New Clause 1 — Supplementary charge in respect of ring fence trades: financing costs

Orders of the Day — Finance Bill — [1st Allotted Day] – in the House of Commons at 5:30 pm on 3rd July 2002.

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'. After section 501A of the Taxes Act 1988 insert—

"501AA Supplementary charge in respect of ring fence trades: financing costs

The adjusted ring fence profits of a company shall be computed without regard to the assumptions in section 501A(3) to the extent that the financing costs are incurred for the purposes specified in section 494 (2)(a)(i) and (ii) of this Act.".'.—[Mr. Flight.]

Brought up, and read the First time.

Photo of Alan Haselhurst Alan Haselhurst Deputy Speaker and Chairman of Ways and Means

With this it will be convenient to discuss the following: New clause 2—Termination of supplementary charge

'. After section 501B of the Taxes Act 1988 insert—

"501BA Termination of supplementary charge

The provisions of section 501A shall cease to have effect for accounting periods beginning on or after 31st March 2005.".'.

New clause 3—Supplementary charge: termination

'. Section 92 above shall have effect for a terminal straddling period beginning before 31st March 2005 and ending after that date.'.

New clause 4—Ring fence trades: capital allowance supplement

'. After section 501AA of the Taxes Act 1988 insert—

"501AB Ring fence trades: capital allowance supplement

(1) A company's adjusted ring fence profits for an accounting period shall be subject to a deduction for the capital allowance supplement.

(2) For the purposes of subsection (1) above the capital allowance supplement is the amount A + B where A and B are as calculated below—

(a) A = 10% x C, where C is the written down value at the end of the immediately preceding accounting period of the separate plant and machinery pool of expenditure required pursuant to section 162 of the Capital Allowances Act 2001; and

(b) B = 10% x D, where D is the written down value at the end of the immediately preceding accounting period of expenditure qualifying for allowances under Part 5 of the Capital Allowances Act 2001.

(3) For the purposes of computing the capital allowances supplement only, any expenditure incurred on or after 1st January 2003 qualifying for capital allowances under the provisions of Part 2 or Part 5 of the Capital Allowances Act 2001 shall be ignored.

(4) For the avoidance of doubt, the capital allowances supplement for an accounting period shall not reduce the amount of unrelieved qualifying expenditure carried forward into the following accounting period for the purposes of any provision in the Capital Allowances Act 2001.

(5) Where an accounting period is less than twelve months the capital allowances supplement shall be restricted to the amount given by the following formula—

(A + B) x E/365 where E is the number of days in the accounting period.

(6) The provisions of this section shall have effect for the company's first accounting period ending on or after 1st January 2003.".'.

Amendment No. 42, in clause 63, page 41, leave out lines 13 to 27.

Amendment No. 43, in clause 91, page 64, leave out from beginning of line 34 to end of line 33 on page 68.

Amendment No. 44, in schedule 21, page 252, leave out from beginning of line 5 to end of line 30 on page 257.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

I add my congratulations on your coming silver celebration, Mr. Deputy Speaker, although I seem to remember that you were first elected to the House nearly 32 years ago.

These four new clauses, and the Scottish nationalist amendments, are self-evidently about what we view as the Government's unwise and excessive taxation of the North sea industry. The Scottish nationalist amendments simply propose to reverse both the taxation and the new capital allowances. Our new clauses, which are supported by the Liberal Democrats and the Scottish nationalists, seek to alleviate the effect of those measures.

Somewhat typically, when the Chancellor of the Exchequer responded to my hon. Friend Chris Grayling on 20 June, he candidly displayed an arrogant and unwise attitude to this issue. He commented that he hoped that Members would not fall for the industry's propaganda and he argued that the 100 per cent. investment allowance would

"make it more profitable to develop new oil fields".

That is absolutely not the case for the new operators that have no profits. He also argued that the British tax regime would be

"more favourable than that of other countries."—[Hansard, 20 June 2002; Vol. 387, c. 400.]

As I will show later, that is also not the case.

I respect the noble efforts of the Paymaster General to put the Government's economic case, but the essence of our case is that these taxes will cause serious damage to North sea oil recovery in the coming years. As everyone knows, the North sea field is at a very mature phase, and most subsequent recovery will depend on smaller, newer companies. Many of them will not have the profits to qualify for the 100 per cent. allowance.

Have the Government even considered the fact that the projected average fall in North sea oil production is 1.5 billion barrels a day, which is the equivalent of a cost of £12 billion to the current account deficit, which is already at the highest real figure on record? According to the Government's own assessment, it is calculated that the measures will lose 50,000 jobs by 2010 and £10 billion- worth of capital investment. If we add up the loss of income tax and national insurance revenues and the potential welfare costs, it is unlikely that the Government will see more than half the tax take projected for the measures.

The Government were extremely unwise to act in bad faith in relation to the substantial £4 billion—a figure much higher than in previous years—of new investment that resulted from the PILOT collaboration. The former Secretary of State for Trade and Industry—yet again, Mr. Byers—assured investors of the future stability of the tax regime that prevailed. However, investors have been zapped with an extra 30 per cent. of taxation without even being able to benefit from the capital allowances on the new investment that they have made.

The Government try to argue that they have warned the industry since 1997 that they were going to raise taxation, so I place the Chancellor of the Exchequer's remarks on the record again. He said:

"It has been put to me that the North sea oil companies earning higher profits from higher oil prices should be subject to special taxes, but I can tell the House that I am determined not to make short-term decisions based on short-term factors. The key issue is the level of long-term investment in the North sea. This will be the approach that guides tax decisions in future."—[Hansard, 8 November 2000; Vol. 356, c. 317.]

We would argue that the Chancellor has stood his promise on its head and introduced tax measures that will clearly reduce investment in the North sea.

The Government have based their arguments for extra tax on the excessive returns that have been made, and they have quoted the return of 34 per cent. achieved in 2000 at the top of the cycle. The industry has responded by quoting returns on investment since 1996, and those figures are most relevant for the future. They show a return of only 7.2 per cent., reducing to 5.9 per cent. after tax. In the whole decade of the 1990s, the average return was 14 per cent. before the new tax was introduced.

I turn to the fundamental reason why it is economically unwise to increase North sea taxation at this point in the oil price cycle given that the North sea field is in its mature phase. Taxation of oil and gas provinces needs to reflect the relevant basin's geological realities as well as their maturity. The average UK continental shelf discoveries now contain only 25 million to 30 million barrels of oil equivalent. By comparison, the figure is 100 million barrels in Norway, 150 million in the gulf of Mexico and 350 million in Angola. The UK continental shelf is virtually the most expensive province in the world in which to engage in activity. Development costs average $4 a barrel; operating costs add another $4 a barrel; and exploration and appraisal costs add a further $4 a barrel.

According to the recent Wood Mackenzie study, of 59 recent developments, only one province—the east coast of Canada—is more expensive than the UK continental shelf. The study ranked the UK continental shelf as 31st out of 51 countries in terms of exploration attractiveness and concluded categorically that there was no room to extract additional fiscal rent from the UK continental shelf.

Those findings reflect the fact that the North sea field has entered its most difficult phase as it declines and enters maturity. Average discovery sites are likely to be much smaller than in the past, and discoveries will be more difficult to make and more expensive to develop. In short, North sea activity is far riskier than it has been and the fiscal regime needs to reflect that fact and compensate for the high costs and geological realities. It should not add extra penalties in the way that it is now doing.

The Government will argue that some UK continental shelf fields have been very profitable in the past and have been highly taxed. However, in reality, it was only the hope of discovering such profitable fields that provided the incentive to future activity and to overcoming technical barriers. Indeed, there has been far greater extraction from the North sea than was previously predicted. There is little hope of discovering such profitable fields in the future if success is to be excessively penalised on the rare occasions that a profitable field is discovered.

Some have argued that our fiscal regime is generous. However, the facts, when properly analysed, do not support that view. Allowance must be made for geological realities and, even before the Budget, taxes imposed on the UK continental shelf ranged from 30 to 69 per cent. depending on a field's age and profitability. Those taxes have now gone up to between 40 and 74 per cent. They are high tax rates for a province that has high costs, poor prospects and small fields.

The Government have relied on analysis that assumes much larger fields than are found in the North sea and lower development costs. If allowances are made for the differences, the British tax regime is considerably less attractive than appears on a shallow analysis. Other basins in other countries are more attractive. For example—comparing like with like—the top rate of tax in the gulf of Mexico is 44 per cent., in Norway 78 per cent. and in Angola 68 per cent. Those are some of the UK continental shelf's main competitors, so the Chancellor's comment that the UK has one of the most attractive tax regimes does not stand up.

Photo of Chris Grayling Chris Grayling Shadow Minister (Health)

Does my hon. Friend agree that one of the most fascinating elements of the Chancellor's reply to my question of 20 June was that, although he said that he was creating a wonderfully attractive environment in the North sea, he admitted that he was taking £500 million out of the industry? It beggars belief that any Chancellor of the Exchequer could believe that one could take £500 million out of an industry and benefit it.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

I thank my hon. Friend for making that point clear. However, the Chancellor was wrong even on this issue. The leading expert, Professor Kemp, has estimated an additional tax bill of £7.6 billion for the industry as a whole up to 2010. That is considerably more than the £500 million per annum quoted. I repeat that although the tax revenues are greater than the Government are letting on, the tax losses will be significant as a result.

New clause 1 would allow the financing costs incurred for the purpose of the ring-fenced trade to be deducted to reduce the profits on which the supplementary charge is levied. Hon. Members will know that the supplementary charge of 10 per cent. on the profits of UK companies arising from oil and gas extractions is levied without deducting the costs of financing the trade. In addition to being charged on profits that do not reflect the commercial reality of the businesses, because companies have to finance the investment in the expensive plant and machinery required for oil and gas extraction, the supplementary charge denies a deduction for financing costs. That will make the UK much less attractive, especially to overseas investors and smaller investors who are crucial to further exploitation of the North sea.

For overseas-based businesses, the interaction of UK and overseas tax on profits will be such that the United States of America and France in particular will allow only their residents to credit the foreign tax paid if financing costs have been deducted when calculating taxable profits. In other words, the effect of the financing costs not being tax deductible and the newly defined additional taxation not being a straightforward corporation tax will be the loss of double taxation treaty benefits.

No doubt the Government will respond by saying, "Hard luck", because they think that the interest deductions from which the industry has benefited have been too great. No doubt they also believe that although the costs will not qualify for double taxation, they might qualify as an expense. Those are not the fundamental issues at stake on the double taxation arrangements, however. The Revenue has received no response from the IRS to its inquiry about the new charge. However, the tax counsel to Mobil Oil advised definitively that the result will be unfavourable and the new cost will not be allowed.

Photo of Malcolm Bruce Malcolm Bruce Liberal Democrat, Gordon 6:00 pm, 3rd July 2002

The hon. Gentleman makes an important point. Does he find it extraordinary that the Government are so willing to acknowledge the problem that they have written to the IRS, the tax authority in the United States, asking it to consider reviewing its tax policies as a result of changes to UK tax? Do they really think that that is likely? How would the Inland Revenue respond to America trying to change our taxes?

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

I thank the hon. Gentleman for his common-sense comment. It underlines the fact that the costs will not be allowable under double taxation treaties and, according to all the tax advice that I have received, I am afraid that the Government and the Revenue will get a response from the IRS to that end.

New clauses 2 and 3 address a separate territory. They would bring the supplementary charge to an end by 31 March 2005 and negate it if the price of oil falls significantly in the meantime. That is designed to give the industry an idea of how long the windfall tax will apply and could help to encourage investment today in fields that are expected to be profitable in a few years' time.

The interaction between accounting requirements and tax arrangements is an important consideration. The key result would be that the 2002 earnings of oil companies will not be hit as dramatically. I am sure the Government would not welcome further downward spirals in share prices if pension schemes are unable to pay the pensions to which they are committed when the measure makes its way through to oil prices. The Government's response is likely to be that they want a stable regime, but it is self-evidently a disaster to have the stable regime that this Finance Bill institutes if it is no good for the industry, the country or our external overseas accounting position.

New clause 4 would allow accelerated capital allowances on new assets used in a ring-fenced trade. As we debated in Standing Committee, we want to take a cash flow advantage approach, which does not reduce the total tax payable over the life of the project or improve accounting profits. The new clause would allow an extra 10 per cent. deduction over and above normal capital allowances in 2003. It would apply only to assets acquired before 1 January 2003 on which normal non-accelerated allowances were claimed.

We want to reduce some of the bad faith evidenced in the PILOT encouragements. The Government have been stonewalling by denying that there is bad faith. For the past 20 years, transitional arrangements have been available when significant changes have been made to the tax regime. If the Government argue that there is the odd historic case of a retroactive tax, measures have been designed to offset those. The key problem for the oil extraction industry is that it perceives two major risks: first, the operating risk of the oil price; and, secondly, the operating risk of a Government who have a regime that lacks fiscal integrity in terms of what the future will hold. If the risks increase, the returns have to increase to justify the same investment by having a higher risk:reward ratio.

I pay tribute to the efforts of Mr. Blizzard for his attempts to get the Government to see sense. I am aware that Scottish MPs have been involved in significant lobbying behind the scenes, but they have been feeble in not defending their homeland in public. The industry employs 6 per cent. of the labour force in Scotland.

Photo of Alex Salmond Alex Salmond Scottish National Party, Banff and Buchan

The hon. Gentleman puts at risk his cross-party support. I take it that when he says "feeble" he is referring to Scottish Labour MPs.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

Indeed I was. I thought I made that clear. However, I am sure that anyone who appreciates what is at risk would have wanted more Scottish Labour MPs to join the Scottish nationalist MPs, the Liberal MPs and Conservative MPs in speaking out against the wanton damage that will be caused, and the wanton reduction of the prospects for recovery in the North sea. No doubt they would also have wanted them to speak out against measures that will reduce investments substantially, destroy jobs and boost an already vulnerable current account deficit to the extent of £12 billion per annum.

Photo of Bob Blizzard Bob Blizzard Labour, Waveney

As I said on Second Reading, I very much welcome efforts to raise more money for the NHS, but I am concerned about the Bill's effect on future investment in the United Kingdom oil and gas industry. That is important not only to local economies in many parts of the country, such as my own, but to the country generally, because investment in the industry has amounted to about 16 per cent. of total industrial investment over many years, which means that it has generated a lot of employment.

Having listened to debates on this subject throughout the Bill's proceedings, I still find it hard to see how a big increase in tax cannot have some effect on that investment, whether it be a reduction in the cash flow from the existing fields which is available for reinvestment or an impact on the psychology of investors who have just taken a hit, perhaps shaking confidence in investment.

Behind the measure lies the argument that the oil and gas companies make big profits. They certainly do in bumper years such as 2001, when we had high oil prices, but they do not make big profits all the time, as we can see by looking at returns over the full cycle or over the full lifetime of individual projects. The return on capital employed over those periods is not greatly different from that in other industries.

Mr. Flight quoted a figure of 14 per cent. over time, before corporation tax is taken into account. That compares with returns of between 11 and 13 per cent. for other companies in non-financial sectors over, say, a decade. That has to be the case, or everybody investing in stocks and shares would just plunge all their money into oil and gas. It would be the only game in town and those companies would constantly be at the top of the stock market. No one would need to engage a financial adviser.

Oil exploration and production is a risky business, and companies find many expensive dry wells or uneconomic fields in an area before they discover the successful ones that make money. Fiscal stability is therefore an important factor when companies are making plans, and it has been seen as one of this country's great strengths. As we know, the industry is arguing that that fiscal stability is now at an end, so it has to factor a fiscal risk into its calculations for future investment, which adds to the overall risk.

The Treasury argues that fiscal stability has now been achieved and that the review started in 1997 and halted in 1998 has now concluded. The essence of its case is the argument that although it is unquestionably taking more money out of existing developments, the fiscal position for new developments is improved by the combination of 100 per cent. first-year capital allowances and the supplementary charge. The industry's figures, which I have seen and which have, I know, been presented to the Treasury, also show that to be the case, on paper. The argument is about whether the reality is more complicated.

The industry's figures also show, however, what happens if fiscal risk is factored in and corporation tax of 40 or 50 per cent. applies. In that analysis, the fields do not work at all. The Treasury says that it would never set the tax at 50 per cent. because that would kill everything off, but at 40 per cent, the fields still work.

Notwithstanding that argument, we have to consider now the key question of how we can maximise investment in what will clearly be a new regime of a 10 per cent. supplementary charge and 100 per cent. capital allowances. The key issue, which is the subject of one of the amendments, is financing costs. We know that, over the years, companies have normally been allowed to offset them against corporation tax, but it is proposed to change that so that they will not be creditable against the supplementary charge. That is absolutely relevant to new development, and we have to be extremely careful that it does not act as a disincentive that will undermine the incentive given by the Treasury in the 100 per cent. capital allowances.

I have been asking why the measure is necessary. The answer given in the Committee of the whole House was that it is important if the supplementary charge is to work; otherwise there would be scope for companies to manipulate their financing costs so that they could offset more than is justified against the new charge. The industry maintains that that is not possible under the existing regulations and the close scrutiny by the Revenue.

Will the Financial Secretary tell us exactly what loopholes the measure is designed to plug, and will she deposit that information in the Library? I realise that it is not normally the business of the Treasury to broadcast the existence of loopholes, but if the Government are introducing measures to plug loopholes, it would be helpful to know what they are. We would then be able to see clearly whether there is a need for a measure preventing financing costs from being offset against the supplementary charge.

I fear that if we have got this wrong, it will create unnecessary problems, even within the new regime, for certain types of company whose continued investment in the North sea is desperately needed. The first type is smaller companies, for which financing costs assume a greater proportion of their costs. They have a vital part to play in the development of the North sea. The experience in other mature provinces around the world is that smaller independent companies—the experts who get stuck in—are the appropriate ones to go after smaller reserves and make money by extracting them. We want to ensure that those small companies, which the Government accept have a part to play in future, are not put off by the measure.

That is particularly the case with new entrants. We have managed to attract 23 new entrants to the North sea since 1997. We know that they will not get the real benefit of the 100 per cent. capital allowances because they have no profit in the first year against which to offset them. I know that they can roll them over, but they would then have, for example, 25 per cent. allowances for four years, which is what they already have. Financing costs are an important consideration if we are to encourage new entrants.

Another reason for considering the measure carefully concerns the origin of much of the investment—parent companies or venture capitalists in the USA. There are issues of double taxation which are not yet clear. I know that the Government have written to the IRS in the hope of clearing up the matter through double taxation treaty agreements. I fear, however, that until that agreement is confirmed by the IRS, investors will not go ahead in case they are caught by the measure. Furthermore, I am told that if the financing costs are not creditable but companies take them as an expense, the measure will still make a difference of about 6.5 per cent., which might make the difference between investing here or in another country.

I ask Ministers to try to find an alternative way of protecting the supplementary charge—the Treasury introduced it, so it will want to protect it—that does not have the negative effects on smaller companies and new entrants that I have described. In addition, it would be helpful if the measure and the reasons why it is needed were set out clearly for us to see.

At the core of the issue are the integrated companies that have both upstream and downstream activities, and the fear that money might be moved between the two spheres of activity. However, new entrants, smaller companies and independents are not downstream companies; they are only upstream companies. If we carry on as we are, those companies will be hit by a measure that is presumably not designed to hit them, so we must make sure that it does not. Those who have been bitten by the supplementary charge might—rightly or wrongly; it depends on what view one takes of the argument about fiscal stability—be shy of further investment, but we cannot afford to deter new and smaller companies.

Royalty is part of the package, and it is important that we proceed quickly with the consultation that will lead to its abolition. Everyone seems to agree that it need not take long as it is a technical consultation, not a full public consultation. I worry that the longer we leave the position on royalty unattended, the longer we will hold back the investment we need, even under the new regime. It will therefore be helpful if the Minister says something about royalty tonight and confirms that once the consultation is over, the Chancellor can abolish royalty without further legislation, and can fix whatever operative date he wants—even today, if he were so minded.

Photo of Malcolm Bruce Malcolm Bruce Liberal Democrat, Gordon 6:15 pm, 3rd July 2002

I am pleased to follow Mr. Blizzard, who made a characteristically well-argued and consistent contribution. He spoke about real issues that are clearly affecting the industry. Although the Government have to some extent acknowledged those issues, they have not yet answered them. All of the participants in the debate would like to know how the Government can acknowledge the problems, but leave them unaddressed.

The impact of the changes is real and perceptible, not theoretical. As I said in the Committee of the whole House, I have been indirectly or closely involved with the industry for more than 30 years. Thirty years ago, oil and gas was a boom industry—a crazy industry. Everyone was scrambling to get the stuff out and money was almost no object. There was an OPEC-induced oil crisis and the Government were interested only in getting the oil out and resolving the balance of payments position; they would worry about the regime later.

Now, the position is completely different. The North sea is, in the precise term used by the industry, a mature province, which means that marginal rates of return are being squeezed and the risks are higher in a high-cost area. The Government appear to have picked precisely that moment to create a new pressure on an industry which already has enough pressures on it simply because of where it operates. I urge the Government not to discount the actual and the psychological effects of the change.

The industry believed that it had established a relationship with the Government that was based on a recognition that it should be treated as an industry, not merely a source of revenue, and provided with a regime that created a climate conducive to long-term investment. The least it should have been able to expect is not that there would never be any tax changes, but that changes would not be introduced without proper consultation, transitional arrangements, and a willingness to hear the industry's explanations of how Government proposals might adversely affect investment. In reality, however, the industry has had to make that case after the Government have made their decision. In the past five years, the industry has invested £23 billion on the presumption that either the existing regime would continue, or any change would, first, be negotiated, and, secondly, allow for transition. Companies that have made investments on the basis of the pre-Budget regime are understandably extremely miffed that they have been treated in such a fashion.

Companies that made calculations based on assumptions about the oil price that were not borne out have also been hit. The Government can say, perfectly reasonably, that the risk in the industry is that the oil price fluctuates; the industry has to calculate that fluctuation and build it into its risk assessments. However, I should have thought the Government understood that an industry that has to deal with an extremely volatile fluctuating commodity price could do without a similarly volatile fluctuating fiscal regime. The combination of those two factors substantially increases risk.

The Government seriously underestimate the damage that is being done to this country's reputation for promoting inward investment and industry. The new tax regime wholly contradicts the very rhetoric that the Chancellor placed at the heart of his Budget. He expressed his desire to create a stable, predictable corporation tax regime for business in general in the United Kingdom, so as to make the UK an investor-friendly, business-friendly economy. If that is what he wants for every other sector of the economy, why has the oil industry been singled out as not entitled to benefit? We can legitimately seek an answer to that question.

The new clauses deal with the specific concerns that have been identified by the industry as "addressable". The industry wants the Government to rethink its approach to those matters. The hon. Member for Waveney stated well the Government's argument that they cannot allow financing costs to be offset against the windfall 10 per cent. The implication of that argument is that they do not trust the industry. They will allow the industry to fiddle the other 30 per cent., but not the 10 per cent. margin. However, as the hon. Gentleman said, the Inland Revenue is perfectly well aware of the regulations, so it would be interesting to hear precisely how much abuse the Government think is going on. Much more to the point, many of the smaller companies, by definition, finance their projects by going to the market to secure finance. They have real, not theoretical, financing costs which they assumed they would be allowed to offset in a proper way that, in the case of American and French companies, conformed to double taxation agreements.

In the previous debate, the Government acknowledged that problem and said that they have taken up the matter with the American tax authority, the IRS. As I said in my intervention on Mr. Flight, if the Government admit that the problem is severe enough for them to ask the American IRS to consider changing the regime, are they prepared to revisit the issue if the IRS declines to do so? Alternatively—or additionally—are the Government prepared at least to engage, or to allow the Inland Revenue to engage, in negotiations with individual companies that can demonstrate that the offset is crucial to the viability of their project and that the project will not happen without it? That would reassure us—and the Department of Trade and Industry—that the Government genuinely want to ensure that they do not seriously reduce the amount of investment that would otherwise take place.

I suspect that here we have a point of argument between Ministers, the industry and the Opposition. We genuinely believe that some investment—possibly a significant amount—is at risk and may not happen. The Government do not appear to accept that argument. At the heart of our concern is our genuine belief that investment will be prejudiced, further jobs will be lost, and some oil and gas that would have been recovered will not be recovered, at least in the short run, and possibly not at all. I therefore ask Ministers whether they are prepared to consider case-by-case representations rather than merely shut the door.

Ministers have stressed that there is a package. Part of it is the capital uplift, which is a contribution for some companies, but not all, and does not quite offset the windfall. The other part is the abolition of royalties. I am told that £2 billion of investment is proposed in respect of fields that are paying royalties, but are clearly on hold. No company is going to commit itself to investing in a royalty-paying field until it knows whether, when and how the royalties will be abolished, so the £2 billion of investment is on hold until the consultation paper is published, all the consultation is concluded and the Chancellor makes his decision. I hope that Ministers will understand that speed is of the essence if that £2 billion is not to be lost or its investment is not to be unduly delayed.

The proposal for a three-year limit has genuine merit. First, it would close off what Professor Kemp has identified as the very high potential return to Government and cost to the industry in the later years, which are difficult to predict at this stage. As a number of industry representatives have said, such provision would enable them to say that the regime will either end or be continued, but only following further debate and consultation. There is genuine merit in the proposal, especially if the new arrangement is a windfall tax that is being imposed because of the high oil price. What the Government have said about that is contradictory. Is this a windfall tax or a permanent increase that makes the tax regime less attractive at a time when the industry is having more difficulty squeezing out marginal oil at higher costs and greater risk? Now does not seem the right moment to make a permanent change of that sort.

Photo of Chris Grayling Chris Grayling Shadow Minister (Health) 6:30 pm, 3rd July 2002

Like me, the hon. Gentleman will have seen the many references made by commentators in recent weeks to the potential problems that the Chancellor still faces in raising revenue for the latter years of this Parliament. Clearly, any fall in growth rates will also have implications for the Chancellor. Does he share my opinion that it is extremely unlikely that the tax is a windfall tax, as we cannot be sure that the Chancellor will be able to afford to give the money back?

Photo of Malcolm Bruce Malcolm Bruce Liberal Democrat, Gordon

That is a fair point, but Chancellors always have to consider the dynamic of their tax changes. I have drawn the following analogy before. When the previous Government's plans to introduce VAT on fuel were frustrated by the will of the House, they decided that they would further tax whisky, perhaps as a slightly spiteful revenge. As a result, demand for whisky fell so much that the following year, their net revenue from the spirits industry was reduced. The hon. Gentleman puts his finger on an important point: if the Government try to squeeze more taxes out of an industry that is marginal and mature when the economy is struggling, their actions will become almost counter-productive. They will depress the industry, the investment and the profits that they are trying to tax, and finish up promoting reduced revenue. That is a genuine issue that the Treasury will, of course, find impossible to quantify until after the event. Surely, it must bear that in mind.

It is certainly not possible to look at the North sea and say that the industry is booming and therefore deserves to have some money clawed back from its windfall profits. I understand that 11 rigs are currently stacked in the Moray firth. It is forecast that by the autumn, that number will have risen to 18. Nobody is suggesting that that is a direct result of the tax changes, but it is nevertheless an indication of reducing activity, and the tax change that we are considering will not stimulate new activity.

It is interesting to note two points made in the briefing circulated by BP. First, although the 100 per cent. capital uplift effectively reduces the tax burden in the first year, the whole package increases the tax take and reduces the return over the lifetime of the field. The Government know perfectly well that any analyst will consider the life of an investment and not only its first year. Although a contribution is made to that overall calculation, the net effect is negative.

BP, which is the biggest operator and UK company, is also saying that the North sea taxation regime now needs to be changed further. The industry is therefore saying not only that it needs concessions on the financing costs and the immediate abolition of royalties, but that further tax inducements may be necessary to ensure that it maintains its long-term commitment. It is often said, and it bears repeating, that the oil industry is a worldwide industry and that the North sea and the UK continental shelf are by no means the most attractive prospect for it. All the major companies operate worldwide and it is not that difficult for them to switch their investment to more attractive areas.

This debate started on the day of the Budget announcement, was conducted in Committee on the Floor of the House and has returned several weeks later, but a number of concerns remain on which the Government have acknowledged that there is a problem, but they are not prepared to address it. I ask Ministers to acknowledge the concerns that are being expressed by the industry, Opposition Members and, indeed, some Labour Members on the basis of a genuine commitment to ensuring that the North sea continues to be a major source of investment, employment and technical innovation. We are concerned that the Government, through the Budget, are encouraging the industry to take much of that activity outside the United Kingdom, which will damage employment, investment and technical innovation in the UK economy. I cannot believe that that was the Government's intention, but I urge them to recognise that it may be the consequence of what they are doing.

Photo of Frank Doran Frank Doran Labour, Aberdeen Central

I must confess to being one of those feeble Scottish Members of Parliament who have been doing all their lobbying behind the scenes. The comment that was made from the Opposition Front Bench either shows just how long it is since Mr. Flight was in government or, as I cannot recall exactly when he came into the House, demonstrates that he has not experienced government at all. Full-frontal attack is not always the best way of dealing with issues. The ability to sit down and talk directly to Ministers is more important, and I am very pleased about the access that Ministers at every level have provided for Scottish Members who are interested in discussing the issue. [Interruption.] Malcolm Bruce comments from a sedentary position, but I can excuse him, as he has never experienced government and is never likely to do so, so such a way of operating will be completely alien to him.

The presentations from those on both Opposition Front Benches reveal one of the difficulties about this debate. On one side, it is clear—I am very clear about this—that the complaints made by the oil industry are wholly expected. I have listened carefully to the arguments and have engaged in debate with those involved, who are doing what is appropriate for them to do. However, the doom and gloom scenario does not reflect the debate in the industry, which is not unified on the issue. Certain companies, including one of the major ones, have been pressing the case very hard directly and through the United Kingdom Offshore Operators Association, but there is a much livelier debate below the surface.

The discussion is about the balance in the budgetary measures that affect the North sea. It is often conveniently ignored in public statements that the measure is not only about extra tax, although that is important, but about the balancing measure of the tax reliefs that have been provided. Yes, there are concerns about how those provisions will operate in practice, but the bulk of the industry is sitting down to see how particular companies will be affected by the new taxes. It is important to get that on record. The oil industry has a diversity of views on this as on every subject, but the only views that we are hearing at the moment are those of the Private Frazers—the doom and gloom merchants.

Photo of Robert Smith Robert Smith Opposition Deputy Chief Whip (Commons)

Does the hon. Gentleman recognise that some of the people expressing doom and gloom might be those who saw the royalties relief that was promised by the Chancellor as an important part of the upside? Even now, as we reach the final stages of the Finance Bill, the consultation paper on the abolition of royalties has yet to be published. Does the hon. Gentleman think that if the Chancellor is serious about that commitment, he should ensure that the paper is published?

Photo of Frank Doran Frank Doran Labour, Aberdeen Central

I shall make my own contribution to that debate shortly. The hon. Gentleman makes an important point, but I may express it slightly differently.

In their new clauses, the Conservatives are trimming around the edges somewhat in that there is no direct attack on the 10 per cent. increase. The SNP amendments would simply wipe everything out to return to the status quo.

The allegation that I have heard most frequently in every debate on this matter concerns the stability of the tax regime, and Conservative Members mentioned it again today. In fact, the hon. Member for Arundel and South Downs went a lot further in his comments. He said, to quote him verbatim, "The UK tax regime lacks fiscal integrity as a result of this Budget measure." That is an extreme statement, and I find it difficult to see how he has reached that judgment.

Photo of Frank Doran Frank Doran Labour, Aberdeen Central

The hon. Gentleman is anxious to leap to his feet. Before he does so, it is important to say that although we need to have a debate, it must be conducted in a measured way, and his comment was a long way from reality.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

With respect, I think that I made the point straightforwardly. In the past, Governments have always observed the principle that if the tax regime is changed, it does not affect existing arrangements. Even in the one or two instances where that was not so, compensation was made in other ways. That is not the case as regards this provision, which is why I, and many in the industry, believe that it does not have tax integrity. Moreover, it follows the Secretary of State for Trade and Industry having encouraged substantially higher levels of investment through the PILOT scheme and having implied that the existing tax regime was going to continue. It is a pity if the hon. Gentleman—

Photo of Michael Lord Michael Lord Deputy Speaker (Second Deputy Chairman of Ways and Means)

Order. The hon. Gentleman's intervention is starting to become a speech.

Photo of Frank Doran Frank Doran Labour, Aberdeen Central

I agree with you, Mr. Deputy Speaker. Methinks the hon. Gentleman protests overmuch. I shall remind him of some history. He may not have been around at the time of the 1993 Budget, when the Conservative Government did exactly what he is accusing this Government of doing. They introduced tactics of which the industry—at least, the bulk of the industry—had no advance warning. One company—I think that it was Texaco—signed a deal on the day before the Budget. On the following day, as a result of the Chancellor's statement, that deal lost it several million pounds. The company did not anticipate what was going to be in the Budget, and there was no consultation. That is exactly what the hon. Member for Arundel and South Downs is accusing the Government of, yet nobody compensated Texaco.

Photo of Chris Grayling Chris Grayling Shadow Minister (Health)

I, too, had not entered the House in 1993. Did the hon. Gentleman oppose the changes in the 1993 Budget, and, if so, how can he support those in this Budget?

Photo of Frank Doran Frank Doran Labour, Aberdeen Central

Unfortunately, due to a little disagreement with the electorate, I was not here in 1993 either. However, I was acting as a consultant to one or two of the people involved and contributed to the discussions.

On stability, it is difficult to know what the oil industry wants. I understand why PILOT has been mentioned, but PILOT has a completely different focus. The Chancellor's words were clear. In 1998, when he dropped the review of the oil tax regime, he made it clear to the industry that the decision to do so was a decision for the duration of the Parliament. He made it equally clear in this year's Budget that he was giving us a tax regime for the oil industry for this Parliament. I know of no other area of the economy with that level of stability—a guarantee that that is it for the entire Parliament.

There are three high watermarks in the history of oil taxation. In 1975, the then Labour Government established the modern petroleum tax regime with the introduction of royalties, petroleum revenue tax, and so on. That, with some changes around the edges, remained the position until 1993. This year, a further substantial change is being introduced. That is a considerable degree of stability for any industry, and it should be noted and recorded.

Photo of Alex Salmond Alex Salmond Scottish National Party, Banff and Buchan 6:45 pm, 3rd July 2002

The hon. Gentleman is being somewhat disingenuous. He may recall that in a Scottish Grand Committee last year, Miss Begg said:

"The oil industry in the North sea is doing so well because this Government have provided a stable fiscal regime. When they came to power, my right hon. Friend the Chancellor considered the fiscal regime and took advice from the industry, and those of us in the north-east who advocated leaving well alone."—[Official Report, Scottish Grand Committee, 28 March 2001; c. 26.]

Did the hon. Gentleman agree with his hon. Friend, or has he since changed his mind?

Photo of Frank Doran Frank Doran Labour, Aberdeen Central

I am not sure what the hon. Gentleman's question is. He is right that in 1997 and 1998 I lobbied the Chancellor—not publicly, but privately—to leave well alone. As the hon. Gentleman well knows, at that time, the industry was experiencing a sustained period of low oil prices. This year, the Chancellor is reacting to a sustained period of nearly three years of high oil prices.

Photo of Frank Doran Frank Doran Labour, Aberdeen Central

The hon. Gentleman took part in the debate and he knows exactly what I said. He is twisting words; he is very good at that. At that time, in 1997 and 1998, leaving well alone was the approach that both he and I took.

I have already spoken for longer than I intended, but I want to make a couple more points. Despite the support that I have given to the Chancellor's measures, two issues need to be addressed. The first of those—royalties—was mentioned by Sir Robert Smith. It is important to get an early decision from the Treasury on royalties, and I know that the intention is to publish a consultation paper. From the industry's point of view, and from my perspective as a Member of Parliament with an interest in the industry and a constituency that houses part of the capital of the industry—the city of Aberdeen—an early decision on royalties would be extremely welcome. There is a genuine fear in the industry that the Chancellor intends to delay the introduction of any reliefs until the next financial year. I would be disappointed by that. The oil industry sees the royalties relief as part of the package, and would appreciate it if it were part of the package for this year, starting on 17 April when the new supplementary tax was introduced.

The second point concerns financing costs, the most important aspect of which is to deal with the uncertainty that has arisen. My hon. Friend Mr. Blizzard has already made the position fairly clear. I do not go the whole way with him, but the industry needs to know as soon as possible exactly what the position is.

With those two qualifications, this is an important measure. The industry will learn to live with the new arrangements. When they are properly examined, the tax allowances provided in the Budget will be welcomed and will take the industry forward into the new era. That is inevitable. It is a maturing province, which remains the most important part of our economy—not only in the north-east of Scotland, but in the whole of the UK. Last year, a little under £4 billion was invested, and the hon. Member for Gordon mentioned the five-year figure of £23 billion. That is a massive amount of investment in one part of our economy, and it should be supported.

Photo of Alex Salmond Alex Salmond Scottish National Party, Banff and Buchan

I did not quote Miss Begg to play with words or twist phrases. The quote was from the proceedings of the Scottish Grand Committee in March 2001. It matched the general understanding that the idea of an unannounced tax change, made without consulting the industry, had been seen off. The oil industry was not labouring under an illusion; it had not simply forgotten about the change. The belief that no such change would be made was widely shared throughout the industry and among Members of Parliament, including the hon. Member for Aberdeen, South.

The hon. Lady went on to claim the credit for, as she put it,

"those of us from the north-east", who persuaded the Government to "leave well alone". I doubt whether she would have been foolish enough to say that unless it was a general perception among Labour Members of Parliament from the north-east of Scotland.

I well remember the Scottish Grand Committee last year. The debate was optimistic. Perhaps Mr. Doran also remembers it. I could quote other passages from it. However, the theme that the industry would advance from a base of stability because the Chancellor had abandoned the idea of a sharp change in the tax regime was shared by all Committee members.

The industry did not sleepwalk into a tax change. The shock of it is therefore all the greater. I do not oppose changes to the fiscal regime. The Government are entitled, in the public interest, to change a fiscal regime if they choose. However, there are two absolute requirements for such a change to be in the public interest. The first is consultation. That is especially true of the industry, with which a framework of consultation has been established. In all conscience, one cannot establish a PILOT initiative based on consultation to extract more, necessary investment in the industry, yet proceed with an unexpected tax change without consulting the institution that was set up to deal with such matters.

I am open to contradiction from the Financial Secretary, but I believe that not only was the tax change not discussed with the industry through PILOT, but that there was no prior discussion with the Minister for Energy or the Secretary of State for Scotland. I believe that they found out about the tax change only a short time before the rest of us—probably on the morning of the Budget. If the Financial Secretary does not agree, perhaps she can tell us when Treasury Ministers consulted the Secretary of State for Scotland—who had a huge interest in the matter because of the employment implications of the change—and the Minister for Energy and Construction—who is responsible for general oil policy—about the tax change. I believe that they were not in a position to anticipate events. I base that strong belief on watching their reaction at the time. [Interruption.] Sir Robert Smith agrees with that. He was also present and he, too, saw their reactions.

The second requirement is minimising the impact on jobs and investment. It is in the public interest to minimise the effect on jobs. Minimising the impact on investment is in the long-term interests of the Treasury, let alone the rest of us. It is vital that the North sea oil show is kept on the road through investment. With the right approach to fiscal policy and the industry, we are only halfway through the North sea oil and gas story. It is reasonable to assume that there is as much to be extracted in future as in the past 30 years. Deciding that now is the time for a short-term, smash-and-grab raid to maximise revenue in the next few years is a fundamental error, not only for the public interest but for the Treasury and economic interest.

In previous debates in the Chamber and in Committee, the Financial Secretary outlined the model that she had followed, probably without sharing it with her colleagues in the Department of Trade and Industry. The model was based on the change being good for the industry. Indeed, she claimed that it would be a boost for the industry. However, on the previous day, in the Scottish Grand Committee, the Secretary of State for Scotland said that the Government were trying to minimise the impact on jobs. If the Treasury had shared the wonderful news of a boost for the industry, why was the Secretary of State trying to minimise its impact? The Secretary of State for Scotland was simply acknowledging the reality that the overall impact of a tax change that means, in five or six years, taking £1 billion out of the industry, will be negative, regardless of the skill with which the effects are distributed.

We are simply debating the extent of the negative impact. Will it mean the loss of 50,000 jobs, as the United Kingdom Offshore Operators Association suggested, or less, as other sources have predicted? The Government have criticised the industry for the estimate of 50,000 jobs. It will be jeopardised in the longer term by a decline in investment. Surely the Government's argument that a £1 billion tax raid is a boost to jobs and investment is far more fantastic than the argument about the extent of the negative impact. The Financial Secretary owes us a reasonable explanation of the exact basis for the Treasury's belief that the Government can take so much out of the industry yet have a positive impact on jobs and investment. That is daft, without credibility and ignores the substantial anxieties of hon. Members who represent those who work in the industry about the impact of the tax change.

Earlier, I said that there were arguments for the Government changing oil taxation, but with consultation. Key issues must be tackled. Mr. Blizzard raised one: the well-rehearsed question of financing charges and the way in which a new entrant, who will not qualify for the full capital allowance relief, can be protected. How will such a company be protected so that it can exploit opportunities? Bringing in new, smaller operators to exploit and increase the overall extraction from the North sea is meant to be Government policy. That matter has not been properly tackled.

I was pleased to read in today's edition of The Press & Journal that the hon. Member for Aberdeen, Central acknowledges exploration drilling as a serious concern. That has been a theme of every speech that I have made about the matter in the past few weeks. Any reasonable Government would be worried about the downturn in drilling activity in the North sea in the past few years. In 1996 there were 112 exploration and appraisal wells; last year the figure was 51.

Exploration is largely financed from cash flow. It is therefore difficult to conceive that the measure will do anything other than further depress an already declining statistic. Now would be the moment to introduce a further uplift for exploration and probably appraisal drilling. There are mechanisms and means to do that. I suggested such a method in an amendment. However, for technical reasons, the proposal might be considered a subsidy, and the amendment was not selected. However, providing an uplift can and should be done. If exploration drilling continues to decline at the same rate, we will mortgage the future of a possible further 50 years of substantial oil and gas activity to gain an extra few billion pounds to add to the £160 billion—more than £30,000 for every man, woman and child in Scotland—that successive Chancellors have already extracted from the North sea.

It would be common sense for the Financial Secretary to answer the points about financing charges and the impact of the tax change on exploration drilling. She should also answer the genuine worries about the provision, which has not been thought through, has caught the industry by surprise, is likely to have a huge impact on jobs and investment, and will mortgage the future of an enormous industry that is responsible for a huge amount of overall capital investment in the United Kingdom. It will sacrifice jobs in Scotland and elsewhere for short-term gain by the Chancellor of the Exchequer.

The hon. Member for Aberdeen, Central talked about the past and about Budgets in which there had been unexpected tax rises. Hon. Members—not he or I, because we were not here—can go right back to the early 1980s, when one of the first actions of the Thatcher Government was to increase oil taxation. Given that the previous Secretary of State for Energy had been Anthony Wedgwood Benn, it was interesting that the Thatcher Government wanted to levy taxes at a higher rate than Tony Benn had done.

The accusation that was always levelled at people who had doubts about the approach to the industry was not just about individual tax rises, because they could sometimes be justified, given the shape of the industry, the price of oil and the windfall profits being made. It involved the underlying assumption—in relation to many of the moves and manoeuvres taking place—by the Treasury and the then Department of Energy that North sea oil and gas was a short-term story and that it would be there for 10, 15 or 20 years, then it would all be over bar the shouting. Many of the tax changes of that period and later were predicated on that short-term assumption.

Many people in the industry believed—as did the hon. Member for Aberdeen, South and I—that over the last few years there had been a realisation, through the PILOT initiative and other schemes, that this was a long-term game, worth playing over the long term because there was huge potential for maximising jobs and investment over the next few generations. More than anything else, this foolish tax change has damaged the credibility of the notion that, at last, some long-term thinking and planning was going into the industry, to maximise the benefits over a long period of time.

This is not a matter of passing an amendment or getting a tax measure into a Finance Bill, although I know that the Minister will be focusing on that at the moment. This is much more than that. It is about the future of the whole industry and about the jobs of many of our constituents.

Photo of Mr Iain Luke Mr Iain Luke Labour, Dundee East 7:00 pm, 3rd July 2002

I rise, as I did in Committee, to make a contribution to this debate. I say to Mr. Flight that I am one of those Scotsmen who is happy to stand up and defend the implementation of the 10 per cent. supplement proposed in the Budget. I take my daily dose of Irn Bru, so I might not be as soft as some of the more feeble Scots in the House.

Contrary to what has been trailed through the press by some of the major companies, I do not believe that the current changes have had any effect on jobs in the North sea oil industry to date; nor, perhaps, will they in the near future.

Photo of Chris Grayling Chris Grayling Shadow Minister (Health)

Surely the hon. Gentleman does not believe that the kind of business changes that would inevitably lead to job cuts would have taken place in the eight weeks since the Budget. The impact of these measures will be long term, and they will result in fewer jobs and a lack of investment in the years ahead, not just in the short term.

Photo of Mr Iain Luke Mr Iain Luke Labour, Dundee East

I am happy to come back to the hon. Gentleman on that, because that was exactly the point I was making. People in the press and in multinational companies are already talking about job losses. Indeed, an hon. Member remarked in Committee that he had heard from another hon. Member that there had already been job losses because of these changes. I accept the point made by Chris Grayling, but I do not believe that that is the case or that it will be the case in the short and medium term.

As many hon. Members have already said, we need to ensure that the future of the oil industry is safeguarded. We have to do that against the changing scenario in the North sea, in which different types of company are becoming involved in exploration and in the production of oil. The hon. Gentleman makes a worthwhile point, along the lines of other points that I shall make in my speech.

I do not believe—as was suggested by the hon. Member for Arundel and South Downs—that we are attacking the integrity of the tax regime. This is the first major change in tax to be introduced in this area in the last five years. Although it has been talked about as a short-term smash and grab, I believe that the Government's proposals will create a pool of revenue that hon. Members across the House have argued should have been put in place a long time ago. There has been constant talk of a windfall tax, to make sure that the massive profits made over many years were taken into account and used for the benefit of the taxpayer.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

Mr. Doran referred to the last major change, introduced in 1993, when the Minister responsible was, I think, my right hon. Friend Mr. Jack, who served on our Committee. This can be checked with my right hon. Friend directly, but I believe that those changes, though significant, did not have a retroactive impact on the new fields that had previously been invested in; they were changes for the future. There was, therefore, a major difference between what happened in 1993 and the changes that are now being proposed.

Photo of Mr Iain Luke Mr Iain Luke Labour, Dundee East

I take the hon. Gentleman's point. He has made many illuminating points during this debate. I was trying to suggest that this measure does not represent an attack on the integrity of the tax regime. If the change in 1993 was the last major change to the North sea oil tax regime, one tax change nine years later is not a big change. We are setting up a scenario which we hope the companies and organisations involved in the North sea will be able to live with and adapt to in the future.

Photo of Robert Smith Robert Smith Opposition Deputy Chief Whip (Commons)

The hon. Gentleman has to accept that a dangerous signal is being sent—not just to the oil and gas industries, but to others such as the biotechnology industry—about the integrity of the tax system. The oil and gas industries feel that they were lured, through the operation of the PILOT scheme, into making major investments last year, and that they are now being hit by a tax that they cannot escape. They feel trapped by it, because they were lured into making investments in the first place. Had they steered clear of the United Kingdom, they would not have been hit by these taxes.

Photo of Mr Iain Luke Mr Iain Luke Labour, Dundee East

Many large multinational oil companies have already taken the decision to move out of the North sea. That is part of a corporate plan, given the maturity of the oilfields there. The issue is how we encourage the smaller companies to break in and take on the mantle of the large multinationals. Given that those smaller companies are not arguing against the changes in the supplementary charges—or at least, not shouting as loudly about them as others—I believe that they will see the opportunities available.

There have been recent examples of small companies taking on that mantle, and making finds left in parcels of the North sea left by the multinationals, such as the Buzzard field. The large reserve of oil discovered there—1.1 billion barrels has been proposed—was obviously one that the multinationals had walked away from, leaving the smaller companies to carry out the exploration and make the connection with those reserves.

Changes in the companies working in North sea oil involve the bigger companies—because of their corporate nature—planning to move their corporate investment to other, more profitable, less difficult, lower-cost investment options, because of the nature of oil production. Malcolm Bruce said that it was not difficult for those companies to do so. My response is that it is inevitable that they will do so, given the maturity of the field and their own corporate plans.

We need to ensure that we create the conditions to encourage newer, leaner companies that are more innovative, enterprising and cost-effective, and more willing to take risks, to take up these opportunities and to become more fully involved in this area. There is a history of 20 or so newer, smaller companies becoming involved in the North sea, making finds and carrying on the tradition of employment and production that the big companies started.

That activity has been mirrored in other fields. There has been evidence of that kind of change in the gulf of Mexico, and there are indications that the trend will continue. Last week, a bumper find was announced in the Buzzard field. That had recently been abandoned by one of the bigger multinationals, which moved on to more profitable fields, given the higher costs that such companies carry, and was explored by a smaller company. The potential of 1.1 billion barrels of good oil over the next 10 to 15 years was an opportunity spurned by bigger companies taking easier options elsewhere.

Mr. Salmond mentioned that we are only halfway through the life of North sea oil. I believe that there will be more finds like the one that I described. A common theme of hon. Members' contributions is the need for the Government to ensure that all the areas that need to be investigated are investigated, in view of the number of jobs and livelihoods that depend on the industry. Much useful information has been provided by UKOOA—the United Kingdom Offshore Operators Association—including a recent update on employment. Because of history and the traditional view of Dundee's role in the economy, my area spurned many chances to be involved early on in North sea oil, but many people in Dundee are nevertheless involved in servicing the rigs and in innovative engineering to provide access to the difficult fields.

We must allow smaller companies to become involved. Like many hon. Members, I have had discussions with the industry. The big fear is that companies that hope to become more involved in exploration will not be able to do so because of the costs. In a recent article in Scotland on Sunday, the American head of a European investment company was quoted as saying that there was great potential for smaller companies to become involved in the North sea. The problem was the financing cost. Like many other hon. Members, I believe that the Government should consider offsetting the financing costs against the supplementary increases, to provide more impetus for companies to become involved. That possibility was raised in the newspaper article, which was supplied to my hon. Friend the Economic Secretary at the time.

The Government must provide incentives to ensure that the interests of North sea oil and employment there are maintained, and that investment and production are stimulated. Although I believe that the Chancellor is justified in his revenue-raising initiatives, he should not jeopardise the good work undertaken—I have been involved in several discussions through the all-party oil and gas group—by the Department of Trade and Industry and its work with the industry. The PILOT programme was a means of encouraging future exploration, and I hope that that work is not wasted.

I congratulate my hon. Friend Mr. Blizzard who, is in his role in the all-party group, has been discussing with the Minister the future role of the group, and asking questions about the tax issue. I hope that we can get together to make sure that the work of PILOT is progressed. At the next meeting of the group, we will consider the way ahead for PILOT. That is a discussion topic that deserves to be taken further.

Hon. Members in all parts of the House have urged the Government to confirm that they are taking seriously the need to nurture the industry by ensuring that the issue of the abolition of royalties is moved up the agenda. I hope that they will soon announce the date on which deliberations will begin and when the abolition of royalties will come about. That would send a clear signal that the Government want to engage with the industry on a joint agenda.

The situation in the North sea is changing, and the Government should be monitoring it. There is a movement away from the larger multinationals being involved—they are being replaced by smaller, more investment-oriented companies. As someone who comes from a city that used to be known as Juteopolis—in other words, a one-industry city—I and the other citizens of Dundee know the problems and the despair that ensue when an industry disappears. It is inevitable that North sea oil will eventually be exhausted. We must encourage smaller companies that want to make the investment to start planning the future for energy and energy renewals in the UK.

In Committee, the Government gave a commitment to listen, to take comments on board and to respond positively. I look forward to the Minister's reply. I hope that the Government will make it a top priority in our economic agenda to prolong the life of the North sea industry and the livelihoods connected with it.

Photo of Mark Hoban Mark Hoban Opposition Whip (Commons) 7:15 pm, 3rd July 2002

Even those of us who have not had a long association with the oil industry, unlike many hon. Members who have spoken today, have learned a great deal from the discussions about taxation of North sea oil during the progress of the Bill. The matter has dominated discussions both on the Floor of the House and in Committee, on which I had the good fortune to serve.

Two key facts emerged from the discussions of oil taxation. The first was the high preponderance of international companies that are based in the North sea—two thirds of the companies operating on the UK continental shelf are foreign-owned. The second was the great flexibility and mobility of assets in the North sea. The UK continental shelf is perceived as having a highly liquid market for its assets. As a consequence, foreign companies investing in that market can adopt a portfolio approach to the way in which they manage assets across the world, and move in and out of oil-producing areas, depending on the costs that they would incur by doing business in those areas. Clearly, tax costs must be taken into account in that equation.

It is interesting to compare the present debate with the one that we had on the previous new clause, where we were rightly concerned about subsidising an industry that was footloose in the way in which it moved its operations around the world. In this case, we are discussing a change in the taxation regime which acts as an incentive for companies to leave this country and conduct their operations elsewhere. That is a quite different situation from the one that we discussed a little earlier.

Given the extent to which many independent companies are dependent upon debt finance to exploit oil reserves, my concern is that the way in which the supplementary charge is structured—excluding debt finance from costs that are allowable to offset the liability—means that we are penalising companies that invest in the market. New clause 1, which gives the opportunity to offset those debt finance costs against the revenues that companies earn and which are covered by the supplementary charge, is a valuable amendment to the Bill.

Coupled with that, companies paying the supplementary charge will have difficulty in getting credit for the additional supplementary charge in tax computations submitted in the United States or France. Ensuring that interest is deductible from the computation of the supplementary charge will make the process of deducting the tax in the companies' home country's tax computations much easier.

It is disappointing for the industry that the Government did not seek advice from the Internal Revenue Service much earlier in the process. Before they introduced a charge in the UK, they should have thought in much greater depth about the international impact of that charge, and obtained clearance from the US.

An interesting aspect of the rationale for the supplementary charge was identified by Mr. Doran, when he mentioned that a few years ago it was inappropriate to introduce a windfall tax because oil prices were low, but now that they are high, it is okay to do that. That is a convenient justification. It reinforces the argument for a sunset clause on the supplementary charge that is the subject of other new clauses.

The new clauses would limit the timing of the operation of the supplementary charge, and would bring it to an end when oil prices are low, and when the good times that North sea oil companies are apparently enjoying at the moment have come to an end. We could then consider afresh the impact of the supplementary charge. In the meantime, we could see whether the United Kingdom Offshore Operators Association was right when it said that this tax will have a negative impact on jobs, or whether the more optimistic forecasts by the Government and Mr. Luke are correct and that, miraculously, a tax that takes £0.5 billion out of our economy every year will be neutral and will create jobs.

The new clauses address some of the issues at the heart of the supplementary charge. The Government would do well to listen to the concerns that we have raised, reflect on them and consider whether the new clauses are the right measures for us to take to ensure the future vitality of the North sea oil industry.

Photo of Chris Grayling Chris Grayling Shadow Minister (Health)

I support these amendments and new clauses with slight misgivings, because although they will take the sting out of a thoroughly unwelcome measure, I still believe that this new taxation is ill-thought-out, and I would much rather that it was not in the Bill.

My biggest concern about and lack of understanding of what the Government are trying to do involve the impact that this tax will have on the manufacturing sector. This industry employs 300,000 people across the United Kingdom, and it represents 6 per cent. of Scotland's work force alone. The new tax is being introduced at a time when manufacturing in Scotland is at an historically low level, and when manufacturing across the UK has been through a number of years of extremely difficult business circumstances. The industry has suffered from the adverse value of the pound and a deluge of regulation and ill-thought-out measures from central Government, and it operates in a world in which it is increasingly easy for manufacturing companies to relocate to other parts of the globe where the cost bases are fundamentally different from those in the UK.

Photo of Malcolm Bruce Malcolm Bruce Liberal Democrat, Gordon

What the hon. Gentleman is saying is obviously true, but it is even easier than he suggested, because many of these companies have already relocated to other parts of the globe. It does not take much to switch the investment. It does not require a major switch of funds. It is merely a matter of redeploying their existing assets.

Photo of Chris Grayling Chris Grayling Shadow Minister (Health)

The hon. Gentleman is right.

Photo of Mr Iain Luke Mr Iain Luke Labour, Dundee East

Not only is it easy to redeploy assets, but many of the companies in the North sea oil industry took corporate decisions well before the Budget to shift to much more profitable fields where the higher costs are covered by the larger profits that they will make out of fields that are easier to access.

Photo of Chris Grayling Chris Grayling Shadow Minister (Health)

The point that I was making about manufacturing is that, as well as the oil operators, there is in the UK a substantial industrial sector that provides the industry with components, support and other services and products. Inevitably, the consequence of levying a charge on the industry of hundreds of millions, if not billions, of pounds, thus reducing its margins and making business ventures less viable and less economic for companies to pursue, is that they will seek ways to cut their costs. One way to do that is to source the components that they use from other parts of the world where the cost bases are lower. That will have an adverse effect on employment and manufacturing businesses across the UK.

Hon. Members should not take my word for it. The chief executive of the Aberdeen and Grampian chamber of commerce said:

"There is no doubt that there will be a knock on effect on jobs. These changes will not just affect the oil majors but the countless small businesses operating in the supply chain."

This is not merely about the major companies operating in the North sea: it is also about the huge industrial sector that supports them. As a result of the combination of this and other Budget measures, such as the increase in employers' national insurance contributions, there is no realistic way in which this levy of a huge amount of money on the industry can avoid having a serious effect on jobs in Scotland.

The Government's approach in levying this new tax is ill-thought-out. I fear that the consequences will be far greater than they pretend. I listened to Labour Members who defended the tax, and realised that they do not understand the consequences of what is happening. It is simple maths. They cannot levy hundreds of millions of pounds on an industry, reduce its margins, as will happen as a result of this tax, and expect that not to have an effect on investment and jobs. That is basic business arithmetic. Our manufacturing sectors have suffered badly in the past few years, and many companies are under pressure, so this is precisely the wrong moment to take such an adverse tax step.

Sadly, I am certain that the Government will not change their approach, but I hope that at the very least they will take note of these new clauses and amendments, which would take the sting out of this measure. They would put a time limit on the effects of the taxation, so investment decisions over the long term could be taken in the context of a point of termination. I urge the Minister, for the sake of manufacturing industry in different areas of the country, not just in Scotland, to accept the new clauses and take the sting out of what is otherwise a thoroughly unwelcome measure.

Photo of Robert Smith Robert Smith Opposition Deputy Chief Whip (Commons)

I welcome a chance to take part in the debate. These new clauses have allowed us to return to this subject on Report. It was discussed in Committee on the Floor of the House and in the Standing Committee, and this is a welcome opportunity to see how the debate has moved on. The vocal support of Labour Members at the start of the Budget debates seems to have melted away on Report. We have heard far more thoughtful contributions, and even those who support the Government's general approach seem ready to recognise that some of these amendments make serious points and raise serious issues.

Chris Grayling made a valid point about the importance of the supply chain to the North sea oil industry—the manufacturing that is supported by it and the onshore jobs not just in Scotland but throughout the United Kingdom. Some companies are finding life difficult. They do not necessarily want to be named, but some companies in my constituency are already concerned. When orders are cancelled, the cash flow of manufacturing companies is hit.

The Treasury needs to understand more about the structure of the industry. When major companies are hit by indecision and uncertainty about whether royalties will be abolished, investment decisions are put on hold. For those companies, that is a nuisance, an irritation, a frustration and a worry, and it affects their bottom line, but they survive because their cash flow can take such a hit. Down below them in the supply chain are many companies whose everyday cash flow is crucial. They cannot switch off the business for a few months while the Government sort out the tax regime and the major investors decide whether to invest. The Government must consider the knock-on effect on the many small businesses that supply the industry. There has been much more outsourcing of functions. Investment houses are much more involved, and the supply chain is much more dependent on a continued flow of business.

Many hon. Members have referred to the fact that this measure has been a surprise and a shock to the industry. The Treasury still seem to be under the illusion that that is a fiction or an elaborate hoax, and that it was not a shock or a surprise because the industry saw it coming and understood what was happening. I assure the Treasury that there could not be that many well-paid actors giving such a consistent message from many levels of management and from many different businesses in the industry. Many people have worked closely with PILOT, with Logic and with the taskforce. There is genuine shock and surprise, and it would be helpful if the Treasury recognised that. Whether it intended to surprise the industry, or whether it thought that it had surprised the industry, the reality is that it has surprised it.

There must now be some damage limitation, and some undoing of that damage. That is what these new clauses would do. New clauses 2 and 3 on termination and new clause 4 on transition would relieve the shock and the sense of betrayal. They would also deal with the fiscal instability by getting the message across that if companies made the investment last year because of what they got out of PILOT, this year they can get some of the relief on that investment against the new tax. Similarly, a three-year period gives a chance for further consultation with the industry, a chance to address these concerns and not to have hit the immediate Red Book figures. My hon. Friend Malcolm Bruce made a very valid comparison with whisky, in that overtaxing can kill the goose that lays the golden egg.

Given the surprise felt by the industry, we need an explanation from the Treasury on when it chooses to consult and when it does not. When debating the timing of the Finance Bill and the business motion relating to it, the Leader of the House said:

"I think that two full days in total to consider the remaining stages is perfectly adequate provision. It is adequate partly because this Finance Bill has already been through more consultation with industry, outside bodies and financial services than any previous one. Many of the clauses were seen in draft form by the industry, which may partly explain why the Opposition ran out of things to say in Committee."—[Hansard, 24 June 2002; Vol. 387, c. 710.]

The oil and gas clauses were not seen by the industry before the Finance Bill was published. It might be helpful if the Financial Secretary would outline the Treasury's thinking in consulting some sectors and industries prior to the Budget to allow them to understand the measures. Why were there no draft clauses on which the oil and gas industry could consult? Will she put in the Library what percentage of the Finance Bill honoured what the Leader of the House told us only the Monday before last?

When it comes to sending strange signals and conflicting messages, the industry is entitled to argue that PILOT psychologically sent a message that this was its way of engaging with Government and that it was engaging with the whole of Government, not just a part. The Government pride themselves on encouraging joined-up government, but the signals from PILOT were about the need to obtain investment and deal with fallow fields. There was a response, and the PILOT objectives were being met, so the shock felt is quite understandable. That is reinforced by what the Secretary of State for Scotland said in Scottish questions on 11 June in answer to a question from Mr. Salmond:

"As part of that review, the Treasury was represented on the oil and gas industry taskforce and on Pilot, which I chaired for about two years, by no less a figure than Sir Steve Robson. At that time, very few Treasury officials were ranked higher than him. It was the discussions within Pilot that led us to reach a decision on the North sea fiscal regime that is designed to help companies which are investing in the North sea."—[Hansard, 11 June 2002; Vol. 386, c. 707.]

If the Secretary of State for Scotland was under the impression that PILOT and the Treasury were closely linked and that there was a link between what PILOT was up to and the fiscal regime, it is little wonder that the industry thought that messages were coming from that engagement.

Previous speakers have alluded to what was said last year about the tax regime and the messages sent out in the north-east of Scotland. The Press & Journal—the voice of the north—serves the north-east of Scotland. It serves Aberdeen, the capital of the oil industry for Europe. The paper wrote in its editorial about the Prime Minister's visit to Aberdeen in May 2001, in the run-up to the election. It said that the Prime Minister made it clear in his speech in Aberdeen, South that there were

"no plans for a windfall tax on the oil companies, and accepted the offshore industry's need for a stable tax regime.

He said:

"We have been strongly supportive of the oil industry and oil production and I'm well aware of the fact it is of crucial importance to Aberdeen."

The Press & Journal said in its editorial:

"His insistence that there will be no windfall tax on North Sea oil operators is a major relief not just to the multinationals, but to all whose prosperity and services depend on a healthy oil trade."

If, just before the general election, the Prime Minister promises that there will be no windfall tax, and then within the year the Chancellor introduces a new tax regime that is even worse than a windfall tax because it is for ever, regardless of the price of oil, what kind of industrial policy are the Government pursuing? What is their long-term fiscal strategy for encouraging inward investment and a thriving investment potential for this economy?

It was the Government's declared aim to lay to rest the fears that a new Labour Government would damage industry, but if every sector suddenly finds that the rug is pulled out from under it, and that promises are made just before elections and reneged on within the year, that does not create an investment climate that is conducive to long-term fiscal stability.

Photo of Alex Salmond Alex Salmond Scottish National Party, Banff and Buchan 7:30 pm, 3rd July 2002

Let us dwell on that point for a moment. If we assume that the Prime Minister was telling the truth before the election last year, that would destroy the Treasury argument that this was part of a continuous process from 1997, culminating in this tax change. Or we could conclude that the Prime Minister was not telling the truth, but even Treasury Ministers would not want to go down that road, would they?

Photo of Robert Smith Robert Smith Opposition Deputy Chief Whip (Commons)

It would be extremely helpful if the Treasury could clarify the Secretary of State's view of PILOT and the Prime Minister's comments in the run-up to the election. Or was the right hon. Gentleman's speech simply a message designed to be heard in the north of Scotland where votes were important so that Labour Members could be re-elected in marginal seats? That is not the way to deliver a stable, long-term economic environment, but it is a dangerous way to mislead people. Once people feel misled, the damage must be undone, which is, I hope, what the Treasury is looking to do. However, its response so far to the debate seems to be to put pressure on the industry. The Treasury seems to be saying that if the industry complains, it will drag its heels on the other half of the package.

If this proposal was thought out on day one and abolishing royalties comprised part of the package, why on earth has the consultation not started? Why on earth is there no consultation paper on the abolition of royalties? It was something that the Chancellor promised, to dress up the presentation of the Budget, yet we still hear nothing about it.

The most frightening thing about the Treasury's lack of understanding is how it thinks that someone can make investment decisions about a field that is subject to royalty tax when he does not know what is happening to royalties. It beggars belief that the Treasury believes that it can sit on this measure without it doing any damage. Every day is a delay when a decision needs to be made. The longer the wait, the worse the situation becomes as people find other places to make their financial investments.

Amendments Nos. 42, 43 and 44, tabled by the hon. Member for Banff and Buchan, provide a chance to undo the damage completely. It would be impressive if, when those votes take place tomorrow, the House could reject this part of the Finance Bill. We could go back to square one, have a proper consultation with the industry, with proper draft clauses, as the Leader of the House thought that the Government were doing with other sectors of industry. In that way, we could have a long-term, stable, clearly thought-out policy for the future of oil and gas.

This does not matter so much at the very top. The middle and senior managers whose job it is to manage an asset in the North sea are the ones who have been betrayed. They have been telling their bosses in France or America that they are a good bet, they have a good climate, a taskforce and PILOT. They have been saying that they have engaged with each other, that a logical way of working has been established, that they have tried to get the industry to work together, that they have learned a lot of lessons and that much good has come out of 1997. As the hon. Member for Banff and Buchan said, only a year ago many of us were praising the Government for what they had done. The middle and senior managers feel betrayed because their bosses in France, America or elsewhere in the UK are saying, "You got the money out of us under false pretences. You said that there was no fiscal risk and that the bet was long term. We backed your judgment and you have let us down because you have not delivered." That delivery is the Government's failure—it has sent the wrong signals. In fact, those people probably regret ever becoming involved in PILOT and changing the culture of the industry. It would have been better if they had remained isolated and carried on as before because they would not have exposed themselves.

It will be a sad outcome if the Treasury does not find a way of engaging in the debate on financing costs, royalties and long-term stability. PILOT requires the commitment of individuals and industry money to make it work. It is quite difficult to motivate people after such a bad hit. Anything the Financial Secretary can do to smooth the waters and rebuild confidence will be most welcome, but she must realise that there has been a genuine shock. The new clauses provide a chance for the Government to show that they are listening and willing to address that shock. They provide an opportunity for the Government to address the point about financing costs, which has been raised on both sides of the House.

The Treasury must look at the smaller companies who look to lease assets to exploit smaller fields and ensure that the tax system is not a straight hit on those companies, with no compensation to encourage them to maintain their projects. We have real potential in terms of the technology of floating production, which is an exportable technology. If we can develop that expertise, nurture it and maintain it, we can take it elsewhere.

There has been talk about major companies walking away. However, the crucial thing about major companies being here as long as possible is that they often own the central asset to which many small fields are tied back, and the tax regime and Government stability must maintain those central core assets if we are to maximise the exploitation of the North sea. I urge the House to back the amendments and new clauses tabled in the names of Conservative and Liberal Democrat Members, which address what is a tax too far.

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

This has been an interesting debate. Mr. Flight has accused the Government of unwise and unnecessary taxation. He attacked the good faith of my right hon. Friend the Chancellor, when he warned the Opposition not to fall for the propaganda of the oil industry. However, it seems to me that the hon. Gentleman, who speaks for the Opposition, has fallen hook, line and sinker for that propaganda. In the process, he has accused the Government of undermining the integrity of the tax system.

Last year—even after investing £4 billion—oil companies generated net cash flow of £10 billion from the North sea, after all the taxes that they paid. I do not accept the argument that an additional annual tax burden of, say, £600 million must reduce investment in the UK because there are no longer sufficient funds to maintain it.

Mr. Salmond accused the Government of a short-term smash and grab raid. I tell him, as I tell other hon. Members, that the Government have consistently made it clear that the North sea tax regime needs to strike the right balance between securing a fair share of profits for the nation and encouraging investment.

North sea oil and gas is a limited national resource. Oil companies produce oil and gas under Government licence, and the returns generated from that often exceed a normal commercial rate of return. Furthermore, at times, producers make large profits simply due to movements in the world oil price. But the key point is that underlying rates of return are high, even when adjusted for short-term oil price movements. Every single major oil-producing country has a special tax regime to reflect the economics of the oil industry and to ensure that their country shares in the benefits.

Photo of Alex Salmond Alex Salmond Scottish National Party, Banff and Buchan 7:45 pm, 3rd July 2002

When the Prime Minister told people in the north-east of Scotland immediately before the last election last year not to expect any windfall tax, was he unaware of the arguments that the Economic Secretary has just outlined or was he purely misleading people for electoral purposes?

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

The hon. Gentleman's proposal would result in a windfall tax on oil companies; a time-limited specific additional tax on oil companies. It is the Government who are committed to a long-term stable regime for the oil industry that is based on securing a fair share of the industry's resources for the UK citizen while making sure that there is a favourable climate for investment.

Several hon. Members, including the hon. Member for Banff and Buchan, have difficulty in understanding the relatively simple concept that we can design a tax measure so as to promote future investment, while securing more revenue from the oil industry.

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

If the hon. Gentleman will allow me to continue, I will explain how it works. There are two elements. The first is the investment allowance. That means that even with the supplementary charge, companies investing in new products will have higher post-tax rates of return than under previous rules. Secondly, in net present value terms, the benefit of the 100 per cent. allowance outweighs the additional tax for marginal projects. It is the effect on marginal projects that determines the effect on investment. Marginal projects will be encouraged by this change; the increased tax reduces the net present value of more profitable fields, as it is designed to do. But these are likely to go ahead in any event, so the combined package increases the incentive for oil companies to invest in marginal fields.

Photo of Alex Salmond Alex Salmond Scottish National Party, Banff and Buchan

We need a bit of humility from the hon. Lady; some of us were working in the industry on these matters even before she was a Minister. Can we get back to the Prime Minister and the explicit undertaking that he gave to people in the north-east of Scotland that no such change was envisaged? Was he, at that stage, aware of the arguments that the Financial Secretary is making just now, or was he merely misleading people last year for electoral purposes? Can we have an answer this time, instead of a lecture?

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

The hon. Gentleman accuses the Government of imposing a windfall tax on the oil companies. We are determined not to do that; that is why we have carefully designed a package that promotes investment while securing a fair share of resources for the country's citizens. The package is designed to promote a long-term stable fiscal regime for oil companies to operate in. I shall return to the perceptions of the oil companies in due course. I have spelled out in considerable detail to the House the investment criteria and the criteria that we took into consideration when designing these tax measures.

Photo of Robert Smith Robert Smith Opposition Deputy Chief Whip (Commons)

Will the Financial Secretary explain why the Treasury chose not to consult on draft clauses and engage with the industry on them—as it has done, according to the Leader of the House, for other businesses—and instead chose to surprise the industry?

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

I will come on to deal with the element of fiscal risk, the perceptions in the oil industry and why we did not consider PILOT to be an appropriate forum to discuss those issues before the new regime was introduced.

I was on the point of explaining the analysis behind our tax changes. A full analysis has been made of the impact on investment, and I have spelled it out in great detail to this House, including the criteria behind the analysis. The analysis has been open thereafter to public scrutiny and scrutiny by oil companies. I will not run through all the criteria used for the analysis again today.

We looked, for example, at 108 new fields that were potentially commencing development over the next five years. We applied all the investment criteria that companies used to establish whether projects will proceed. We used the long-term oil and gas prices typically used by the industry when calculating those rates of return. The conclusion of all of our work—particularly that on new fields and incremental investment—was that, on average, the impact on marginal investment projects was positive.

The oil industry broadly accepts that analysis. The industry differs over specifics, but broadly accepts that if we have a 100 per cent. capital allowance—which makes new investment in marginal fields more profitable—and combine that with a supplementary charge, there can be a positive impact on investment. The industry differs on the impact on fiscal risk and the stability of the long-term regime. We have heard interesting and thoughtful points made by hon. Members on that precise subject.

I disagree fundamentally with the projections that the oil industry is now claiming to attach to the impact of our regime change. The hon. Member for Arundel and South Downs quoted industry figures for the fall in production, a forecast of 1.5 million barrels a day by 2010. He quoted figures on investment and jobs. The problem is that the industry was forecasting those figures before the tax changes. It is very difficult to say that the impact on jobs and investment is as a result of the tax changes when those forecasts were produced, apparently, before the industry had any idea of what those tax changes were to be.

Photo of Chris Grayling Chris Grayling Shadow Minister (Health)

In April, Lord Browne said of the changes in the Budget:

"Taken together those steps are likely to reduce investment and to hasten the decline of production."

Is the Financial Secretary suggesting that Lord Browne, whom I believe to be a man of integrity, is not giving an accurate picture of the truth?

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

I was saying that the oil industry was forecasting an impact on jobs and investment before the results of the tax changes had even been announced. It is completely inappropriate to tie that analysis to subsequent tax changes.

Photo of Malcolm Bruce Malcolm Bruce Liberal Democrat, Gordon

If the industry is predicting a reduction in jobs, production and investment, why do the Government believe that increasing the tax burden on it will halt or reverse that process?

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

I have just been through the analysis supporting our conclusion that, taken as a whole, the tax package will promote marginal investment in new fields. In fact, the industry is blaming decline—which was forecast—on tax changes that were designed to help investments with less attractive returns. That analysis is completely disingenuous, and I am surprised at those hon. Members who have fallen for it.

I do not accept that the North sea regime is uncompetitive; on the contrary, tax rates for new fields remain lower than for all other major oil and gas producers. Combined with generous allowances, the low rate means that the United Kingdom will remain an attractive place to invest. All companies have their own hurdle rates of return and other criteria for investment. If they were prepared to invest here before the tax changes, there is no logical reason why they should not be prepared to do so now. In general, the tax changes should not reduce any returns below companies' own thresholds for investment; indeed, as I have explained, in some cases the changes may raise returns from marginal projects, so that they will be above the required thresholds in future.

I am aware of the arguments, put forward after the Budget announcements, concerning the tax changes' impact on the fiscal regime. I am also aware of the argument—made by, among others, the hon. Members for Arundel and South Downs, and for Gordon (Malcolm Bruce), and my hon. Friends the Members for Aberdeen, Central (Mr. Doran) and for Waveney (Mr. Blizzard)—concerning the impact of any tax change on the perception of fiscal risk in the United Kingdom. I intend to deal with that specific issue in as much detail as I can. The industry is claiming that the fiscal risk has somehow increased since the Budget changes, and that although the changes would in principle lead to greater investment and more jobs, changing the perception of fiscal risk could impact on jobs and investment. Indeed, the industry is putting great stress on a predicted hypothetical 20 per cent. supplementary charge for future projects.

Labour Members have discussed such issues with me, and they are fully aware that that is the industry's projection, and that it is using those figures to back its analysis of the impact on investment and jobs. However, the regime that we have introduced is a regime for the long term, combining a 10 per cent. supplementary charge with 100 per cent. relief for capital expenditure. That is the regime that we are debating today—not some hypothetical future regime. In fact, as far as is practical, fiscal risk has now been eliminated. Before the Budget, a substantial element of fiscal risk was clearly attached to North sea investment. The Government reviewed the position in 1997–98, and when the review ended, we gave no commitment to maintaining an unchanged North sea regime. Indeed, as the 2001 Budget Red Book states, the Chancellor made it clear that he was considering "the next steps" on North sea taxation. We have made the changes required—

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

If the hon. Gentleman will allow me, I want to make a little progress. We have made the changes required to put the regime on a sustainable, long-term footing. It now provides a fair share of profits for the nation, and helps to encourage long-term investment. We introduced these changes only after careful analysis, and we are being absolutely clear in our commitments. Before this year's Budget, we gave no indication that we considered the North sea fiscal regime sustainable in the long term. We are now putting it on the record that, with the Budget changes, we have a stable regime into the next Parliament. We cannot be any clearer than that.

Photo of Chris Grayling Chris Grayling Shadow Minister (Health)

The industry has not got the message. Lord Browne also said the following about those changes:

"Their direct impact will be compounded by the fact that a change made in this way reduces confidence in the stability of the regime going forward and imposes an added element of risk on all future decisions."

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

I have set out what the oil industry is claiming, and our response to it. This is a long-term fiscal regime that is stable into the next Parliament—we cannot be clearer about that. As far as we are concerned, fiscal risk has reduced. Of course, it is up to individual companies to argue and decide, and to set their own fiscal risk criteria. We could never challenge an individual company's subjective assessment of fiscal risk, but if it is irrational and inappropriate, other companies will come in and make profits where profitable opportunities exist.

Photo of Robert Smith Robert Smith Opposition Deputy Chief Whip (Commons)

Will the hon. Lady help to restore fiscal stability by explaining why the Government chose not to consult on the draft clauses before the Budget, and why the sector was not given the same opportunity to consult as other sectors? There must be some explanation as to why the proposal was sprung on people. Will she also recognise that, whether or not it was rational, the people involved were genuinely surprised?

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

We have already debated these matters at length. It was clear that, in the late 1990s—when the matter was first put out for consultation—two different regimes might apply, and we consulted on that basis. It became increasingly obvious that one of the policies was inappropriate, because of the time that had elapsed. The hon. Gentleman might agree that it is slightly odd to consult on the basis of one possible remaining regime. We have designed a regime that clearly takes into account investment needs, jobs and growth in the North sea, Scotland and the rest of the United Kingdom. Moreover, we have planned for the future with a long-term, stable fiscal regime. We cannot be any clearer about our intentions.

Photo of Alex Salmond Alex Salmond Scottish National Party, Banff and Buchan

On the question of people being taken by surprise and the careful analysis of the impact on jobs, did the Treasury consult the Minister for Energy and the Secretary of State for Scotland on this matter before the Budget, or on the morning of the Budget?

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

Of course, Ministers and officials from different Departments have regular conversations about the oil industry, but I hope that the hon. Gentleman will agree that tax matters and tax changes are a matter for the Chancellor. The real issue that has rightly been raised today by my hon. Friends is the question of why we did not consult within the framework of PILOT, an organisation that was set up to encourage investment in the North sea. The Government accept that PILOT has a very valuable role to play in discussing issues of concern to the industry, but it—

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

I have given way to the hon. Gentleman many times, and I must make progress. I will doubtless give way to him later on in my speech.

PILOT is not, and never has been, the appropriate forum for discussing tax; indeed, the position has been clearly set out. I think that it was the hon. Member for Arundel and South Downs who mentioned Steve Robson, who was present at the very first meeting of the oil and gas industry taskforce, which became PILOT in due course. At that meeting, Steve Robson made it clear that taxation was a Budget issue, and was not for consideration by the taskforce. PILOT, and the taskforce, always operated within that framework. PILOT's terms of reference refer explicitly to working within the parameters set by Government policy. Of course, PILOT sometimes deals with administration and the efficient operation of the tax system, but it was explicitly made clear that it was not for PILOT to consider the quantum of taxation of the oil industry.

Photo of Robert Smith Robert Smith Opposition Deputy Chief Whip (Commons)

The chair of PILOT for two years is now Secretary of Scotland, and she made it clear at Scottish questions that it was from PILOT that the tax regime was developed.

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury 8:00 pm, 3rd July 2002

PILOT has always been concerned with legitimate questions of tax administration and implementation, but it was made clear in its terms of reference and set out at its first meeting that it was not the forum for discussing the quantum of taxation, which was an issue for the Chancellor that should be taken forward with the industry in the normal way.

I wish now to deal with some specific concerns that have been raised in this debate. In particular, many hon. Members raised the issue of financing costs. New clause 1 would allow financing costs to be taken into account in the calculation of the profits base for the supplementary charge. The new clause says that the costs would be allowed to the extent that the existing provisions referred to—section 494—permit them to be allowed. That is on the false assumption that that resolves the problem of manipulation of borrowings to minimise the effect of the charge. It does not.

My hon. Friend the Member for Waveney asked whether I would be able to put on record the precise arrangements that companies use to take advantage of the ring fence and the current disallowing of finance costs, and why we could not also apply that to the supplementary charge. I shall do my best to make the position clear, although I shall of course be willing to follow up later if he feels that I have not made the position sufficiently explicit tonight.

Section 494 restricts interest deductions against profits arising inside the ring fence to the extent that the money borrowed has been used to meet expenditure incurred by the company in carrying on its trade of producing oil or gas in the North sea. So the borrowing cannot be for downstream operations or some activity overseas. That is of course wholly sensible.

Essentially, what section 494 does is to set an upper limit on borrowing inside the ring fence based on the amount of spending in the North sea. What it does not do is to prevent the company from choosing to borrow for North sea purposes rather than other purposes. What it does not do—and neither do any of the transfer pricing rules that apply to finance costs—is to prevent a company from borrowing heavily, or even exclusively, to fund its ring fence activities, leaving other activities of the company, or the group of which it is a member, to be financed in other ways.

It is accepted that some groups, which are profitable in the North sea and unprofitable outside, will have already borrowed up to the limit allowed by the present rules. However, others will not have exercised that capacity and would be able to increase their borrowing further. With a higher rate of tax inside the North sea ring fence than outside, there will be a considerable additional incentive for companies to arrange their borrowing in that way. However, it is not just the potential for further shifting of borrowing that is of concern: it is also the current uneven distribution of debt within companies and groups.

It is clear that if new clause 1 were to be accepted the yield from the supplementary charge would be significantly eroded and the North Sea regime would fail to give a fair return to the nation from profits derived from a national resource.

Photo of Malcolm Bruce Malcolm Bruce Liberal Democrat, Gordon

The Minister is giving a fair explanation of why the Government would apply that regime to companies that have a wide range of interests nationally and internationally, upstream and downstream. It does not however answer the issue for those companies that do not have any of those offsets and that are investing by means of finance for marginal projects in the North sea. Those companies have no downstream and no offset, and they cannot even benefit from the full capital outlet. Cannot the Minister accept the case for varying the provisions in the Bill for those companies?

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

I accept that finance costs are a cause of concern, especially to smaller companies. However, it is not possible to distinguish, company by company, those companies for which it is a real concern and those that might use the additional latitude to rearrange their borrowings. What is clear is that the solution cannot be just to allow all finance costs in computing the new supplementary charge. Any alternative approach would need to ensure that the overall yield from the North sea—both ring-fence corporation tax and the supplementary charge—is maintained.

There are alternatives to allowing finance costs to be set completely against the supplementary charge that the Government are willing to discuss with oil companies. For example, we could try a system of apportioning finance costs so that those used for North sea purposes would be allowable against the extra charge. However, we must have a fair system that does not penalise those companies with least scope to manipulate their borrowings and does not lead to a reduction in the overall yield. We have already contacted oil companies with certain proposals that they may wish to discuss with us. I hope that that gives some comfort to my hon. Friends and other hon. Members that we take the issues very seriously.

New clauses 2 and 3 would bring the supplementary charge to an end after just three years. That is totally unacceptable. I shall not rerun the argument that that would be a windfall tax on oil companies, not the long-term fiscal regime that the oil industry needs.

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

I will not give way to the hon. Gentleman, because I must make some progress.

I cannot accept new clause 4 because it would do nothing to increase investment in the North sea, but would simply hand money back to companies that have made very good returns from the sector in recent years and, as I said in Committee, will continue to do so when the changes in the Bill are enacted. It seems to have been forgotten that this tax is not like petroleum revenue tax. It is not a tax on individual fields. It is a tax that applies to company profits in the North sea—profits that have been shown to have far exceeded those of other industries since petroleum revenue tax was abolished for future fields in 1993, even with the effect of oil prices stripped out.

Several hon. Members have questioned our relationship with the US tax authorities and whether the supplementary charge will be allowable under double taxation treaties. The Inland Revenue has written to the Internal Revenue Service in the US to ask for its view on whether the supplementary charge will be creditable. That is, of course, an issue for the US. It was the industry which asked us to do that, and it was then up to the Revenue to contact the IRS and deal with the issue in the usual way.

Photo of Robert Smith Robert Smith Opposition Deputy Chief Whip (Commons)

Does that mean that until the industry raised the issue as a concern the Inland Revenue was not aware of it? Does the Inland Revenue think that it is a genuine concern or did it miss it completely?

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

It clearly is of concern to certain companies and it needs to be sorted out one way or the other. It is not clear, however, that companies will be significantly disadvantaged if the supplementary charge were not to be completely allowable under the double taxation treaties. I urge those companies for which that is a real issue to approach the Government and the Inland Revenue and set out their concerns. We will then liaise with those companies and address their concerns. If the hon. Gentleman has evidence that the issue is of real concern, I will also of course be willing to listen to him.

Several other hon. Members raised the question of royalties. Many views have already been expressed to the Government about the abolition of royalties and several dates have been suggested. I expect the Department of Trade and Industry to issue a consultation document in the near future. I can certainly confirm that it remains our intention to abolish royalties subject to that consultation.

The Government have considered the returns on capital employed in the North sea. We have found that, since the tax changes made by the Conservative Government in 1993, the rate of return has risen from 10.5 per cent. to 34 per cent. last year. In comparison, the rate of return for other non-financial industries was, on average, 11 per cent. last year, and the difference was not caused by temporarily high oil prices. In fact, the rate of return in the North sea was higher than that for other industries in every one of the past nine years—even in 1998, when the oil price fell sharply.

It is only right that we take a fair share of revenue from the North sea for the United Kingdom taxpayer. Our reforms promote investment, jobs and development in the North sea. They are right; they are for the long term. I urge hon. Members to reject the Opposition's new clause and to support the Government.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

I will be brief.

The economic life of the North sea in the 1990s was enormously better than expected, which has been largely reflected in a sensible tax regime since 1993. The Government clearly have a windfall strategy: oil prices have gone up, so it is appropriate to charge more tax. Indeed, the Financial Secretary said so. I warn her that, with the economic outlook facing the world today, and as the European Bank for Reconstruction and Development is funding the installation of a new pipeline from Russia, it is highly questionable whether higher prices will be sustained.

The Opposition have won the argument overwhelmingly. This tax grab will put at risk the maximum future exploitation of the North sea. I commend the Financial Secretary on doing her best to defend the indefensible. I am slightly saddened that someone as bright as she is has swallowed the spin that the Treasury has fed her. We have already made the point that the 34 per cent. return figure is nonsense. It represents the top return for 2001, compared with the 14 per cent. average. Indeed, the figure is only 7 per cent. for investments since 1996.

The Financial Secretary will come to eat her words. The leading oil industry economist, Wood Mackenzie, has made it absolutely clear that the Government's case is rubbish and that the industry cannot sustain any further marginal taxation without a major loss of investment and employment. The Government will regret what they are doing. They have misled the industry by their lack of consultation, but they then try to tell the industry, "Trust us. This is another long-term regime." Pull the other one, mate. When confidence has been broken, people do not give their trust. Britain will suffer; the current account will suffer; jobs will suffer; and investment will suffer. This additional taxation is very unwise.

Question put, That the clause be read a Second time:—

The House divided: Ayes 177, Noes 303.

Division number 288 Orders of the Day — Finance Bill — [1st Allotted Day] — New Clause 1 — Supplementary charge in respect of ring fence trades: financing costs

Aye: 177 MPs

No: 303 MPs

Ayes: A-Z by last name

Tellers

Nos: A-Z by last name

Tellers

Question accordingly negatived.