New tax rules relating to e.g. activities in the economic zone and tax depreciation for hydrocarbon facilities

On 1 June 2023, the Danish Parliament adopted amendments to several tax acts. These amendments mainly resulted in i) introduction of limited tax liability when carrying out certain activities in Denmark's exclusive economic zone, ii) regulation of tax depreciation and deduction for operating costs when using hydrocarbon facilities for CO2 storage, and iii) deduction for removal costs when using hydrocarbon facilities for CO2 storage. The law changes mentioned as i) will enter into force on 1 July 2023, whereas the changes mentioned as ii) and iii) will enter into force on 1 January 2024.

The law changes relate to the "Climate Agreement for Energy and Industry etc." from June 2020 and the subsequent supplementary agreements entered by several of the political parties in Denmark. These agreements were entered in order to develop, expand and integrate green technologies in the energy sector and industry including establishment of facilities for the capture and storage of CO2 in the North Sea.

A planned energy island, offshore wind farms, and the planned CO2 storage sites in the North Sea are all outside the sea border (12 nautical miles from the Danish coast) but within the Danish exclusive economic zone, which is up to 200 nautical miles from the Danish coast.

The new law expands the rules on limited tax liability for entities and individuals involved in establishment, operation and use of artificial islands, installations and facilities located on the Danish continental shelf outside the sea border limit, within the Danish exclusive economic zone. These are, for example, activities related to the establishment and operation of offshore wind farms, work on the upcoming energy island and the storage of CO2 in hydrocarbon facilities but also work related to pipelines and cables.

For entities and individuals these activities within the Danish exclusive economic zone can create a permanent establishment. Foreign individuals working at such establishments, operations and on such artificial islands, installations and facilities will be limited tax liable to Denmark if employed by a Danish entity, an entity with a permanent establishment in Denmark or employed by a foreign entity but the individual within a 12-month period has been in Danish territory (within the sea border) for more than 183 days. Furthermore, a foreign individual recognized as hired-out labour will also be taxable in Denmark when engaging in the mentioned activities.

The new rules described are not relevant for entities and individuals if the activities relate to establishing and use of underwater cables and pipelines which are exclusively used for transit through Denmark's exclusive economic zone. These activities will still not be taxable in Denmark.

The purpose of these new rules is to make it more attractive for entities to initiate CO2 storage activities. This is based on the UN's Intergovernmental Panel on Climate Change, the International Energy Agency and the Danish Council on Climate Change that all have assessed that carbon capture and storage is a key instrument for mitigating climate change, and that the Danish underground is particularly suitable for storing CO2.

Entities involved in hydrocarbon extraction are paying corporate income tax but also hydrocarbon tax. Revenue from CO2 storage is only taxed with corporate income tax.

The new rules ensure that an entity's possibility to depreciate assets in the calculation of the income taxed under the Hydrocarbon Tax Act is not negatively affected when partly engaging in CO2 storage. Going forward, when facilities build for hydrocarbon extraction are partly used for CO2 storage, all depreciations can generally be made in the income taxed under the Hydrocarbon Tax Act even though mixed use will normally result in only partly depreciations under the Hydrocarbon Tax Act. In some situations, full depreciation is even possible on improvements of assets while used for CO2 storage.

The effect will be that entities will be able to commence CO2 storage activities without losing the higher tax value of depreciation under hydrocarbon tax compared to the tax value under corporate income tax. Once the facility is exclusively used for CO2 storage, the depreciation will only affect the corporate income tax.

Deduction of expenses relevant for the CO2 storage including maintenance of the depreciable facilities can only be made in the corporate income tax unless the taxable entity is able to substantiate that the costs would have been held even though the entity had not commenced with CO2 storage. Only in the latter case may the expenses be deducted in the income taxed under the Hydrocarbon Tax Act.

Generally, hydrocarbon entities have an obligation to ensure the decommissioning of facilities that have outlived their purpose. However, it is expected that as part of the approval process for CO2 storage in the North Sea, entities will be given permission to uphold facilities that will be used in connection with the storage of CO2.

When calculating the taxable income, deductions can be made for costs on the removal of facilities. This is the case when calculating the corporate income tax but also the hydrocarbon tax if the facilities have been used for hydrocarbon extraction. The deduction when calculating the hydrocarbon tax can even be made after the activity has ceased. However, this is not the case if the facilities are built and used for processing third party's hydrocarbon.

In addition, a carry back scheme also applies according to the Hydrocarbon Tax Act, which means that if an unutilised loss remains at the final termination of the hydrocarbon extraction business, the taxpayer can receive a payment equal to the tax value of the part of the unutilised loss that relates to the deductions for removal costs. There is a cap on these payments which equals the total hydrocarbon tax paid.

The new rules mean that entities liable for hydrocarbon tax that conclusively end their hydrocarbon extraction but commence with CO2 storage are given the same opportunity to make deductions for removal costs and also use the carry back scheme, however, with some modifications.

Entities that commence with CO2 storage and remove all facilities that are not used for this purpose, will be able to deduct the costs on the removal of the installations no longer used and apply the carry back scheme according to the Hydrocarbon Tax Act.

Entities that use all the facilities for CO2 storage and later removes all the facilities after end use, will also be able to deduct the costs on the removal of the facilities and apply the carry back scheme according to the Hydrocarbon Tax Act at this later point.

However, the possibility to use the carry back scheme will be phased out through a 20-year period as the amount to be received is lowered by 5% for each year‑end. The 20 years are calculated from the first time when the carry back scheme could be used. Furthermore, the 20 years are calculated from the time when the hydrocarbon extraction conclusively ended if all the facilities were kept for the use of CO2 storage and the carry back scheme could not previously be used. As an example, if the 20 years are calculated from 2030 and the removal of the facilities are ended during 2031 or 2032, but before the year end of 2032, a 5% reduction in the payable amount is relevant.

The new rules means that in some cases the carry back scheme can be used twice – once when hydrocarbon extraction has conclusively ended and not all facilities are used for CO2 storage, and then again when the CO2 storage ends, and the facilities are finally removed.