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Mr. Salmond: I have explained that my intention is simply to double the initial allowance to 12 per cent. The hon. Gentleman will have to take me at my word, because I now want to make some international comparisons.
Mr. Salmond: No, the hon. Gentleman must sit down.
The issue of the interest rate is important. It is arguable—indeed, I think it is beyond argument—that it should reflect the relevant cost of capital. That will involve a risk premium, given that exploration is a particularly risky activity. The conceptual basis of my argument is recognised in countries that have moved to resource rent taxes. Typically, an interest rate used for compounding forward tax loss will involve a risk premium and a risk-free element.
I think the Economic Secretary should pay close attention to recent experience in Australia, where the conceptual framework is highly developed. It has a petroleum resource rent tax, a cash-flow tax levelled on pre-corporation tax cash flows at a rate of 40 per cent. Allowances for all expenditures are 100 per cent. on a first-year basis. There is generally a ring fence for the tax, but the compound interest rates for expenditure vary substantially between exploration and appraisal and development.
For exploration and appraisal, which is inherently risky, the rate is 15 per cent. real plus a long-term Government bond rate. For development expenditures, which are inherently less risky, the rate is 5 per cent. real plus long-term Government bond rate. The difference reflects the extra risk, and the higher cost of capital for exploration and appraisal. A further feature is the breach available in the ring fence for exploration and appraisal expenditures. These can be relieved against any—that is, company-wide—PRRT income. The compound interest factor of 15 per cent. plus thus represents the effective compensation to the new player, compared to an established one for exploration and appraisal activities.
I find the Australian example interesting. The Australians have made a concerted and developed attempt to devise an allowance that matches the difference in experience of a new player in the sector, compared with the tax shelters available to an existing player. Notwithstanding Tory-Front Bench scepticism, that is what the amendments are designed to do. I could talk about the Norwegians, who have also made provision for the tax disadvantages experienced by new players, but as I do not think the Norwegian system is as established or as thought through as the Australian one, I shall submit the latter to the Economic Secretary's undoubted interest in these matters.
Last year's Finance Act looked favourably on an argument advanced during the passage of the previous year's Bill, when the issue arose of whether it was
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possible to ensure more equitable treatment of existing infrastructure and pipelines in the North sea in order to allow new developments, particularly of gas, with the use of that infrastructure. I do not know whether the Treasury has yet had an opportunity to make a proper assessment, but early indications from the tax change are that we may well have achieved the magic bullet of taxation changes: that is, a tax reduction may well be about to increase Government revenue in the medium term. For instance, the entry of the major Statfjord field into St. Fergus strikes me as a direct and early result of that sensible tax change, with other fields perhaps very much in the pipeline.
I hope that the Government will also look favourably on my attempt to suggest that the welcome 6 per cent. on offer is not enough to bring about the change that is desired—that is, to match the real risk to new players with a tax allowance to equalise their position in relation to established players.
6.15 pm
It is not enough to persuade the existing major companies to relinquish the vast acreage and the many fallow fields that lie un-drilled or undeveloped in the North sea, although that certainly needs to be done. Given that there is a generation of new companies willing, able and anxious to come into the environment, it is also necessary to give them the opportunity to do so. For that to happen, we must make sure that the tax incentive matches the risk that they will have to bear. Given that we want high-risk activity in the North sea and in the waters around Scotland, that tax incentive, which would not cost the Government a great deal in global terms, could provide a tremendous payout by way of increased revenues in the medium term, and increased jobs and activity in the short term. The Government achieved that virtuous circle through last year's sensible taxation change; hopefully, they are prepared to consider a further such sensible change in future.
John Healey: I am very pleased to respond to the hon. Member for Banff and Buchan (Mr. Salmond). He is right: although this is the last, it is certainly not the least of the debates on this Finance Bill. The issue that he raises is indeed important, relating as it does to an industry that is of great importance to the UK economy. I pay tribute to him for championing its interests and consistently coming up with fresh proposals. I am particularly grateful to him for his welcome for the change that we are making through clause 280 and schedule 36.
The Government share the hon. Gentleman's desire to encourage new entrants into the UK continental shelf, so that the recovery of our national oil and gas resources can be maximised wherever doing so is economically viable. The introduction of the exploration expenditure supplement complements the action being taken on other regulatory matters, and it reinforces the Government's aim to encourage new firms to enter the North sea. That policy is showing some signs of success. The response to the Department of Trade and Industry's recent 22nd licensing round has been very encouraging. Twenty of the 68 companies applying for a licence are potential new entrants, which shows that the North sea is still attracting worldwide interest.
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As the hon. Gentleman said, the purpose of the EES is to deal with a tax disadvantage that might impact on new entrants wanting to undertake exploration. The tax disadvantage arises because companies new to the North sea might not have the taxable income against which to set their 100 per cent. exploration and appraisal allowances—a point made by the hon. Member for Chichester (Mr. Tyrie). The full economic value of those allowances could be significantly eroded over time if there is no stream of profits against which they can be used in year one. The purpose of the EES is to deal with that tax disadvantage. It compensates for this loss in value by providing an annual uplift of 6 per cent. compound on the pool of unused allowances.
The hon. Gentleman posed the question: why 6 per cent.? Six per cent. is currently judged to be the right rate to compensate for the loss in value of the allowances over time. The rationale is that the rate is consistent with current medium-term high-grade commercial borrowing rates, and with the Government's social time preference rate—in other words, the discount rate applied in evaluating the use of public funds, with an allowance for inflation. The hon. Gentleman argues for a doubling of the rate, but to do so is not currently justified, according to those comparators, without going beyond the purpose of the EES, which is to deal specifically with the tax disadvantage faced by new entrants. A higher rate risks giving new entrant companies an advantage over existing North sea companies with a taxable income.
Mr. Tyrie: So far, I agree with everything that the Economic Secretary has said, but will he confirm that the purpose of the existing 6 per cent. rate is to create a level playing field between new entrants and existing operators, and that coming to some other figure—removing the 6 per cent. or doubling it—would create a bias in favour of the new entrants?
John Healey: I thought that I had already made that clear. The purpose of the special provision is to compensate for the loss in value of allowances and to put new entrants on a par with other companies that may have year one profits against which to use those allowances. To go further than 6 per cent. would be wrong in principle in relation to the purpose of the clause and would distort the market in favour of new entrants. As I said, that is not the purpose of the measure. However, we have taken the opportunity to ensure that we have the power to amend the rate quickly if the economic factors change, making it right to do so.
Mr. Salmond:
I do not think that there is any disagreement between the Economic Secretary and me that a 12 per cent. increase would substantially increase the advantage for new entrants, but I am not certain that that view is shared by the Tory Front Benchers. My problem is with the justification for the 6 per cent. rate, so will the Economic Secretary tell us more? It is effectively a risk-free rate, but the average capital cost for new players in respect of exploration and appraisal is at least 17 per cent.—and it can be much higher. Will the Economic Secretary run over again the justification for the 6 per cent. rate, given that informed views—certainly more informed than the views of Tory Front Benchers—would suggest that it is too low?
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