Cap on bareboat charter payments

On 1 April 2014 the UK Government introduced a cap on bareboat charter payments made by companies working on the UK Continental Shelf (UKCS). The cap applies to payments made to an associate for the leasing of a drilling rig or accommodation vessel and is equal to 7.5% of the capital expenditure on the asset. Any amounts in excess of the cap can be offset against non-UKCS activity, although the transfer pricing rules will still apply. In addition, the taxable profits arising from these activities will be ring-fenced. Draft legislation was published on 1 April 2014.

Oil contractor activities
These rules apply to oil contractor activities which are where a company (the “contractor”):
• carries on activities in connection with the exploration or exploitation of the seabed and subsoil and their natural resources; and
• the contractor provides, operates or uses a “relevant asset”.

A “relevant asset” is an asset which can be moved and can be used to:
• drill for the purpose of searching for or extracting oil; or
• provide accommodation for individuals working on or from a structure used on the UKCS for exploration or exploitation activities.

7.5% cap
The 7.5% cap is based on the original capital expenditure on the asset incurred by an associated person, plus the cost of any capital improvements. It will apply where the asset is leased and in other circumstances, for example where the purchase price of the asset is paid to the associate in instalments.

If the relevant accounting period is less than 12 months, the limit is adjusted accordingly. The 7.5% limit is also adjusted if the asset is used outside the UKCS during the period.

Use of excess amount
If the 7.5% cap is exceeded, tax relief is still available for the excess as a deduction from the contractor's total profits or it can be surrendered by way of group relief.

Ring fencing
Taxable profits relating to oil contractor activities are ring-fenced as follows:

Loan relationship rules
There are restrictions on the extent to which debits arising on loan relationships can be offset against the profits of the ring-fenced trading activities. If a restriction applies, then the relevant amount is treated for tax purposes as a non-trading loan relationship debit.  Similar rules apply to credits and debits arising in respect of exchange gains.

Management expenses, trade losses and group relief
The following cannot be used to offset taxable profits of the ring-fenced activity:
• management expenses incurred by the contractor;
• tax trade losses incurred by the contractor in respect of non-ring-fenced trading activities; or
• group relief unless the losses relate to oil contractor activities of the surrendering company.

Further comments
HMRC have stated that the aim of these rules is to address unfair tax outcomes. However, it is debatable whether the existing rules were unfair as the transfer pricing rules applied (and still apply) to bareboat charter hire payments made to associated entities. The concern seems to be that the arm’s length rate under the transfer pricing rules agreed by HMRC in the past would be based on the current market value of the asset which is likely to have taken into account its expected future earnings.

Provided that the group has other UK activities, the effect of these rules should not be too serious. Where the payments made (in accordance with the transfer pricing rules) are greater than the cap, any excess amount can be used to offset against other taxable profits in the UK. However, the ring fencing of contractor activities for tax purposes may be of concern, depending on individual circumstances.


Sue Bill
Michael Simms

Related links

Energy and mining
Business tax
Cap on bareboat charter payments factsheet