OT26237 - Capital Allowances: Mineral Extraction Allowance

Intangible Drilling Costs

In the UK the phrase intangible drilling costs has no legal or technical meaning. The term is used to describe expenditure on drilling other than that incurred in creating or acquiring physical assets or legal rights.

Prior to ICTA 88/s91C introduced by FA97/s66 intangible drilling costs were dealt with as follows. The intangible drilling costs attributable to production wells drilled on a field after a decision had been taken to develop that field commercially were treated as a revenue deduction. The costs of the first development well were excluded from the treatment and qualified for allowances under the MEA code.

The above treatment was agreed with UKOITC in 1967, when the UK oil industry was in its infancy, and applied a decision by the Special Commissioners in 1920 to the treatment of intangible drilling costs of a second and subsequent development wells. The 1920 decision was that once the first development well had won access to an oil deposit, the intangible drilling costs of subsequent production wells were deductible for tax purposes as revenue costs.

The practice, often known as New Brunswick, lasted on until 1996/97 but became uncomfortable in the sense the 1920 decision was seen as increasingly out of line with the way in which capital and revenue expenditure was being distinguished by the courts. It was also seen as inconsistent to treat the tangible costs of drilling wells as capital and the intangible costs of drilling wells as revenue.

ICTA 1988/s91C prohibits a Case I deduction for New Brunswick treatment for expenditure on intangible costs of second and subsequent development wells. Relief for such expenditure is now given only via the MEA code. Incidentally, the legislation brought the taxation treatment more into line with the accounting treatment.

The legislation operates by cancelling the New Brunswick decision. If mineral exploration and access expenditure incurred in an area during the exploration phase does not qualify as a Case I deduction, then similar expenditure in the development phase will also be ineligible for a Case I deduction. The legislation applies to expenditure incurred on or after 26 November 1996, unless incurred before 27 November 1997 in pursuance of a contract entered into before 26 November 1996.

Where a contract is varied post 26 November 1996 then the expenditure which remains eligible for New Brunswick may not be greater than would have been the case if the contract had not been varied. This allows variations to exist in contracts to the extent that the expenditure is not greater than under the original contract.

CAA2001/s407(4) was inserted by ICTA 88/s91C to prevent MEA's being claimed on expenditure for which a previous trader had a Case I deduction. Where a previous trader obtained a New Brunswick deduction for expenditure on mineral exploration access, then MEA is not available to any subsequent trader on an asset whose value is partly attributable to that expenditure.

As New Brunswick was abolished some years ago the general area is not covered in depth in this Manual. Therefore the Manual does not go in any detail into the dividing line between tangible drilling costs and intangible drilling costs. The categorisation was sometimes important when intangible drilling costs were capable of achieving full up-front relief when incurred before 26 November 1996. Again, this Manual does not look at the way in which a well might or might not be identified as first development well.