The Government published on 20 December 2022 a number of significant documents in relation to the Electricity Generator Levy.
These include a supplementary technical note, draft legislation and an explanatory note to the draft legislation.
Our view is that these are clearly rushed through proposals and are far from perfect. What everyone in the energy sector always craves is clarity and certainty. The draft legislation in particular, does not really achieve this and our view is that it does not match clearly the principles and wording in the technical note. There may be time to resolve this, including through the publication of guidance and regulations by the treasury, but not much!
Background
As commented in our previous post, the Electricity Generator Levy (the Levy) will apply to revenues from “in scope” electricity generated on and from 1 January 2023 to 31 March 2028 and will be a 45% tax on extraordinary returns from low-carbon electricity generation. Extraordinary returns are defined as the aggregate revenue that generators make in a period (the relevant company’s accounting period) from in-scope generation at an average output price above, initially, £75/MWh. Normal corporation tax principles will also apply.
The recently published documents change and refine a number of points in the original technical note and seek to set out the formal legislation to implement the Levy. There are though some contradictions between the draft legislation and the technical notes.
We explore these points and some of the contradictions below.
Calculation of Exceptional Receipts
The Government has indicated that the benchmark price of £75/MWh will now be adjusted in line with CPI (all items). There was no indication previously that it would be indexed, but this was something that a large number of generators made representations about). The draft legislation indicates that the £75/MWh value will apply for the financial years (1 April – 31 March) ending in 2023 and 2024. From 01 April 2024 however, the £75/MWh will be indexed in line with CPI with the first indexation adjustment using December 2022 as the base date and with subsequent adjustments working on an annual adjustment by reference to the change in CPI from December to the next December.
The supplemental note and the draft legislation provide that no other value will be indexed. This includes the £10 million allowance (which will be pro-rated for periods shorter than 12 months) and the baseline fuel cost.
The supplemental note states that generation receipts will not include the following for the purposes of calculating the Levy:
payments for accepted BM bids for reducing output (although the measure of output will be adjusted upwards for certain purposes to reflect the volumes not generated as a result of the accepted bid);
ROCs, REGOs, FIT generation tariff payments and FIT export tariff payments (but Feed-in Tariff sites that have opted out of the export tariff regime and sell the power on commercial terms, will potentially, have such export revenue included in the Levy calculation contingent on other variables); and
payments not in connection with power provided to the grid (such as ancillary services) and Capacity Market payments.
The supplemental note and the draft legislation also indicate that gains and losses in connection with imbalance settlement, non-government contracts for difference (including virtual corporate PPAs), financial derivatives in relation to hedging power prices and BM actions will be taken into account in determining the amount realised from relevant generation output. This will be welcomed by all generators that have entered into and/or that are looking to enter into corporate power purchase agreements (back to back or synthetic) and/or electricity derivatives. Please see our comments below on Anti-Avoidance though.
This detail is a helpful refinement of the position set out in the original technical note and will, we suspect, be appreciated by generators. However, the draft legislation does not currently appear to expressly reflect all of these principles. The definition of generation receipts is currently very wide (arguably capturing some of the revenues referred to above) whilst the category of excluded revenues is tight.
More generally, the volume calculation principles throughout the draft legislation appear to be based from a terminology perspective on “generated” volumes, rather than export volumes (noting that there will always need to be adjustments to reflect BM bids etc.). We suspect some of this divergence is the result of inadvertent mistakes, but it is clear that the draft regulations have been produced under time pressure and would benefit from refinement, along with supplemental guidance documents and ancillary regulations being published.
Private Wire Volumes
The supplemental note states that the Levy will “not apply to electricity generated and used under a private wire arrangement or behind the meter generation that is not exported”, with the relevant measure of output being metered output exported to the grid within the relevant period, subject to some adjustments for line losses, BM bids and other matters.
Again, this is a positive refinement of the position set out in the original technical note, but the draft legislation does not reflect these principles. The relevant section of the draft legislation which defines “Grid connected electricity generation”, when combined with the definition of “distribution system” and “transmission system” in Part 1 of the Electricity Act 1989, could, in our view, result in any electricity generated and distributed along any distribution system forming part of the attributable generation volumes, rather than just volumes which are generated for the purpose of giving a supply where the supply involves the use of a distribution system operated by a licensed distribution network operator or a transmission system operated by a licensed transmission network operator.
Fuel Costs
Fuelled generating stations caught by the Levy (primarily biomass, but also AD) should be able to deduct from their generation receipts exceptional fuel costs. These will be calculated by reference to a baseline fuel cost of whatever is lower - £65/MWh (not indexed) or the fuel costs (£/MWh) over a period of at least 12 months between 01 January 2017 and 01 March 2020 (with additional detail being included in the draft legislation). Fuel costs in excess of the baseline (calculated using the total fuel cost in the relevant period divided by the relevant volume of electricity generated during the relevant period (potentially not taking into account the effect of accepted BM bids) minus the baseline fuel cost) being permitted to be deducted from the generation receipts for the applicable qualifying period. Fuel costs can potentially include the cost of acquiring the fuel and the cost of transporting such fuel (but it does not appear that the cost of fuel storage will be taken into account).
Landfill gas generators and potentially other affected fuelled generators, will be able to deduct from their generation receipts certain exceptional revenue sharing costs for access to fuel. The example given in the supplemental note is landfill gas generators paying a third party, for access to landfill gas, payments calculated by reference to the wholesale price of electricity / the price received by the relevant generator for generation.
Other Allowable costs
The draft legislation indicates that the Treasury may publish additional regulations setting out other types of allowable cost that are permitted to be deducted from generation receipts.
Excluded Generators
The volume threshold (below which generators are not subject to the Levy) has been reduced from 100GWh to 50GWh per 12 month period (pro-rated for shorter periods). This 50GWh limit applies across corporate groups (please see the corporate groups section below). The stated rationale for the reduction from 100GWh to 50GWh is to reduce the risk that generators are incentivised to stop generating to avoid the Levy applying to them. As before, once a generator / group exceeds the 50GWh volume, all generation volumes and revenues are taken into account in determining extraordinary returns.
The Levy will not apply to the sale by a generator of electricity that is generated whilst there is a live CfD or investment contract in place between that generator and Low Carbon Contracts Company Limited. As anticipated by many though, the Levy will apply to the generation receipts of those that are party to a LCCC CfD prior to the time that their strike price commences (i.e. the merchant nose).
The supplemental note indicates that the Levy is not intended to apply to storage assets (pumped storage, innovative storage technologies, battery storage etc.) or gas, oil and coal generating assets. Conversely, it does bite on subsidy free renewables (whether in existence now or in the future) which will upset many given increased construction costs, significantly reduced upside and no-downside protection for such assets. The draft legislation partially reflects this, but does not seem to exclude storage assets (we suspect this is a mistake) and given the drafting, also results in diesel gensets potentially being a “relevant” generating station. We think the draft legislation will need to be updated to reflect, at a minimum, the exclusion of non-pumped hydro storage.
Corporate Groups, JVs and Minority Shareholdings
The draft legislation and the supplemental note indicate that for the purposes of the Levy, the corporate group analysis will look at a company that is not a 75% subsidiary of any other company and then all of that company’s 75% subsidiaries and the 75% subsidiaries of such subsidiaries etc.
The supplemental note and the draft legislation include principles in relation to the allocation of energy generator liabilities between a majority and minority shareholders of members within a corporate group.
The draft legislation also introduces detailed principles in relation to the allocation of generation revenues to partnerships, minority shareholders and separately joint venture parties in various circumstances.
Generators, funds and limited recourse funders will want to look at these principles closely, consider how it affects their overall generator liability level position and potentially obtain tax advice in relation to the position and the allocation of tax liabilities.
Implementation
The supplemental note and the draft legislation indicate that the generator Levy will incorporate the existing corporation tax rules for tax administration.
This includes principles in relation to self-assessment, penalties and payment of the Levy (annually or instalments contingent on whether the undertaking is or is not (for corporation tax purposes) a large company, a very large company or another classification of company).
One difference though is that within a corporate group which exceeds the 50GWh threshold, one entity within the group, the “lead member”, will be responsible for payment of the Levy in respect of all exceptional revenues accrued by any members of the group, but with nomination rights for another member of the group to be responsible for paying the Levy in various circumstances. Further regulations and details are expected to be published setting out how this procedure will work.
All members within a generator undertaking that is a group will though be jointly and severely liable for any Levy amount payable by the “lead member”.
Anti-Avoidance
The draft legislation includes a comprehensive anti-avoidance section. The drafting reflects equivalent principles in other tax legislation, with the wording being familiar to many tax lawyers and accountants. Given that the generator Levy is not a behavioural tax though, the section means that generators will need to think carefully before implementing (and be able to commercially justify), for instance, any corporate restructuring, mirror CfDs and/or Behind the Meter supply arrangements that were not already in existence prior to the publication of the draft legislation.
Next Steps
The Government intends to introduce the draft legislation as part of the next Finance Bill, with HMRC issuing draft guidance for taxpayers early in 2023. The key policy decisions will not be revisited apparently, but the Government has stated that it will continue to consider the rules for a small number of identified areas such as the treatment of qualifying joint ventures. Anybody with questions about HMRC’s expectations of taxpayers and/or observations about the draft legislation should get in touch with HMRC using the following email address: egl@hmrc.gov.uk.
Burges Salmon has been sitting on the industry groups looking at these emergency measures as they emerge from Government and is already considering the ramifications of these announcements on a wide range of contracts. If you would like to discuss any of the above get in touch with Ross Fairley or Alec Whiter.