The Act on Special Hydrocarbon Tax and Amendment of Certain Other Acts of 25 August 2014 as been widely, but often unduly or superficially criticised. It is now obvious that the provisions of that Act bring the Polish system closer to international arrangements for the industry, while tax burden is not much higher. This is particularly important in the conditions of falling crude prices.
On 25 August 2014 the President of Poland signed the Act on Special Hydrocarbon Tax. The amended Geological and Mining Law is in effect with 1 January 2015. It is now a good opportunity to remind the debate on hydrocarbon taxation in Poland.
Plain errors and oversimplifications have been common in the debate. The term “shale tax”, frequently used by mass media and analysts, or the issue of tax on unconventional hydrocarbons are just two examples of such errors or misleading generalisations. Without going into details, it should be noted that those debating the issue have not addressed the key fact: State Treasury is the owner of mineable resources under the law of Poland. Therefore, the State is authorized to earn profits (government take) on production of mineables, while the pre-existing applicable regulations were extremely liberal. A review of the Act endorsed on 25 August 2014 should be preceded by an assessment of the Polish government take system in the aspect of conformity with specific requirements of the E&P industry.
The most important debate misconceptions regarding the tax on production of hydrocarbons are addressed below. The definition of the mineable resource under the Act is the first of them. Contrary to some analysts and press media, it is not about the so-called shale gas. The title of the Act on Special Hydrocarbon Tax clearly specifies that hydrocarbons, i.e. not only the so-called shale gas, or even natural gas, but also crude oil is subject to taxation.
The second issue to be clarified is the amount of burdens to be levied on the taxpayers following the enactment of the new law. It is untrue that the produced hydrocarbons (revenues thereon) are subject to a tax rate of 40%. Neither this nor any other law does foresee any such rate of tax. The rate of “40%”, that appears frequently in press media, is the total rate of government take, i.e. government's share in the profits of E&P industry. In addition to taxes (special hydrocarbon tax, the tax on production of certain mineables, real estate tax or the traditional corporate income tax), government take includes royalty and charges of the civil law, such as mining usufruct fee. It should be noted at this point that E & P companies have argued repeatedly that government take is higher than the amount specified in the justification of the Act.
A cursory assessment of the tax system, considering nominal tax rates only, is the final but the most important misconception of the debate on taxation of hydrocarbons. An analysis of the government take system should not be limited to the total amount of the levies. The way it addresses industry needs should be considered. The entire system should be analysed, taking into account such aspects as the approach to taxation basis calculation and the availability of tax deductions or breaks. Therefore, the whole system of government take transfers must be considered.
Three legislative acts determine government take rates and structure. The first of them (Special Hydrocarbon Tax Act of 25 July 2014) was adopted in 2014, while the second one (Act on the Tax on Certain Mineables of 2 March 2012) has been thoroughly amended by the Act on Special Hydrocarbon Tax and Amendment of Certain Acts. The third legislative act – Mining and Geological Law of 9 June 2011 – provides for the amount of royalty due and authorizes the Minister of the Environment to change it accordingly. The former act will be under vacatio legis until the end of 2015. Consequently, its provisions will take effect with 1 January 2016.
Moreover, the Parliament has amended the Act on the Taxation of Production of Certain Mineables. Initially, the Act regulated taxation of silver and copper production, but the legislator extended the scope of its applicability to the tax on hydrocarbons (natural gas and crude oil).
It should be kept in mind that the enacting of these legislative acts does not mean that additional taxes will be charged to entrepreneurs with the beginning of 2016. According to Article 32 of the Act on Special Hydrocarbon Tax, they will be obliged to do so as late as with 1 January 2020. Initially, the obligation to pay the tax on production of certain mineables was to take effect with the effective day of the Act (1 January 2015), but it was postponed on PGNiG's request. This demonstrates that, contrary to media's speculations, the Ministry has subscribed to the position of production industry enterprises which argued that early imposition of the tax obligation may pose a risk to the E&P industry. Now the entrepreneurs will have several years to prepare themselves for the tax to be introduced in 2020.
One more change in Poland's government take regulations is a higher royalty the companies pay to the local governments and to National Fund for Environmental Protection and Water Management. The new rate was imposed by the aforementioned amendment of Geological and Mining Law of 25 August 2014. It is now equal to PLN 20 or PLN 24 per 1000 cm of the gas produced from marginal and non-marginal reservoirs, respectively. These categories reflect different specificity of production from these two sources. Similar categories apply to crude oil production.
It should be noted that prior to the amendment of Geological and Mining Law the fee on natural gas production was equal to PLN 5.18 and PLN 6.23, respectively. Although the fee is not a tax in a strict sense (as the Constitutional Court demonstrated in its decision of 9 February 1999, file U 4/98), it is still a fiscal burden to the entrepreneurs.
On the other hand, the new rate of CIT deductible depreciation on drilling wells should be mentioned. This will enhance significantly depreciation capabilities of E&P companies by enabling them to deduct from taxation basis the cost of drilling wells, including those that failed to reach the reservoir and produce oil or gas.
It should be kept in mind that, by principle, the level of government take on hydrocarbons produced is not uniform and depends on the kind of accumulation which is being produced. Under Art. 7a.6 of Special Hydrocarbon Tax Act the tax on production of certain mineables is equal to 1.5% in the case of unconventional natural gas or 3%, if natural gas is produced from other reservoirs. Permeability and porosity of reservoir rocks are the criteria of attribution to any of the above categories. Similar principles apply to crude oil production.
More importantly, an appraisal or production gas well is exempted under Art. 7b from tax obligation, if its monthly output is less equivalent 1100 megawatt-hour. Similar provisions apply to crude oil production. It should be emphasized that the tax is on revenues rather than income. Up to 19% of cumulative deferred loss may be deducted under Article 10a.1 of the Act on the Tax on Production of Certain Mineables.
It should be noted that royalty is the primary government take component in most European and North American countries. Unlike product sharing agreement, whereby the State, as resource owner, is by default a shareholder (a passive or active one under the SFDI system used in Denmark, Norway and Holland, or initially considered in Poland in the form of National Operator of Mineable Resources – NOKE) of production projects. Therefore, we may conclude that the Polish government take system brings us closer to international standards.
Special hydrocarbon tax provides for some regulations that are advantageous to the industry. The tax cap is set at 25% of revenues on oil and gas production only if the ratio of cumulative eligible expenditures to cumulative revenues is above 2. Accordingly, the entrepreneur is subject to taxation only if the profit on production exceeds twofold the investment on profit generation. Otherwise, proportionally lower rates apply.
Tax rate calculation details are presented in Art. 14 of Special Hydrocarbon Tax. It should be noted that if the ratio is less than 1.5, oil or gas producer is exempted from the tax obligation. Therefore, the tax can hardly be perceived as a very burdensome one. Entrepreneurs have argued that the catalogue of expenses that are eligible under the Act does not reflect the specificity of the industry. The exclusion of expenses on patent, technology or insurance acquisition is particularly controversial. Nevertheless, the entrepreneurs are still able to make significant deductions from the tax basis, especially that the legislator's catalogue is not close-ended.
The conclusion from a review of the newly established Polish oil and gas tax system is that, notwithstanding the reservations made by the entrepreneurs, it is to some extent advantageous to them, as they can take advantage of extensive tax optimisation and deduction possibilities.
In order to assess how the new Polish tax system reflects the specificity of the industry one more question should be asked: to what extent it protects the entrepreneur against the risk of exploration failure. Even extensive knowledge of geology and investigations (seismic surveying, fracture stimulation or appraisal drilling) do not guarantee the success of an exploration project. Therefore, legislator should provide for a mechanism to protect the E&P industry against the risk of tax payment on unsuccessful projects.
The ability to set individual depreciation period of up to three years is such a mechanism provided for by the new legislation to protect investors against an excessively high tax burden at initial project stages, when the profits on production are small or nonexistent.
Under optimal conditions, it takes five or more years for an E&P project to start oil or gas production. This is reflected by the policy of geological licensing authorities whereby appraisal and production concessions are awarded for a minimum term of 5 years. Only after that time the expenditures decrease and the output is high enough to offset the risk of project failure due to an excessive tax burden. As the above regulations are indispensable from the industry's perspective, the legislator made a wise decision to consider them.
The conclusion from a review of Poland's government take system is that, despite a general but frequently superficial criticism, it reflects the specificity of the E&P sector and is consistent with European standards. Worth of noting is that the Ministry of Finance acquiesced to some important requests of the industry, such as the postponed introduction of the tax on certain mineables.
Therefore, the Act that imposes a new government take system should be considered as a trade-off between E&P industry's postulates and fiscal interests of the State which, as the owner of mineable resources, is authorized to government take.
author: Szymon Dziubicki – student, Law and Administration Faculty, Maria Curie-Skłodowska University in Lublin and Vice-president of the Students for the Republic Association
- According to estimates by PKN Orlen S.A., Polish Oil and Gas Joint Stock Company (PGNiG) and other companies, the actual government take will be in the range of 130% of the profit of oil and gas companies.
- file:///C:/Users/Downloads/129-146_Pawel_Turowski.pdf s. 133
- SDFI (State's Financial Direct Investment) – a system whereby a government entity holds a mandatory share in an E&P project. Consequently, it contributes to project costs, participates in management and holds a share in the profits thereof. NOKE (National Operator of Energy Mineables) was a similar mechanism initially considered in Poland.