This blog is written by Mr. Saif Uddin Khilji, Senior Manager Taxation Advisory Services. Please read this blog and provide your valued comments.
RING FENCING
[1]What is a Ring-Fence?
A ring-fence is a virtual barrier that segregates a portion of an individual’s or company’s financial assets from the rest.
[2]Ringfencing or Ring-fencing occurs when a portion of a company’s assets or profits are financially separated without necessarily being operated as a separate entity. This might be for:
- regulatory reasons,
- creating asset protection schemes with respect to financing arrangements, or
- segregating into separate income streams for taxation purposes.
[3]Ring-fencing means a limitation on consolidation of income and deductions for tax purposes across different activities, or different projects, undertaken by the same taxpayer.
It is important to determine the extent of “ring-fencing” of tax accounts. Some countries ring-fence oil and gas activities, others ring-fence individual contract areas or projects. This can become complex if a project incorporates extraction, processing and transportation activities. If the oil and gas tax regime is more onerous than the standard tax regime, the taxpayer could seek to have certain project-related activities treated as down-stream activities outside the ring fence. If they are treated as a separate activity, the taxpayer through transfer pricing may attempt to shift profits to the lightly taxed downstream activities.
Ring-fencing rules matter for two main reasons:
- Absence of ring fencing can postpone government tax revenue because a company that undertakes a series of projects will be able to deduct exploration or development expenditures from each new project against the income of projects that are already generating taxable income.
- As an oil and gas area matures, absence of ring fencing may discriminate against new entrants that have no income against which to deduct exploration or development expenditures.
Despite these points a very restrictive ring-fence is not necessarily in the government’s interest. More exploration and development activities may occur if taxpayers can obtain a deduction against current income, generating more government revenue over time by increasing the taxable base. The right choice is again a matter of balance within the fiscal regime, the degree of government’s preference for (modest) early revenues over (greater) revenues later on and the extent of the government’s bargaining power with oil and gas companies.
In Pakistan, FBR and taxpayer have locked horns a number of times on this issue however latest full bench judgment is in favor of taxpayer.
Saif Uddin Khilji
[1] Extracts from Investopedia.com
[2] Extracts from Wikipedia.org
[3] Extracts of Emil M. Sunley Paper
