Upper Tribunal decision - extent of the ring fence

The case concerns a royalty arrangement which entitled a non-resident bank to payments contingent on production from a UK oil field, calculated by reference to the oil price at the time. The First-tier Tribunal (FTT) found that although the taxpayer did not have an interest in the oil licence, it did, by virtue of the royalty agreement, enjoy ‘the benefit of’ the oil and therefore should be subject to the UK ring fence tax regime. The taxpayer appealed the case to the Upper Tribunal (UT) on a number of grounds, including the application of the UK-Canada Double Tax Treaty (DTT) and the interpretation of the reference to ‘the benefit of the oil’ for the purposes of section 1313 CTA 2009 (Activities in UK sector of continental shelf). The UT agreed with the FTT’s findings.

The case considered whether royalties received by a non-resident bank gave rise to UK taxable profits subject to ring fence taxation. The royalty agreement entitled the bank to quarterly payments based on production from an oil field which were linked to the excess of the market price of the produced oil above a benchmark level.

Profits related to exploitation of UK oil and gas assets are subject to the upstream tax regime (broadly known as ‘the ring fence’ which aims to prevent the dilution of such taxable profits and also subjects such profits to higher rates of tax). The scope of the ring fence encompasses oil-related activities, defined in Part 8 CTA 2010. The taxpayer considered that as it did not own any UK oil rights it should not be subject to the UK upstream tax regime.

The FTT found that the royalty arrangement gave the taxpayer the rights to ‘the benefit of’ the oil won from the field and therefore the payments were received by the taxpayer as part of a trade carried on by it in the UK through a deemed permanent establishment. As a result, a UK ring fence trade was triggered.

The UT found that:

• The DTT did not provide protection to the taxpayer as the income was from immovable property; and
• The rights to the payments held by the taxpayer were sufficient to constitute rights to ‘the benefit of the oil’ despite it not owning the licence or having proprietary rights over the oil. ‘Benefit’ can include a wide range of arrangements, whether proprietary, contractual or commercial.

Structures involving payments calculated with reference to production are increasingly common and this decision highlights the risk that such arrangements may subject related profits to ring fence taxation, even where the taxpayer is not directly undertaking UK oil activities.