990 when sales would cease.

1974 –early 1975 - the proposals for a petroleum revenue tax

22.The negotiations between the Appellant and British Gas were at an advanced stage when, in August 1974 a representative of the Appellant met the Paymaster General who said that there would be consultation with the oil companies about the structure of a proposed new petroleum revenue tax. On 26 October 1974 the Department of Energy wrote to HM Treasury to say that the Appellant had agreed terms with British Gas (for the sale of gas from the Brent field) yielding no more than a reasonable profit and had asked for assurances that the contract would be sheltered from the forthcoming petroleum revenue tax. The reason why the Appellant asked for these assurances was that the price under the contract had, under the 1964 Act, to be a reasonable price and that was lower than the market price at the time. Also, the tax was primarily addressed to sales of oil, whose price had increased rapidly, but the price of gas was constrained by the 1964 Act.

23.A meeting was held on 19 November 1974 between representatives of the government and representatives of the gas industry. This was followed by an internal meeting held in the Paymaster General’s office on 20 December 1974 when it was reported that the Appellant felt strongly that gas from the Brent field should not be subject to petroleum revenue tax because the price payable by British Gas bore no relation to its energy value because of the monopsony position of British Gas. The proposed contract was to run for twenty years and if it had to be renegotiated there would be further delay. There was a meeting between a representative of the Appellant and representatives of the Paymaster General on 22 January 1975 when it was reported that, if the Appellant did not get exemption from petroleum revenue tax, it would expect the government to instruct British Gas to give the Appellant a higher price. It was noted that the effect of giving an exemption from tax in respect of contracts with British Gas concluded up to some forward date would give the Appellant the option of concluding its contract on the basis of the existing heads of agreement in time to benefit from the exemption or it could let the deadline pass and re-negotiate the price with British Gas. The date of 30 June was suggested as the forward date.

24.In January 1975 the Oil Taxation Bill was considered in Standing Committee D of the House of Commons. The Tenth Sitting was on 30 January 1975 when the Paymaster General tabled a new clause the purpose of which was to exempt from petroleum revenue tax gas supplied to British Gas under contracts concluded with it by 30 June 1975.

25.An internal meeting was held at the Department of Energy on 17 February 1975 when it was explained that the 30 June deadline for the petroleum revenue tax exemption was meant to allow time for the conclusion of the final Brent contract with British Gas and it was explained that the already comprehensive heads of agreement could probably be converted quickly into a full contract. On 2 May 1975 the Minister of State at the Department of Energy wrote to the Appellant referring to the statement of the Paymaster General on 30 January 1975 regarding the exemption from petroleum revenue tax of gas supplies which were contracted with British Gas before 30 June 1975.

May 1975 – the 1975 Act

26.The 1975 Act received the Royal Assent on 8 May 1975 and sections 1, 2 and 10 are briefly summarised in paragraphs 2 and 3 of this Decision. Schedule 2 contained the provisions about the management and collection of the tax. Most of the provisions of the Taxes Management Act 1970 were stated to apply with some alteration. For each chargeable period (of six months) each participator had to deliver a return to the Revenue stating the quantity of oil delivered, the person to whom the oil was disposed of, and the price received or receivable. If it appeared to the Board that an assessable profit had accrued to a participator they made an assessment and gave notice of it to the participator. If the Board were satisfied that the information given in the return was correct the assessment was made in accordance with the return; if the Board were not so satisfied then the assessment was made to the best of their judgment. The tax was payable four months after the end of any chargeable period or, if later, 30 days after the notice of assessment.

27.The rate of petroleum revenue tax remained at 45% until 1978; in 1979 it was 60% and in 1980 and 1981 it was 70%. From 1982 to 1993 it was 75% and in 1993 it became 50%. It has remained at that rate. After 1993 petroleum revenue tax was not charged on new fields.

27 June 1975 – the contract