This thesis has addressed the neutrality properties of the Norwegian Petroleum Tax Act (PTA). More specifically, we have answered if the PTA is neutral in investment decisions and treatment of companies with respect to tax position. The choice of topic is motivated by
an Official Norwegian Report published in 2000, finding distortive aspects detrimental to optimal resource allocation on the Norwegian Continental Shelf (NCS). In the aftermath, several changes have been made. It was therefore of interest to see if the authorities have succeeded in promoting efficiency in the resource rent taxation. This topic is also motivated by the different opinions regarding how the petroleum tax system ensures optimal allocation of resources. Industry, state and independent groups are not aligned in their views, and this is often expressed in the public discourse.
Prominent literature on neutral taxation has been employed in a descriptive analysis of the PTA. We found that the systemic properties are in place, also under uncertainty. The reason is symmetric treatment of costs and income due to full certainty regarding redemption of tax allowances. Since the net present value of any scheduling of used tax allowances are the same, when valued as risk free cash flows, companies are in theory indifferent to when tax allowances are received. Companies may, however, perceive the alternative cost of the tax allowances differently than the state. Furthermore, the PTA is found not to be aligned with theory when it comes to shielding the normal return from the special tax. The applied analysis has therefore investigated if investment decisions are equal in the onshore and offshore tax regime and furthermore if they are dependent on tax position.
The main differences between a capital investment offshore compared to onshore are the additional special tax (50%) and beneficial deductions (tax credits) offshore. Tax credits include both faster depreciation allowances and uplift. Financial value added, as a consequence of favourable financial cost deductions, is not considered in this thesis. This is a weakness in our analysis, but would not change the conclusion, only the neutral rates (threshold values). Furthermore, to include how tax allowances affect the capital structure of a company, and to what degree this is essential for investment decisions, would increase accuracy.
From the analysis, we have shown how a higher tax rate in one sector will have a disincentive on investments and that counteracting measures are necessary to ensure neutrality between capital allocation onshore and offshore. The analysis has determined under what conditions the special tax is proportional to the tax credits, and thus when investment decisions are not distorted by tax regime. By assuming value additivity, we have separated cash flows according to their inherent risk, and applied a DCF model to assess how tax regime and tax position affects an equity based capital investment.
Since the state assumes tax allowances to be risk free, while the industry may have different perceptions, both perspectives have been compared in the analysis. Why the industry do not value tax allowances as risk free, can both be the perceived risk (systemic features in the Norwegian system) or it may be due to valuation method. Summers (1987) and other more recent studies finds that companies base investment decisions on DCF-models using a single discount rate on the net cash flow. Companies do not necessarily risk adjust the discount factor to incorporate risk free tax allowances. The latter, represent the industry’s point of view in our analysis. When analysing neutrality from different perspectives, we have shown the difference between perceived and theoretical neutrality, and this is a perspective that is often forgotten in the public discourse. However, we have analysed two extreme points of views, and a middle point may be more in tune with reality.
From the state’s point of view, our findings suggest that investment decisions are the same regardless of tax position, but the system gives an investment incentive offshore on the margin. The latter is caused by too beneficial deductions. These reduce the ordinary tax base as well and cause lower effective tax rates offshore than onshore on marginal capital investments. Considering a maturing shelf with evidently more marginal investments, it is unfortunate to have such incentives in the PTA.
We find that the industry’s perception is dependent on the employed discount rate. For rates below 11.7 percent, the offshore tax regime is favourable and above there is found an investment incentive onshore. 11.7 percent represents the intersection of the IRR-curves and thus neutrality. The industry is likely to perceive an advantage for companies in tax position.
Exploration investments are neutral regardless of tax position as they are immediately reimbursed, thus representing a Brown tax cash flow-element in the PTA.
The conclusion is that the problems described in the official report in 2000 still prevails with respect to the investment incentive offshore from a theoretical point of view. The reasons are still too favourable tax deductions. However, this can be perceived differently by the industry, depending on valuation method and the discount rate employed. If it is above 11.7 percent, the two points of view will have opposite conclusions. As the analysis shows, the conclusion is sensitive to the assumptions we make, and a recent study by Lund (2012) had a different conclusion than ours. Our findings should therefore be regarded as indications, rather than facts.