A taxing question for shale gas exploration in the UK

Stamp duty is paid on all transfers of interest in land – not just ownership of the land – but where does this leave purchasers of onshore shale exploration licences? Edward Milliner investigates.

Everyone will be familiar with the requirement to pay stamp duty when purchasing land, buildings or other property located in the UK. But what about the acquisition of an interest in an onshore exploration and production licence? While the question does not appear to have received much attention, as the fracking sector grows and matures it is likely to become more pertinent.

First, a word on terminology. While the tax is commonly referred to as “stamp duty”, it is properly called “stamp duty land tax” (SDLT) in the context of real estate. SDLT was introduced by Gordon Brown in 2003 in place of traditional stamp duty as a means of counteracting avoidance and increasing revenues (although traditional stamp duty still applies to purchases of shares in UK companies).

While the modern tax applies to a far broader range of transactions in land than stamp duty, its territorial scope is limited to UK land. Offshore licences have therefore never been within its potential reach. For onshore licences, the position is less obvious.

SDLT is chargeable on acquisitions of interests in UK land: this would include a freehold or a lease, and also certain lesser interests such as rights of way and rights of light. An onshore licence such as a Petroleum Exploration and Development Licence, like an offshore licence, confers upon the holder a right “to search and bore for, and get” hydrocarbons from the relevant licence area, but does not confer any right to enter onto or gain access to the land either on the surface or below – for that, the licence-holder must enter into separate discussions with the relevant landowners (and, if they buy land or take a lease from one of them, they will pay SDLT on that). This was made clear in a decision of the Court of Appeal in 2009, albeit in the context of a commercial case rather than a tax one. Surely, then, no SDLT is due as regards the licence itself?

A view expressed in some quarters and apparently taken by HMRC (in certain cases at least) is that the onshore licence is akin to hunting or fishing rights, which are themselves within the scope of SDLT. Such rights are known to conveyancing lawyers by their somewhat archaic name of “profits à prendre”. They are essentially rights held against the owner of the affected land to enter on to that land to hunt game, or to fish, or to extract some other natural resource and take it away. As has been noted elsewhere, if the analogy with a profit à prendre holds good, then SDLT will be payable on the transfer of an interest in an onshore licence.

There is, however, a fundamental problem with the analogy. If I extend a personal invitation to you to enter my land whenever you like to hunt or fish, I create only a personal licence. If I sell my land, then the new owner is not bound by my invitation and could sue for trespass if you enter their land.

This is therefore not a profit à prendre. Hunting and fishing rights run with the land itself, so that the right to hunt or fish continues regardless of any change in the owner of the affected land. It is this characteristic that makes them proprietary rather than personal rights, and – because they are proprietary rights over UK real estate (the affected land) – they fall within the scope of SDLT. But an onshore licence confers no such right in relation to any UK land. As noted above, those rights must be acquired separately.

A recent case in the Administrative Court (concerning the power of the department for Business, Energy and Industrial Strategy to vary licences) touches on this issue.

The judge says that the grant of an onshore licence constitutes the grant of an interest in land. Taken at face value, that statement could be read as meaning that the licence-holder acquires ownership of the petroleum prior to its extraction. Elsewhere, however, the judge is rightly clear that ownership passes once the petroleum is “got” or “won” (and, by implication, not before). This brings us back to the analogy with hunting rights (under which ownership of the game passes only once it is successfully hunted) – and the key difference that, by contrast with hunting rights, the onshore licence confers no rights that attach to any affected land.

Hunting rights entitle a person to enter on to affected land and to take what is hunted. The onshore licence has the latter component but not the former. That is the fundamental distinction for property law and therefore SDLT purposes, and that is not something that was addressed in this case.

Is it possible that the hydrocarbons in situ constitute “land” in their own right? Arguably the particles of shale gas are effectively one and the same thing as the rock in which they sit. That may well be the case, but in my view does not change the analysis. The licence confers no ownership in the hydrocarbons until they are extracted, at which point they will have ceased to be land, if they ever were. The proprietary interest arises too late in the day for SDLT to bite.

Is the answer that SDLT should not arise the right one, as a matter of principle? I would suggest that it is. The taxation regime concerning oil and gas is a carefully crafted instrument of government policy, and it seems unlikely that parliament intended that a property tax should (by virtue of some fairly obscure legal analysis) catch transfers of interests in onshore production rights.

While SDLT is broader in scope than traditional stamp duty, it has at least only ever been understood as a tax on transactions relating to real estate as such. To levy it as a stealth tax on onshore production is a proposition about which even its creator may have hesitated.