On April 11, 2014, the Dutch Supreme Court provided guidance regarding on the treatment of tariff income for Dutch State Profit Share (‘SPS’) purposes. In this memorandum we will elaborate on the Supreme Court’s decision.
Although the decision is very factual, the Supreme Court confirms the rule of thumb as used in practice that (i) third party income for the use of platforms (‘tariff income’) is not subject to State Profit Share and (ii) that the attributable costs – which need to be eliminated from the State Profit Share result – are equal to 1/3rd of said tariff income.
1. Facts and background
The simplified key facts of the case, which deals with the 2006 tax year, are as follows.
BV holds license interests in various blocks, together with other license holders. The license holders have concluded a Unitization Agreement (‘UA’) for the production activities in these blocks. BV holds a 26% license interest in one of the blocks and a 36.8% interest in the co-owned platforms for the treatment of gas and a compression station (the ‘Platforms’) based on the UA.
Therefore, on the one hand BV was charged expenses for the use of the Platforms based on its 36.8% interest in the UA (the ‘Expenses’) and, on the other hand, BV received remuneration for the use of the Platforms based on its 26% license interest in one of the blocks (the ‘Remuneration’).
2. Position taken by taxpayer and dispute
In its SPS return, BV has excluded the Remuneration from its taxable income for SPS purposes, as in its view this Remuneration should be regarded as remuneration for third-party use of the Platforms. In addition, BV has claimed a deduction for the Expenses charged under the UA in relation to its 26% interest in one of the blocks in its SPS return.
Pursuant to an agreement with the Dutch Tax and Customs Administration, the costs that can be allocated to the Remuneration should be considered equal to one-third of the Remuneration. As such, the Dutch Tax and Customs Administration agreed to the exclusion of the Remuneration, but disputed the deductibility of the Expenses that can be allocated to the block. This was also the main dispute at the District Court and the Court of Appeal.
3. Decision by the Supreme Court
According to the Supreme Court, if a production license holder is also the (co-)owner of a certain installation (such as a platform), such installation forms part of the business assets of this production license for SPS purposes. Nevertheless, according to the Supreme Court, income and costs related to third party use of platforms must be excluded to determine the profit for SPS purposes, as such income and costs should not be considered to relate to the production license business. In this respect, BV and the Dutch Tax and Customs Administration agree that attributable costs can be considered equal to one-third of the third-party income (tariff income).
Furthermore, the Supreme Court ruled that the joint owners of an installation, which forms part of the business assets of a production license, cannot charge themselves a fee for the use of such an installation in their capacity as owners. In other words, a company cannot rent out a co-owned installation to itself. This implies that BV, in the case at hand, cannot claim a deduction for the related expenses that can be allocated to BV’s production license for a block in which BV co-owns the Platforms.
Finally, the Supreme Court ruled that, with respect to joint exploitation, charging expenses for the use of a platform can have real economic relevance if expenses charged for the use of a platform do not equal the share in the remuneration received for the use of that platform. However, this is only the case if the amounts charged to the user exceed this user’s share in the remuneration received for the use of the platform. In the case at hand, the expenses charged to BV did not exceed its share in the remuneration. Thus, deduction of the expenses charged to BV for use of the Platforms was denied.
4. Potential implications for your business
This Supreme Court case may have significant implications for taxpayers that participate in Unitization Agreements or similar collaboration agreements that allocate platform costs between various production license holders.
We recommend verifying existing agreements to determine whether this case may have implications for your business. Please feel free to contact your ENR contact with any questions and comments you may have in this respect.