Centrica Energy Storage Limited v The Commissioners for HMRC

This appeal concerns the corporation tax (“CT”) treatment of the profits of the Appellant (“CESL”) and more specifically whether, and if so to what extent, CESL carried out ‘oil extraction activities’, as defined by section 272(3) of the Corporation Tax Act 2010 (“CTA 2010”), for its wholly owned subsidiary, Centrica Offshore UK Ltd (“COUK”). If CESL did carry out ‘oil extraction activities’, then the profits from those activities are subject to ring fence corporation tax (“RFCT”) and the supplementary charge (“SC”).

The Respondents (“HMRC”) issued closure notices on 1 April 2022 for the accounting periods ending 31 December 2017 and 31 December 2018 on the basis that CESL’s income from the services that it provided to COUK for those periods did arise from ‘oil extraction activities’ (“the Closure Notices”). The Closure Notices resulted in additional CT due from CESL of £2,124,944.80 for the accounting period ending 31 December 2017 and £3,234,826.85 for the accounting period ending 31 December 2018.

CESL is appealing against the Closure Notices on the basis that it did not carry out ‘oil extraction activities’ for COUK or if it did they were only a very small proportion of all the activities it carried out for COUK. Consequently, CESL asserts that it is either not subject to RFCT and the SC or it is subject to a much lower amount.

The issues for determination by the Tribunal are therefore whether and, if so to what extent, CESL’s income in the periods ending 31 December 2017 and 31 December 2018 arose from ‘oil extraction activities’ within the meaning of section 272(3) of CTA 2010.

The facts are largely not in dispute. The parties have very helpfully provided the Tribunal with their statement of agreed facts which we attach as Appendix A to this decision. We accept the facts as agreed between the parties in Appendix A and adopt the same abbreviations in our decision as used in that statement.

We were provided with an electronic hearing bundle of 2433 pages. Included in that bundle was a written witness statement from Richard Foster (“RF”), Head of Procurement and Commercial Contracts at CESL, of 38 pages plus exhibits. RF also gave oral evidence at the hearing and was cross-examined by Mr Ewart.

Rough became a natural gas storage facility in 1985 and continued to be operated as a gas storage facility until 2017.

During the accounting periods ending 31 December 2017 and 31 December 2018 (“the Relevant Time”):

By an Asset Purchase Agreement dated 20 June 2017, CESL sold the Rough complex (including the Rough platforms and the Easington Terminal) to COUK for £148 million with effect from 1 December 2017.

By a Services Agreement dated 20 June 2017 (“the Services Agreement”), COUK appointed CESL (which was called Centrica Storage Limited (“CSL”) at the time) to carry out all the services and works required in respect of the Production Operations from 20 June 2017, and CESL agreed to provide those services.

On 22 June 2017, COUK notified the Oil and Gas Authority (“OGA”) of the Appellant’s appointment as the operator of the Rough 3B platform.

In June 2017 COUK applied to the OGA for consent to produce a certain amount of gas to reduce the pressure on the Rough wells as an interim safety measure. The OGA granted consent in September 2017 (“the production consent issued on 26 September 2017”) and production of gas commenced in October 2017.

In December 2017 CESL and COUK applied to the OGA for permission to cease storage operations at the Rough reservoir and to produce recoverable indigenous gas from the Rough reservoir. On 15 January 2018 the OGA granted consent with effect from 17 January 2018. Operations as a production facility at the Rough reservoir subsequently began.

On 5 January 2018 CESL and British Gas Trading Limited entered into a Gas Sale and Supply Agreement (“the Gas Sale and Supply Agreement”) in which, broadly and subject to conditions, British Gas Trading Limited agreed to purchase and CESL agreed to sell, all of the Sales Gas produced by CESL from the Rough Reservoir for an initial term of five years, “subject to an earlier termination/cessation of production/expiry of production licences”.

On 17 January 2018 CESL and COUK entered into a Gas Sales Agreement (“the Gas Sales Agreement”) that ensured that any gas CESL sells to British Gas Trading Limited under the Gas Sale and Supply Agreement is automatically treated as having been supplied to CESL by COUK on identical terms.

The Services Agreement, the Gas Sale and Supply Agreement and the Gas Sales Agreement all acknowledge that COUK holds the Second Production Licence.

In its CT returns for the Relevant Time, CESL has accounted for the Services Fees it received under the Services Agreement at the main rate of CT outside the ring fence (“ORF”). COUK deducted the Services Fees from its inside the ring fence (“IRF”) profits.

The parties have produced an agreed summary of the regulatory position in respect of oil and gas extraction, production and storage which we attach as Appendix B to this decision.

We were also provided with an electronic authorities bundle of 1920 pages.

In this appeal we are concerned with Part 8 of CTA 2010. All references to sections in this decision are to sections of the CTA 2010 unless otherwise stated.

Section 279 establishes that “oil-related activities” are treated as a separate trade for CT purposes. Section 279 provides as follows:

This separate trade is a “ring fence trade” for the purpose of Part 8 of CTA 2010 pursuant to section 277 as follows:

Section 274 defines “oil-related activities” as

Further relevant definitions are:

The consequence of having a ring fence trade is that it is subject to RFCT which is different to main CT in the following respects:

In this appeal we are concerned with whether the activities of CESL constitute “oil extraction activities” which are “oil-related activities” pursuant to section 274(a). Oil extraction activities are defined in section 272 as follows:

“Oil” is defined in section 278 to include natural gas and we use the word oil to refer to both oil and gas throughout this decision.

“Associated companies” are defined in section 271 as follows:

CESL’s grounds of appeal, as set out in its Notice of Appeal, are as follows:

“The correct interpretation of s.272(3), reading the provision purposively and in context, is that the term "extracting" (and "extracted" and “extraction") in that provision means only lawful extraction. Only COUK as production licence-holder can lawfully extract oil and gas. The physical extraction activity undertaken by CESL on behalf of COUK, as the person lawfully entitled to extract, is not within the section.”

“In the alternative, even if the term "extracting" and related expressions might be read as including physical extraction, the correct interpretation of s.272(3), and the operation of other words in that provision, again reading the provision purposively and in context, is that it only brings within the ring fence (a) those who are lawfully entitled to extract (i.e. licence holders) and do so (i) themselves or (ii) through agents/sub­contractors, or (b) those who have the ability to cause lawful extraction by the licence-holder and who have an economic interest in what is extracted. CESL does not meet any such criteria and therefore does not carry on a ring fence trade.”

“In the event that it is found that the Appellant does carry on a trade inside the ring fence, the activities that the Respondents have assessed as being part of this trade are too broad as they extend beyond the profits made from “oil extraction activities””.

In summary Mr Peacock KC and Susanna Breslin make the following submissions on behalf of CESL:

In summary Mr Ewart KC and Barbara Belgrano make the following submissions on behalf of HMRC:

The parties agree that at the Relevant Time:

The difference between the parties is limited to what is meant by “oil extraction activities” in section 272(3) which provides that it means:

HMRC submit that we should simply apply the words of the legislation to the facts of this appeal with the result that the provision of the services by CESL to COUK under the Services Agreement clearly fall within section 272(3).

CESL submit that we must consider the historical context of the legislation to determine the purpose of the provision from which they say it is clear that Parliament intended that section 272(3) is only applicable to a company that holds the licence to extract the gas or has a beneficial interest in the gas that is extracted.

We were addressed by both parties on the relevant principles, supported by case law, that we should adopt when interpreting subsection 272(3).

The relevant principles of statutory interpretation were restated by Lord Hodge (with whom Lord Briggs, Lord Stephens, Lady Rose and Lady Arden agreed) at [29] – [31] of the Supreme Court decision in R (0) v Secretary of State for the Home Department 2023 [UKSC] 3 as follows:

HMRC submit that the meaning conveyed by the words of section 272(3) are clear and unambiguous. Further they submit that the statutory definition of ‘oil extraction activities’ does not require the company carrying out the oil extraction activities to own the oil or have a beneficial interest in the oil and that this interpretation is supported by the historical context and purpose of the legislation.

CESL submit that HMRC’s interpretation does not take account of the purpose and historical context of the legislation, which is to tax profits from oil extraction. It follows that a company will only be carrying out oil extraction activities if it has an interest in the oil being extracted.

We were very much assisted by the clear submissions both written and oral on behalf of both parties. However, although we have carefully considered all of the submissions made and the authorities referred to, we have not found it necessary to reference each and every argument advanced or all of the authorities cited in reaching our conclusions.

CESL submit that we must read in the word ‘lawfully’ before ‘extracting’ in 272(3) or limit its application to companies that have a beneficial interest in the gas extracted, because that is necessary to give effect to the purpose of RFCT which was to ensure that the profits from the exploitation of oil rights were taxed in the UK.

Counsel for CESL referred us to various external aids to interpretation which they say support their position. These included a 1973 report of the Public Accounts Committee (“PAC”), which then led to a White Paper dated 11 July 1974, which in turn led to the Oil Taxation Bill (“OTB”) introduced to Parliament in November 1974 and ultimately became the Oil Taxation Act 1975 (OTA 1975), Part II of which is the predecessor legislation to Part 8 of CTA 2010, with which we are concerned.

The PAC report stated at paragraph 14 that:

In the Summary of Main Conclusions the PAC report finds at paragraph 97:

The White Paper in 1974 proposes:

Mr Peacock referred us to the accompanying notes on clauses for the OTB as introduced to Parliament in November 1974 under the heading “The Government’s objectives” which are stated as follows:

In relation to Part II of the Bill that introduces the ring fence, the notes on clauses state:

Mr Peacock concludes from the PAC report, White Paper and the accompanying notes on clauses to the OTB introduced to Parliament in 1974, that the purpose of the ring fence was to ensure that the profits from the exploitation of oil rights was subject to UK tax and therefore it was only ever intended that the party that had a beneficial interest in the oil or gas would be IRF.

The OTB was introduced into Parliament in November 1974. As introduced clause 9 established the separate (ring fenced) trade, and read as follows:

Clause 14(1) defined oil extraction activities as follows:

It is clear from the above that under the OTB as introduced, only licence-holders carried out ‘oil extraction activities’, as defined by clause 14(1) and therefore non-licence-holders were not IRF. As introduced therefore the OTB would not have brought CESL’s activities IRF.

The notes on clauses also provide detailed notes on each clause. In relation to clause 9 the note states as follows:

In relation to clause 14 and the definition of “oil extraction activities” the note states as follows:

The OTB then went on to be considered by the Standing Committee, after which it was published a second time on 6 February 1975. Clause 9 became clause 11 and clause 14 became clause 16 but both were materially identical to the previous version.

The OTB then went to Report Stage on 19 March 1975 at which point the Government proposed an amendment to what had become clause 16 and the definition of ‘oil extraction activities’ so that it would read as follows:

As a result of this amendment clause 16(a) is materially the same as the current section 272(3), including the reference to activities carried out “under rights authorising the extraction and held… by … a company associated with it.” Looking purely at the wording of the clause, this brings the oil extraction activities of CESL IRF, because CESL are carrying out those activities under rights held by COUK which is an associated company.

However counsel for CESL submit that this was not the purpose of this amendment and that the purpose concerned illustrative agreements.

An illustrative agreement is a contractual arrangement that was common in the North Sea oil and gas sector in the 1970s under which the licence-holding UK company extracts the oil, but the economic interest in the oil is held by an affiliated (often non-UK) company (“the Affiliate”). The Affiliate funds the extraction and has a contractual entitlement to the oil at the point of production, even though it is not the licence holder.

Counsel for CESL submit, that as originally introduced, clause 9 did not bring the Affiliate who had a beneficial interest in the oil or gas extracted by virtue of an illustrative agreement IRF and that the Report Stage amendment to what had become clause 16 was made to ensure that the Affiliate is IRF.

However this submission is not supported by the notes on clauses on the OTB as originally introduced or as amended. As originally introduced clause 9(1)(b) brought persons who acquired, enjoyed or exploited oil rights IRF (which has materially the same effect as section 274(b) together with section 279). Clause 14 as originally introduced defined oil rights as follows:

The Government note on clause 14 states:

It is clear from the above that the Government considered that under the OTB as originally introduced, the Affiliate was IRF as a result of the definition of ‘oil rights’

in clause 14 and the application of clause 9(1)(b).

Further the explanation provided by the Government for the amendment to clause 16 at the time of its introduction at Report Stage was as follows:

Based on the clear wording in the legislation and the external aids to interpretation referred to above, we find that it is simply not credible that the Government’s purpose in making the amendment to what had become clause 16 was to ensure that the Affiliate was brought IRF. The Government’s purpose in making this amendment was, as explained by the Government at Report Stage, to bring associated companies of licence-holders IRF, when they are carrying out oil extraction activities under that licence.

This is further supported by the example provided by the Government at the time in paragraph 2 of the quoted Government explanation above. Further if we replace the word ‘transport’ with the word ‘extract’ in that paragraph 2 it would read:

This supports HMRC’s position that this amendment was intended to bring associated companies like CESL IRF. In our view the notes on clauses and Government statement at Report Stage on the purpose of the amendment clearly establish that the Government’s intention was that the amendment would cover exactly the activities of CESL in this appeal.

A further argument that counsel for CESL put forward against this interpretation is that it is contrary to the Government’s note on the definition of “oil extraction activities” in the OTB as it was introduced where it states that oil extraction activities:

Counsel for CESL submit that this note demonstrates that it was not the Government’s intention to bring companies such as CESL IRF as CESL is a ‘mere contractor’.

A contractor that is associated with the licence holder, is arguably not a mere contractor as it is both a contractor and a company associated with the licence holder. In any event this statement was made before the Report Stage amendment and therefore does not necessarily describe the definition as amended so should be read in conjunction with and subject to the Report Stage explanation for the amendment.

CESL further submit that there is no sensible identifiable policy goal in bringing an associated contractor IRF, while an unrelated contractor remains outside of it. CESL says that both types of company should be treated the same because neither of them is making a profit from oil rights, each of them is making a contractor profit.

However, as is clear from the external aids, the primary concern of the Government in 1974/75 was that oil and gas profits were being reduced by the offset of losses and allowances from other activities of the company or other companies within the group. Preventing such losses from being offset against oil and gas profits was the purpose of the legislation when it was introduced to Parliament in 1974.

The IRF profits were subject to the same rate of CT as ORF profits. It was not until the Supplementary Charge was introduced in 2002 that a higher rate of tax became payable on IRF profits than on any other profits. Subsequently the RFCT rate was increased above the main CT rate and more recently the Energy Profits Levy was introduced in 2022. Prior to 2002 however, whether a contractor was IRF or ORF had no impact on the tax payable on its profits.

The purpose of Part II of the OTA 1975 was not therefore to subject oil and gas profits to a higher rate of tax, but to limit the offset of losses and allowances, so that the normal CT rate of tax was paid on those oil and gas profits.

The policy goal in making the amendment was therefore, as explained by the Government when the amendment was introduced, to allow oil extraction activity losses of an associated company to be offset against the profits of the licence holder because they accepted that this was equitable, notwithstanding that the associated company did not hold the rights authorising the extraction, because the associated company would have incurred costs that were directly related to the oil and gas profits. An unrelated company could not offset their losses against the licence holder’s profits so there was no policy rationale for bringing an unrelated company IRF.

It follows that if an associated company is IRF for the purposes of offsetting its losses relating to oil extraction activities, it must be IRF for the purpose of profits relating to oil extraction activities. At the time of introduction and until 2002 that would have been of no consequence because the tax payable would have been the same for the associated company irrespective of whether it was IRF or ORF. However, the fact that the consequences have changed, cannot affect the original purpose and intention of Parliament or change the meaning of the legislation.

We therefore agree with HMRC that there is no doubt or ambiguity in the meaning of the words used in section 272(3) and that the external aids that we have been referred to, together with the history of the legislation, confirm that the clear and unambiguous meaning of the words was intended by Parliament and CESL’s oil extraction activities are therefore IRF.

As we have found against CESL on Grounds One and Two we now consider CESL’s Ground Three which is that only a very small proportion of CESL’s 15% mark-up under the Services Agreement is ‘ring fence income’.

Section 275 defines ‘ring fence income’ as

We must therefore establish the extent to which the services provided by CESL to COUK under the Services Agreement are oil extraction activities.

CESL submit that activities that are not directly related to physical extraction should not be included, such as administrative, engineering and technical support activities.

CESL rely on cost-centre data in the SAP-derived spreadsheets and Mr Foster’s written and oral evidence that describes what each cost-centre actually represents, to establish the extent to which the services provided by CESL under the Services Agreement are directly related to the physical oil extraction.

CESL submit that the services that they are contractually obliged to provide under Schedule 1 of the Services Agreement include the following support services which are necessary for the extraction in a practical sense, but they are not directly related to the physical extraction:

CESL provided the Tribunal with a consolidated spreadsheet that shows for each cost-centre, whether HMRC accept in the Closure Notices that it is ORF or not, HMRC’s stated rationale, RF’s evidence and CESL’s proposed conclusion of whether it is IRF or ORF.

CESL conclude that the services provided under all but one of the cost-centres are ORF because they are providing services that are not directly related to physically extracting gas. Of the one cost-centre that it accepts carries out services that are directly related to physically extracting gas, CESL submit that only 28% of its activities are directly related to physically extracting gas and therefore only 28% of the services charged to COUK from this cost centre are IRF.

RF was a credible, reliable and well informed witness but he did not carry out the exercise to determine the proportion of the service charge that CESL submits is charged for actions directly related to physically extracting gas, so he was unable to fully explain the methodology used.

The apportionment exercise had been carried out at RF’s request by Gary Miller who is an Offshore Installation Manager for CESL. Mr Miller did not provide a witness statement or attend the hearing to give oral evidence. We attach limited weight to the apportionment exercise, both because its author was unavailable for cross-examination and because, for the reasons set out below, we do not consider that the exercise is necessary for the purpose of this appeal.

HMRC submit that the words “activities of a company in extracting…oil” bear their ordinary meaning to include everything that is required to physically remove the oil or gas from the ground. If an activity must happen for gas to be extracted, it is part of the extraction process, even if indirectly. This includes:

HMRC further submit that as the Services Agreement provides that CESL will provide all services “required in respect of, in relation to and arising out of” the ‘Production Operations’ which is defined as “the necessary activities to produce recoverable gas from Rough”, it follows that all the services provided under the Services Agreement must be necessary to extract gas. Further Mr Foster acknowledged in cross-examination that all the cost-centres were “considered to be contributing to the extraction of gas.”

HMRC’s position, as articulated by counsel in their skeleton argumenta and at the hearing, has therefore changed since the Closure Notices were issued. In the Closure Notices HMRC accepted that some of the cost-centres, such as corporate support services, were not providing oil extraction activities. Their position now is that all the services provided under the Services Agreement are oil extraction activities, although they do not seek an increase in the closure notice, only a decision in principle from the Tribunal.

In our view there is no sensible dividing line beyond which the services provided under the Services Agreement are not ‘oil extraction activities’. While some of the services are more remote from the physical extraction than others, we find that all of the services provided under the Services Agreement are sufficiently proximate and operationally integral to extraction, initial treatment or transportation of the gas to constitute oil extraction activities within the meaning of section 272.

Accordingly if CESL were the licence-holder there would be no doubt that it could deduct all of the expenses it incurred in carrying out these activities when calculating its taxable ring fence profit. COUK did in fact obtain a deduction within its ring fence computation for the Services Fees.

Had CESL not been associated with the licence-holder COUK, its 15% mark-up would not be a ring fence receipt because it would not be IRF. However, because it is associated with the licence-holder COUK, all of its receipts for the provision of services under the Services Agreement are for oil extraction activities under that licence and are therefore IRF.

For all the reasons set out above we dismiss the appeal.

This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.