Oil and gas exploration and appraisal do not qualify as R&D under either SSAP 13 or Frascati, and it is specifically excluded from the general definition of R&D in the new Section 837A ICTA 1988. However, there is no specific exclusion for other activities undertaken by companies in oil and gas industries.

Within the context of an R&D project the activities that directly contribute to the achievement of an advance in science or technology through the resolution of scientific or technological uncertainty are considered to be R&D activities. R&D activities commence when work on resolving technological uncertainty begins, and end when the uncertainty is resolved or work to resolve it ceases.

The term research and development (R&D) is defined in the Income and Corporation Taxes Act. The definition is based on the accounting definition of R&D that is contained in Statement of Standard Accounting Practice (SSAP) 13, with some modifications. The accountancy definition is then modified for tax purposes by the R&D Guidelines issued by the Department of Trade and Industry (“DTI”), which are given legal force by Parliamentary Regulations. The definition recognizes three categories of R&D; pure (basic) research, applied research and experimental development.

In order to determine whether a specific project meets the definition of R&D the project must exhibit certain characteristics. In general, R&D projects attempt to achieve an advance in science and technology through the resolution of technological uncertainty.

A project that seeks to extend overall knowledge or capability in a field of science or technology would be an R&D project. A project that involves the creation or appreciable improvement to an existing process, material, device, product or service would also be considered R&D as long as, where something new is being created, the new thing incorporates or represent an improvement in science or technology, or where an appreciable improvement occurs, that improvement is made through scientific or technological changes.

Usually the boundary between oil and gas exploration and appraisal, and other R&D activites undertaken by oil and gas companies is fairly easy to determine. Work that meets the criteria of technological uncertainty and technological advancement is likely to be carried out for the development and testing of new and improved techniques and processes, not for the purpose of exploration and appraisal. Similarly work that is carried out for the purpose of exploration and appraisal is likely to use techniques and processes that are standard practice in the industry and therefore do not involve technological uncertainty and technological advancement.

Field pilots and output from testing done to verify technological advancement in oil & gas industries are essentially treated in the same manner as pilot plants in other industries. Field pilots will generally be non-commercial scale facilities in which new and improved processes are systematically investigated under conditions simulating full production. Construction and operation of a field pilot plant is eligible experimental development provided the principal purpose is to obtain engineering and other data on applications, conditions, interactions, relationships, equipment, environmental effects etc. for evaluation and development of the process.

Experimental development of equipment or processes in oil & gas industries may also require development and testing in commercial field facilities. R&D treatment of costs related to production output from tests in commercial or pilot facilities is dependent on whether the output is sold and whether or not such sales constitute ineligible commercial activity. Factors that will determine commercial activity in the oil & gas industry include production levels and the number of wells involved. Commercial activity decisions and R&D cost allocations are determined on a case by case basis.

In evaluating whether a project would consitute R&D consider the following seven projects as examples. Key questions addressed in the examples are:

• Does the work satisfy the criteria of technological uncertainty and technological advancement?
• Is the testing carried out in a field pilot or a commercial facility?
• Was the work undertaken for the purpose of exploring or appraising?

Example 1

A company developed an in situ cyclic steam stimulation process for oil recovery from oil sands. The test facility was a field pilot because it is not of commercial scale and its primary purpose was to investigate and develop the cyclic steam stimulation process. A limited number of injection, production, temperature monitoring, water source and water disposal wells were performed. These were considered to be part of the research facility. Factors that were investigated included inter-well communication and interaction, heat and pressure distribution, heat sinks, vertical fracture formation, steam placement, shale breaks, steam rates, steam and water volumes, foam sealants, and formation heaving. All of the work in this example satisfies the uncertainty and advancement criteria. This project is considered to be R&D as the project did not fall under the exploration or appraisal exclusions and because the primary purpose was process development.

Example 2

A company performs an unsuccessful multi-year investigation of the viability of a novel steam drive technique for enhanced oil recovery. Oil recovery during the course of the project was minimal. The test facility is a field pilot because it was not of commercial scale, oil recovery was minimal, and its primary purpose was to investigate and develop the steam drive process. Core activities were related to horizontal steam drive, producing vertical, steam injector slant and vertical, temperature observation and water disposal wells and to seismic work on the aforementioned wells. All activity satisfied the criteria of technological uncertainty and advancement. The primary objective of the project was to investigate the novel steam drive process, not to undertake exploration or appraisal. This work would be considered to be R&D.

Example 3

A company develops a process for re-entering existing vertical wells to convert them to horizontal wells. The project involves the development of cutting tools, a cutting process, and drilling equipment to effect the re-entry and horizontal well conversion. These activities are considered to be R&D because they satisfy the technological uncertainty and advancement criteria.

The Strategy

Where the boundary between eligible and ineligible work is not obvious, a careful analysis of the rules are required. Where the claimant can make a case for eligible work, the work should be claimed.

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