In 2009-2011 Fortis Petroleum Norway AS (FPN) bought seismic data related to oil exploration in the North Sea from a related party, Petroleum GeoServices AS (PGS), for NKR 95.000.000. FBN paid the amount by way of a convertible intra-group loan from PGS in the same amount. FPN also purchased administrative services from another related party, Consema, and later paid a substantial termination fee when the service contract was terminated. The acquisition costs, interest on the loan, costs for services and termination fees had all been deducted in the taxable income of the company for the years in question.
Central to this case is the exploration refund scheme on the Norwegian shelf. This essentially means that exploration companies can demand cash payment of the tax value of exploration costs, cf. the Petroleum Tax Act § 3 letter c) fifth paragraph. If the taxpayer does not have income to cover an exploration cost, the company receives payment / refund of the tax value from the state.
On 21 November 2018, the Petroleum Tax Office issued two decisions against FPN. One decision (the “Seismic decision”) which applied to the income years 2010 to 2011, where FPN was denied a deduction for the purchase of seismic services from PGS and interest on the associated seller credit, as well as ordinary and increased additional tax (hereinafter the «seismic decision»), and another decision (the “Consema decision”) which applied to the income years 2011 and 2012 where, FPN’s claim for deduction for the purchase of administrative services from Consema for the income years 2011 and 2012 was reduced at its discretion, and where FPN was also denied a deduction for the costs of the services and a deduction for termination fees. Finally in regards of the “Seismic decision” an increased additional tax of a total of 60 per cent, was added to the additional taxation on the basis of the incorrectly deducted seismic purchases as FPN had provided incorrect and incomplete information to the Oil Tax Office.
In the “Seismic decision” the tax office argued that FPN used a exploration reimbursement scheme to run a “tax carousel”
In the “Consema decision” the tax office found that the price paid for the intra-group services and the termination fee had not been determined at arm’s length.
An appeal was filed by Fortis Petroleum Norway AS with the district court where, in December 2020, the case was decided in favour of the tax authorities.
An appeal was then filed with the Court of Appel
Judgement of the Court of Appeal
The court upheld the decisions of the district court and decided in favour of the tax authorities.
The Court concluded that the condition for deduction in the Tax Act § 6-1 on incurred costs on the part of Fortis Petroleum Norway AS was not met, and that there was a basis for imposing ordinary and increased additional tax.
The Court of Appeal further found that the administrative services and the termination fee were controlled transactions and had not been priced at arm’s length.
Excerpts
– Regarding the acquisition of seismic exploration
Based on the case’s extensive evidence, and especially the contemporary evidence, the Court of Appeal has found that there was a common subjective understanding between FPN and PGS, both at the planning stage, during the conclusion of the agreement, in carrying out the seismic purchases and in the subsequent process. should take place by conversion to a subscription price that was not market-based. Consequently, seismic would not be settled with real values. This was made possible through the common interest of the parties. The parties also never significantly distanced themselves from this agreement. The Court of Appeal has heard testimonies from the management of PGS and FPN, but can not see that these entail any other view on the question of what was agreed.
The loan was never repaid, and in the end it was converted to the pre-agreed exchange rate of NOK 167. In the Court of Appeal’s view, there is no other rational explanation for this course than that it was carefully adapted to the financing through 78 per cent of the exploration refund. The share value at the time of conversion was down to zero. The Court of Appeal agrees with the state that all conversion prices between 167 and 0 kroner would have given a share price that reflected the value in FPN better and which consequently had given PGS a better settlement.
On this basis, the Court of Appeal believes that the conversion rate did not cover the 22 percent, and that there was a common perception that this was in line with the purpose of the establishment of FPN, namely not to pay “a penny” of fresh capital.
The Court of Appeal has also emphasized that the same thing that happened in 2009 was repeated in 2010 and 2011. For 2009, the Oil Tax Office came to the conclusion that it was a pro forma event and a shift in financial risk. In 2010 and 2011, the same actors used the same structure and procedure to finance all costs from the state.
It is thus the Court of Appeal’s view that there was a common understanding between the parties to the agreement that the real relationship within was different from that which was signaled to the tax authorities regarding sacrifice and which provided the basis for the deduction.
Furthermore, in the Court of Appeal’s view, the loan transactions were not fiscally neutral. The seismic purchases constituted the only source of liquidity and were covered in their entirety by the state. In light of ESA’s decision from 2018 as an element of interpretation, such a loss of fiscal neutrality would indicate that when the company has thus not borne any risk itself, sacrifice has not taken place either.
Even if the debt had been real, assuming a sale without a common interest of the parties, in the Court of Appeal’s view in a tax context it could not be decisive, as long as 22 per cent was not intended to be settled between PGS and FPN.
The Court of Appeal does not agree that there is a requirement that the private agreement was entered into between legitimate persons. The question is the common understanding between the parties. In any case, the N7 was legitimized in PGS. He entered into other agreements on behalf of PGS.
After this, the seismic decision is considered valid, and the appeal is rejected.
– Regarding services from Consema:
“The Tax Act § 54 which was assessed in the Court of Appeal’s judgment corresponds to the current Tax Act § 13-1 The precondition for using the CUP method is that there is a relevant basis for comparison, which the Oil Tax Office could not see existed in this case. Now that the Oil Tax Office has chosen the cost-plus method or the TNMM method, this was because Consema did not have independent customers with whom it was possible to compare prices. There were also no sufficient comparable prices from other suppliers that were set under similar circumstances. The court cannot see that it has been substantiated by the plaintiff that the Oil Tax Office has used the wrong method in this case.
Nor can the court see that the starting point is an incorrect factual basis when emphasis has been placed on the special relationship that existed between FPN, Consema and EPH. It is clear that the chairman of the board of Consema, N1 , had or had had central roles in all three companies. After N1 left FPN and FPC, he still represented the shareholder Consema. All Consema’s customers, including FPC and their subsidiaries, were part of the same sphere of common interest. These customers also had in common that they all had a weak financial position, had demanded an exploration refund from the state and had also been denied a tax deduction and exploration refund.
The Court of Appeal agrees that FPN’s desired pricing method (CUP method) can only be used if in the specific case it is at least as equally reliable («equally reliable manner») as other methods, cf. OECD Guidelines (2010) section 2.3. The CUP method presupposes that a relevant basis for comparison is found, cf. the guidelines in section 2.14. A relevant basis for comparison is missing in the case here and has not been the subject of evidence in court. Consema had no external customers to compare with. The business was aimed exclusively at customers who had a common interest
Consema. There are also no sufficiently comparable hourly rates from other suppliers determined under similar circumstances.
In all cases, there was a special relationship between Consema and EPH through N1.N1 had a key role in Consema, EPH and FPN. All Consema’s customers were within the sphere of common interest. The customers had in common that they demanded an exploration refund, that they had a weak financial position, and that they could not pay Consema without the exploration refund. The agreement between Consema and FPC was entered into at about the same time as N1 resigned from the board of FPN.
The Court of Appeal believes that it is very uncertain whether services were provided to such an extent as alleged. [text omitted]”
– Regarding the termination fee paid to Consema:
“The Court of Appeal agrees with the district court’s presentation and cannot see that the presentation of evidence during the appeal proceedings puts the case in any other light. Furthermore, special mention is made of:
It follows, first of all, from statutory allocation principles that the deduction can only be claimed by a person who is bound by private law. There is no agreement on re-billing from FPC to FPN and no other evidence explaining such re-billing. To the extent that in the tax sense there was an obligation to pay the termination fee, it was therefore with FPC, and not with FPN. Any deduction would then have to be allocated to FPC, and not FPN. In the Court of Appeal’s view, the conclusion is that the appellant cannot deduct the termination fee.
The framework agreement’s provision on a three-year lock-in period has also been disregarded in accordance with section 13-1 of the Tax Act, cf. the OECD guidelines section 1.65 on structural adjustment. This has been thoroughly assessed in the decision, and the Court of Appeal agrees with this assessment. The Court of Appeal agrees with the State that independent parties would not have committed to a three-year agreement in the relevant circumstances, as there was no commercially rational basis for it. No consideration was agreed to FPN. When FPN also lacked the financial ability to service the agreement, it was not rational to commit for three years.In any case, in view of the common interest of the parties, there was no reason to fear that the expiry of the lock-in period would lead to the loss of Consema as a supplier.
In the Court of Appeal’s view, the one-off remuneration was also not in a reasonable proportion to a lost profit, based on correct pricing. This is, as the Court of Appeal has been informed, 324 times as high as Consema’s expected profit in the remaining contract period, with pricing based on 2011 figures. It has not been documented that Consema incurred any costs as a result of the early termination.
[text omitted] The Court of Appeal has built on a different legal basis, which leads to the same result, but also agrees with the assessment made by the district court.
The appellant has also stated that the payment of the termination fee was not a consequence of the common interest of the parties, but was due to disagreement between the shareholders. The Court of Appeal has not found any evidentiary coverage for this and points out that the binding period of three years in the framework agreement was agreed before there was apparently a disagreement between the shareholders.
In summary, the Court of Appeal cannot see that the decision is invalid and the appeal is rejected.”
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Facts suggest that FPN received services from Accepta AS after termination of the Consema agreement.
This would mean that services were necessary. The decision refers to margin on cost earned by Consema and Accepta AS but does not provide any information on the price for services paid by FPN to Accepta and Consema. Whether the CUP could have been used as claimed by the taxpayer?