Ask an expert: Selling a UK oil company

Question

I’m acting for an overseas company that proposes to sell its interest in a wholly-owned UK subsidiary company. That UK subsidiary has some valuable UK oil interests, in that it is the holder of a number of offshore production and exploration licences which have been granted by the UK authorities. Are there any particular UK tax issues that might arise for a non-resident seller on a transaction like this?

Answer

In addition to all the normal transactional tax issues that will arise on a corporate sale, there are some specific tax issues which should be considered where the target carries on oil exploration or production activities. For instance, one potentially surprising issue for a non-resident shareholder is that they could be subject to UK tax on any gain they realise on their shares, even though they may have no connection with the UK.

Capital gains

Normally, a non-resident company would be subject to UK tax on capital gains only if it carried on a trade through a UK permanent establishment and the gain arose on assets situated in the UK and used for the purposes of that trade or establishment (TCGA 1992 s 10B).

This rule is effectively extended by TCGA 1992 s 276 so that a disposal of unquoted shares deriving more than half their value from UK oil rights is brought within the scope of UK tax, regardless of the non-resident status of the seller (see s 276(2)(c), (4) & (7)). Therefore, a capital gains charge could arise on a disposal of these shares if the substantial shareholding exemption (SSE) conditions in TCGA 1992 Sch 7AC were not met, and any such charge is not likely to be mitigated by any applicable tax treaty.

In practice, however, the SSE is perfectly capable of applying to exempt a gain arising to a non-resident where s 276 applies, provided the normal conditions are satisfied. The buyer may also be concerned as to whether or not SSE will be available to your client, because under TMA 1970 Part 7A, any tax arising under s 276 and which is not paid can be assessed on any person who holds the licence to which the tax relates, which could render the target liable to pay.

Intra-group debt

There may also be a related issue for your client with regards to any intra-group debt owed by the target. Where the target company’s operations have been funded by group debt, it would be normal practice to expect the buyer to finance the repayment of that debt on completion. The payment of any yearly interest on that debt by the borrower to a non-resident creditor will, subject to any treaty relief that may be available, be subject to a withholding on account of UK tax at the basic rate under the normal rule in ITA 2007 s 874.

The conditions for loan interest to be deductible from ring fence profits are laid out in CTA 2010 s 286, and no relief is available for interest unless the money borrowed has been used to meet expenditure incurred by the company in carrying on oil extraction activities or in acquiring oil rights. As a result, if the existing group debt were to be refinanced on completion, there would be a possible argument that subsequent interest payments on the refinanced debt would not be deductible from ring fence profits on the basis they were incurred on repaying a loan, and not on qualifying expenditure.

HMRC says (Oil Taxation Manual at OT22009) that it will not deny relief for interest payments on this basis where debt is replaced on broadly similar terms; however, there may be temptation to remove this risk by simply keeping the existing debt in place, and instead assigning it to the buyer in return for a sum equal to the loan principal and any interest accrued to completion.

With an assignment of the debt in this way there should be no s 874 requirement to deduct basic rate income tax on the amount received from the assignee in respect of the accrued interest. Additionally, if the assignee were a UK company, subsequent interest payments could be made to it without deduction of tax, relying on ITA 2007 s 933.

Debt assignment

However, if an assignment of the debt were proposed you should consider the application of TCGA 1992 s 276 further.

In addition to shares, s 276 applies to any stock or security, including any security not creating or evidencing any charge on assets, where it derives the greater part of its value from oil exploration or exploitation (s 276(2)(d)). If the debt is to be repaid out of the proceeds of such activities, it would be difficult to argue that it does not derive its value from them, and the definition of stock or security in s 276 is wide enough to be able to capture relatively straightforward debts.

In practice, if s 276 applied to bring the debt assignment within the scope of UK tax on chargeable gains, s 251 of that Act should operate to prevent any actual charge on the capital profit (the accrued interest), provided that the loan is not a debt on a security and is owed to the original creditor.

If the situation is more complex, however, the position is less comfortable. This is because if the debt has the character of a debt on a security, then the QCB exemption in TCGA 1992 s 115 will only apply if the debt were denominated in sterling – and because the oil industry typically deals in US dollars, a dollar denominated loan is more likely.

Graham Brough