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 KAZAKHSTAN №5, 2016
 LAW AND SUBSOIL USE. How to structure a deal

LAW AND SUBSOIL USE. How to structure a deal

When agreeing on the sale of the assets, both parties to a deal/transaction are interested in drafting it as quickest as possible and with minimal risk to the buyer and the seller. The details to be considered in structuring the transactions with the subsoil use objects in Kazakhstan are discussed with the Partner of Grata law firm Almat Daumov.

Structuring the sales assets in the area of subsoil use requires a series of tests to optimize transactions (optimal income taxation for the transaction, minimum number of approvals and permits from the state authorities, etc.). This article describes some of the most common types of transactions on alienating such assets and contains a case study on the necessity of obtaining waivers from the priority right to purchase and approval for transaction from a competent authority in the area of natural resources. In doing so, we will not review the antitrust issues, such as the consent for an economic concentration and others.

To begin, let’s give the examples of three most common types of transactions.

Purchase and sale of subsoil use right through the reissuing of subsoil use contract with the seller (current subsoil user) to the buyer (new subsoil user). This option is often used when the buyer does not wish to acquire a stake in a legal entity- subsoil user and to accept the potential risks (errors, violation of the law and others, in addition to violations under the contract) related to previous activities of the subsoil user. At the same time, this option has its drawbacks. Firstly, the sale of subsoil use right is a turnover, subject to VAT. Accordingly, there is a rise in the price of the transaction for 12%. Subsequently, the buyer offsets the VAT and reimburses it against the VAT amounts, arising on its future sales turnover, but anyway, this creates a tax burden on the parties at the stage of the transaction.  

Secondly, in addition to the standard permits and approvals from the state authorities, the purchase and sale of subsoil use right would require an addendum to the contract according to which the current subsoil user (seller of rights) will be replaced by a new subsoil user (buyer). Although this supplement consists of one or two paragraphs and, in fact, it does not contain no new rights and obligations of the parties to the contract for subsurface use, coordination and signing of such a simple document would take additional time and often delaying the closing of the transaction. Moreover, in some cases, public authorities may insist on the inclusion in a contract of additional obligations of the subsoil users, establishing penalties for failure to perform the contractual obligations (if such sanctions were not stipulated by a contract), etc., which can also extend the approval term for such additions.

Thirdly, the subsoil users usually have several licenses and permits, required to implement their activities in the field development. Obtaining such licences and permits will take some time for the new company (one month or more), and during this period, new subsoil user need to somehow continue the operational activity, since the suspension of operations is extremely difficult and costly. There are also a number of other difficulties in the form of the transfer of the State re-registration of land and other real property. Of course, in practice, there are legal ways to resolve these difficulties, but in any case, a bureaucratic component of the considered options will be much higher than in any of the following ones.

Fourthly, the presence of outstanding obligations under a transferred contract for subsurface use might create the obstacles to its re-registration or become the base for the competent authority to require increasing obligations of subsoil users when negotiating the relevant addendum to the contract.

Purchase and sale of participation share (shares) in the subsoil user. It is one of the most common options, since this case does not require paying the VAT (sales of shares to entities is not subject to VAT) and there is no necessity to sign an addendum to the contract for subsurface use. The company is purchased with the contract, necessary licenses and permits, staff and so on. In this case, as noted earlier, the buyer purchases the subsoil user’s company with all of its "history". In this case, one need to have a certain amount of confidence that the target company duly performed its contractual obligations for subsoil use, as well as the obligations imposed by the legislation of the Republic of Kazakhstan.

Purchase and sale of shares in the holding company of the subsoil user. It can be the parent company of the subsoil user or its "grandparent" through a series of intermediate companies. This option is often used when the parties, for example, want to apply the foreign law to the sale contract and/or for management of acquired asset, in conjunction with the other partners. The considered transactions are also beneficial in terms of optimal taxation, since the applicable withholding tax rate, imposed on the non-resident seller against the gains of the alienable shares/shares is 15% versus a general corporate income tax rate, amounted to 20%.


Permits and approvals

The competent authority in Kazakhstan in the area of subsoil use  for the hydrocarbons, uranium and coal is the Ministry of energy of the Republic of Kazakhstan and the Ministry of investment and development of the RoK takes charge of the solid minerals.  Depending on the version of a transaction, the specified state authorities provide the following permits and approvals:

Refusal of the State from the priority right of subsoil use right acquisition or an object that is associated with the right of subsoil use ("right of the first night"). According to the Law on mineral resources, to maintain and strengthen the resource&energy economic fundamentals of the country, the State has the priority right before any other potential buyer would purchase an object, associated with the right of subsoil use (i.e. the subsoil use contract, share in the resource or its holding company and so on). It means that if you plan to sell a  subsoil use project, then the State has so-called "right of the first night": an alienable right to purchase the asset at the pre-arranged sale conditions. In practice, the State usually waives that right, but this mechanism allows to take into account the national interests in such strategic sectors as oil&gas and mining sectors.

It should be noted that since January 11, 2015, the State priority rights are narrowed to the subsoil areas and fields which are of strategic importance. Currently, Kazakhstan has recognized 361 subsoil plot and deposits, among which 46 oil and gas, 59 uranium, 8 gold, 6 copper, 6 titanium and other structures. In the case of transactions on alienating the control over them, the State, represented by a specially established interdepartmental commissions, as well as NC KazMunayGas JSC (for the hydrocarbon projects) or NMC Tau-Ken Samruk JSC (on the mining projects) can implement its priority right and to purchase the alienated object or to abandon such a right. Therefore, obtaining a refusal is required for the objects, having a strategic value. At the same time, refusal from the priority right is always issued together with the alienation of subsoil use right or related objects.

Approval of the competent authority (Ministry of energy, or the Ministry of investment and development) to the exclusion of subsoil use right or related objects. An entity, having an intention to make such an exclusion, shall submit a statement of authorization for the transaction to the competent authority. In fact, for such transactions the competent authority shall verify:

1) No obstacles to make the transaction according to the competent authority (no encumbrance, invalidity of the contract or expiration of its validity). In practice, such obstacles sometimes include the significant violations of the subsoil use contract or significant contradictions between the competent authority and the subsoil user.

2) Issues of compliance with the requirements to ensure the national security of the country, concentration of rights under the contract and (or) concentration of operations in the area of mining, as well as the international agreements, concluded by the Republic of Kazakhstan. It should be noted that  the competent authority makes a  refusal to grant a permission on this item without giving any additional explanations.

Obtaining an approval from the competent authority is required for all of the above-mentioned three types of transactions, associated with the transition of control over the subsoil assets from the seller to the buyer (whether on strategic fields/sections of the subsoils or not), in addition to deals, related to the objects that are associated with the common minerals, as well as a number of exceptions. For example, a permission is not required if a subsoil use right is taken as a collateral, or if the subsoil use right transfer takes place within the reorganization of a legal person (under certain conditions).

Signing of the supplement to the contract for subsoil use on the change of subsoil user. As discussed above, in case the object of the transaction is the right of subsoil use (actually, the subsoil use contract), then signing of a supplement to the contract is additionally required, to ensure the replacement of one subsoil user (seller) with another (the buyer). This process is complicated by the fact that making any changes or additions to the contract for subsurface use requires several approvals to be obtained from the state authorities. In fact, a simple change of subsoil users without modifying the contractual obligations and other material terms is no exception. Moreover, when approving the simple additions on the change of subsoil users, the competent authority or authorized establishments propose to change the other provisions of the contract, such as an increase in the obligations of subsoil users. Such initiatives can sometimes create so-called deal breakers-a threat to cancel the whole deal.  

The table stipulates a summary picture of the nuances that shall be considered for  three kinds of transactions on change of control (directly or indirectly) over the right of subsoil use.

It remains to add that the above comments are just a part of a larger range of issues, arising from the structuring of transactions in the field of natural resources. Nevertheless, we hope that this review will help the readers to avoid unnecessary bureaucratic procedures or to reduce the risks of liability for "defects" of the purchased assets.


Almat Daumov

Born in 1985, Arkalyk town.

In 2000 he entered the Kazakh State Juridical Academy and graduated with honours in 2004.

Since 2003 he has been working at GRATA law firm.

Since 2005 -the Partner and Director of Tax Law of GRATA law firm; from 2009 -advising to the GRATA clients, working in the natural resources area. One of the senior partners of GRATA Russia. Member of the Chamber of Tax Consultants of the Republic of Kazakhstan.

Almat Daumov advises the clients of GRATA law firm for more than 12 years.

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