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Malcolm Bruce (Gordon): The hon. Gentleman makes an important point. Does he find it extraordinary that the Government are so willing to acknowledge the problem that they have written to the IRS, the tax authority in the United States, asking it to consider reviewing its tax policies as a result of changes to UK tax? Do they really think that that is likely? How would the Inland Revenue respond to America trying to change our taxes?
Mr. Flight: I thank the hon. Gentleman for his common-sense comment. It underlines the fact that the costs will not be allowable under double taxation treaties and, according to all the tax advice that I have received, I am afraid that the Government and the Revenue will get a response from the IRS to that end.
New clauses 2 and 3 address a separate territory. They would bring the supplementary charge to an end by 31 March 2005 and negate it if the price of oil falls significantly in the meantime. That is designed to give the industry an idea of how long the windfall tax will apply and could help to encourage investment today in fields that are expected to be profitable in a few years' time.
The interaction between accounting requirements and tax arrangements is an important consideration. The key result would be that the 2002 earnings of oil companies will not be hit as dramatically. I am sure the Government would not welcome further downward spirals in share prices if pension schemes are unable to pay the pensions to which they are committed when the measure makes its way through to oil prices. The Government's response is likely to be that they want a stable regime, but it is self-evidently a disaster to have the stable regime that this Finance Bill institutes if it is no good for the industry, the country or our external overseas accounting position.
New clause 4 would allow accelerated capital allowances on new assets used in a ring-fenced trade. As we debated in Standing Committee, we want to take a cash flow advantage approach, which does not reduce the total tax payable over the life of the project or improve accounting profits. The new clause would allow an extra 10 per cent. deduction over and above normal capital allowances in 2003. It would apply only to assets acquired before 1 January 2003 on which normal non-accelerated allowances were claimed.
We want to reduce some of the bad faith evidenced in the PILOT encouragements. The Government have been stonewalling by denying that there is bad faith. For the past 20 years, transitional arrangements have been available when significant changes have been made to the tax regime. If the Government argue that there is the odd historic case of a retroactive tax, measures have been designed to offset those. The key problem for the oil extraction industry is that it perceives two major risks: first, the operating risk of the oil price; and, secondly, the operating risk of a Government who have a regime that lacks fiscal integrity in terms of what the future will hold. If the risks increase, the returns have to increase to justify the same investment by having a higher risk:reward ratio.
I pay tribute to the efforts of the hon. Member for Waveney (Mr. Blizzard) for his attempts to get the Government to see sense. I am aware that Scottish MPs have been involved in significant lobbying behind the scenes, but they have been feeble in not defending their homeland in public. The industry employs 6 per cent. of the labour force in Scotland.
Mr. Alex Salmond (Banff and Buchan): The hon. Gentleman puts at risk his cross-party support. I take it that when he says "feeble" he is referring to Scottish Labour MPs.
Mr. Flight: Indeed I was. I thought I made that clear. However, I am sure that anyone who appreciates what is at risk would have wanted more Scottish Labour MPs to join the Scottish nationalist MPs, the Liberal MPs and Conservative MPs in speaking out against the wanton damage that will be caused, and the wanton reduction of the prospects for recovery in the North sea. No doubt they would also have wanted them to speak out against
measures that will reduce investments substantially, destroy jobs and boost an already vulnerable current account deficit to the extent of £12 billion per annum.
Mr. Bob Blizzard (Waveney): As I said on Second Reading, I very much welcome efforts to raise more money for the NHS, but I am concerned about the Bill's effect on future investment in the United Kingdom oil and gas industry. That is important not only to local economies in many parts of the country, such as my own, but to the country generally, because investment in the industry has amounted to about 16 per cent. of total industrial investment over many years, which means that it has generated a lot of employment.
Having listened to debates on this subject throughout the Bill's proceedings, I still find it hard to see how a big increase in tax cannot have some effect on that investment, whether it be a reduction in the cash flow from the existing fields which is available for reinvestment or an impact on the psychology of investors who have just taken a hit, perhaps shaking confidence in investment.
Behind the measure lies the argument that the oil and gas companies make big profits. They certainly do in bumper years such as 2001, when we had high oil prices, but they do not make big profits all the time, as we can see by looking at returns over the full cycle or over the full lifetime of individual projects. The return on capital employed over those periods is not greatly different from that in other industries.
The hon. Member for Arundel and South Downs (Mr. Flight) quoted a figure of 14 per cent. over time, before corporation tax is taken into account. That compares with returns of between 11 and 13 per cent. for other companies in non-financial sectors over, say, a decade. That has to be the case, or everybody investing in stocks and shares would just plunge all their money into oil and gas. It would be the only game in town and those companies would constantly be at the top of the stock market. No one would need to engage a financial adviser.
Oil exploration and production is a risky business, and companies find many expensive dry wells or uneconomic fields in an area before they discover the successful ones that make money. Fiscal stability is therefore an important factor when companies are making plans, and it has been seen as one of this country's great strengths. As we know, the industry is arguing that that fiscal stability is now at an end, so it has to factor a fiscal risk into its calculations for future investment, which adds to the overall risk.
The Treasury argues that fiscal stability has now been achieved and that the review started in 1997 and halted in 1998 has now concluded. The essence of its case is the argument that although it is unquestionably taking more money out of existing developments, the fiscal position for new developments is improved by the combination of 100 per cent. first-year capital allowances and the supplementary charge. The industry's figures, which I have seen and which have, I know, been presented to the Treasury, also show that to be the case, on paper. The argument is about whether the reality is more complicated.
The industry's figures also show, however, what happens if fiscal risk is factored in and corporation tax of 40 or 50 per cent. applies. In that analysis, the fields do
not work at all. The Treasury says that it would never set the tax at 50 per cent. because that would kill everything off, but at 40 per cent, the fields still work.6.15 pm
Notwithstanding that argument, we have to consider now the key question of how we can maximise investment in what will clearly be a new regime of a 10 per cent. supplementary charge and 100 per cent. capital allowances. The key issue, which is the subject of one of the amendments, is financing costs. We know that, over the years, companies have normally been allowed to offset them against corporation tax, but it is proposed to change that so that they will not be creditable against the supplementary charge. That is absolutely relevant to new development, and we have to be extremely careful that it does not act as a disincentive that will undermine the incentive given by the Treasury in the 100 per cent. capital allowances.
I have been asking why the measure is necessary. The answer given in the Committee of the whole House was that it is important if the supplementary charge is to work; otherwise there would be scope for companies to manipulate their financing costs so that they could offset more than is justified against the new charge. The industry maintains that that is not possible under the existing regulations and the close scrutiny by the Revenue.
Will the Financial Secretary tell us exactly what loopholes the measure is designed to plug, and will she deposit that information in the Library? I realise that it is not normally the business of the Treasury to broadcast the existence of loopholes, but if the Government are introducing measures to plug loopholes, it would be helpful to know what they are. We would then be able to see clearly whether there is a need for a measure preventing financing costs from being offset against the supplementary charge.
I fear that if we have got this wrong, it will create unnecessary problems, even within the new regime, for certain types of company whose continued investment in the North sea is desperately needed. The first type is smaller companies, for which financing costs assume a greater proportion of their costs. They have a vital part to play in the development of the North sea. The experience in other mature provinces around the world is that smaller independent companies—the experts who get stuck in—are the appropriate ones to go after smaller reserves and make money by extracting them. We want to ensure that those small companies, which the Government accept have a part to play in future, are not put off by the measure.
That is particularly the case with new entrants. We have managed to attract 23 new entrants to the North sea since 1997. We know that they will not get the real benefit of the 100 per cent. capital allowances because they have no profit in the first year against which to offset them. I know that they can roll them over, but they would then have, for example, 25 per cent. allowances for four years, which is what they already have. Financing costs are an important consideration if we are to encourage new entrants.
Another reason for considering the measure carefully concerns the origin of much of the investment—parent companies or venture capitalists in the USA. There are issues of double taxation which are not yet clear. I know
that the Government have written to the IRS in the hope of clearing up the matter through double taxation treaty agreements. I fear, however, that until that agreement is confirmed by the IRS, investors will not go ahead in case they are caught by the measure. Furthermore, I am told that if the financing costs are not creditable but companies take them as an expense, the measure will still make a difference of about 6.5 per cent., which might make the difference between investing here or in another country.I ask Ministers to try to find an alternative way of protecting the supplementary charge—the Treasury introduced it, so it will want to protect it—that does not have the negative effects on smaller companies and new entrants that I have described. In addition, it would be helpful if the measure and the reasons why it is needed were set out clearly for us to see.
At the core of the issue are the integrated companies that have both upstream and downstream activities, and the fear that money might be moved between the two spheres of activity. However, new entrants, smaller companies and independents are not downstream companies; they are only upstream companies. If we carry on as we are, those companies will be hit by a measure that is presumably not designed to hit them, so we must make sure that it does not. Those who have been bitten by the supplementary charge might—rightly or wrongly; it depends on what view one takes of the argument about fiscal stability—be shy of further investment, but we cannot afford to deter new and smaller companies.
Royalty is part of the package, and it is important that we proceed quickly with the consultation that will lead to its abolition. Everyone seems to agree that it need not take long as it is a technical consultation, not a full public consultation. I worry that the longer we leave the position on royalty unattended, the longer we will hold back the investment we need, even under the new regime. It will therefore be helpful if the Minister says something about royalty tonight and confirms that once the consultation is over, the Chancellor can abolish royalty without further legislation, and can fix whatever operative date he wants—even today, if he were so minded.
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