OT19412 - PRT: Appendices

Illustrative Agreements

The Illustrative Agreement was originally conceived as a device to enable US oil companies operating overseas to benefit from domestic tax incentives associated with oil and gas exploration and production.

To obtain these US tax benefits which were based on groups the "economic interest" in the oil and gas had to be vested in the US incorporated oil company. Until 1976 this was irreconcilable with the UK requirement that UK Production Licences were to be confined to companies incorporated in the UK.

To overcome this difficulty most US oil groups wishing to participate in the North Sea applied for licences through UK incorporated subsidiaries and then transferred the "economic interest" in the licence to a US incorporated parent or fellow subsidiary of the licensee. The agreement by which this transfer was achieved became known as an Illustrative Agreement and the party receiving the "economic interest" is commonly referred to as the "X company".

Official recognition was given to the arrangement by the Inland Revenue agreeing with the oil industry a model form of Illustrative Agreement. The vast majority of Illustrative Agreements in operation conform closely to this model form which has provisions designed to safeguard the UK’s taxing rights over the X company.

Certain requirements have to be met by potential applicants before the DTI awards (or transfers) a production licence. Since 1976 the Secretary of State has dispensed with the requirement that the applicant company be incorporated in the UK. However those companies that were resident in the UK when a licence was granted had still to remain resident. Otherwise the requirement became that a company had a satisfactory UK taxable base, being either resident in the UK or trading in the UK through a branch or agency. Under revised regulations this will no longer be the case but a company must still have sufficient presence to be within the charge to UK tax.

For this reason OTO is advised by the DTI of all licence applications and assignment proposals.

As indicated at OT19410, new Illustrative Agreements are rare. However, the procedure was that the approval of the Board of Inland Revenue had first to be obtained and this was conditional on the foreign company either becoming resident (dual residence might apply) or operating a permanent establishment (branch or agency) in the UK.