Norway proposes cash flow tax on petroleum
Mats Hennum Johanson of Deloitte Norway explains the incoming changes to the Norwegian petroleum tax regime, and how they will affect companies operating in the area.
On April 8 2022, the Norwegian Ministry of Finance proposed significant changes to the tax rules governing the Norwegian oil sector. The proposed rules were largely in line with the proposal that was circulated for public consultation by the former Norwegian government in September 2021. The proposals are expected to be passed and to enter into force from 2022.
Under today’s tax regime, the Norwegian oil sector is subject to both ordinary corporate income tax (CIT) at 22%, and a special petroleum tax with a rate of 56%. The latter only applies to companies engaging in the pipeline transport, exploration, and production of petroleum. It is a resource rent tax that is conceptually similar to the one that applies to the Norwegian hydropower industry.
Both the CIT and the special petroleum tax are profit-based. The basis for calculating the taxes is income minus costs in the petroleum business. However, investment-based deductions (“uplift”) in addition to straight-line depreciation applies for the calculation of the special petroleum tax. The government is of the view that this deduction can give companies incentives to make investments that are not socioeconomically profitable.
Under the proposal from the Norwegian Ministry of Finance, the special petroleum tax is therefore converted into a neutral cash flow tax, where the companies can make immediate deductions for expenses incurred. The standard CIT that the companies are also subject to will continue to apply, but with some modifications.
Main changes to the Norwegian petroleum tax regime
When calculating the special petroleum tax going forward, 100% of the expenses relating to pipelines and production equipment or appliances will be deductible the year they are incurred, rather than being depreciated on a linear basis over a period of six years, as is the case today. The uplift deduction will also be discontinued.
This change will apply to investments carried out from 2022 onwards. The tax value of losses and unused uplift incurred during the income years 2002-2019 will be repaid as part of the tax settlement for the 2022 income year (in other words, in 2023).
When calculating the special petroleum tax, a deduction will be made for calculated CIT on ordinary income. The calculation of CIT on ordinary income will be based on the same costs and income that are included in the base for the special petroleum tax, but with some modifications. For example, the operating assets that – according to the incoming rules – will be immediately deductible in the base for the calculation of the special petroleum tax will still be depreciated for the purposes of calculating CIT on ordinary income.
Since a calculated CIT on ordinary income will be deductible from the basis for the special petroleum tax, the tax rate for the special petroleum tax is technically increased to 71.8% from 56%. The reason for this is that the current effective tax rate of 78% could not be sustained if it was possible to deduct CIT on ordinary income at 22% and if the special petroleum tax rate remained at 56%.
The system for refunding exploration losses and wind-down losses is also discontinued. Instead, the tax value of new losses (both exploration losses and other losses) in the special petroleum tax is refunded at a rate of 71.8%. The general loss refund will be paid annually, as part of the ordinary income tax settlement.
The current rules allow for deductions for interest costs based on an allocation formula between interest-bearing debt and depreciated tax values when calculating the special petroleum tax. These rules are retained. However, the Ministry of Finance expects the deductions to lapse within a few years when old investments and tax bases are fully depreciated.
The Ministry of Finance expects the new rules to improve the liquidity of companies subject to the rules, ensure socioeconomically viable investments, and provide the oil sector with stability and predictability. However, the taxation of the Norwegian oil sector is likely to remain politically controversial.
Although it is likely that the new rules will benefit the liquidity of companies with commercially viable discoveries, some companies may be adversely affected. The new rules will have a negative impact on exploration companies without commercially viable discoveries, as losses under ordinary income will not be paid out as under the current rules. Only 71.8% of the costs will be refunded, rather than 78% as things currently stand.
Furthermore, companies with costs related to the closure of the business will, in some instances, only receive a refund of 71.8% of the costs. This would be the case for the costs related to the last oil field being closed, if the company does not have any other income in the year of closing and the two years prior.