The Evolution of the Tax Framework for Mining in Kazakhstan
Roza Kinchinbayeva, Partner, MinTax consulting company
On 1 January 2002 the new Tax Code1 was enacted, which was an important development for Kazakh tax law. This act was drafted by a team of prominent Kazakh tax professionals who managed to provide a solution to a range of problems that had built up under the former Act On Taxes2. At the same time, like any other act, the new Tax Code brought with it some issues that will need to be addressed in the near future.
1. The Code of the Republic of Kazakhstan On Taxes and Other Compulsory Contributions of 12 June 2001; hereinafter Tax Code.
2. Presidential Decree having the force of law On Taxes and Other Compulsory Contributions; hereinafter Act On Taxes.
This article attempts to analyse the impact of the new Tax Code and its ancillary regulations on mining in Kazakhstan and other related questions.
The Development of the Core Tax Framework for Mining
The Tax Code was intended to be an integrated body of law governing the entire relationship of the taxpayer and the state, including the calculation and payment of all taxes or other statutory contributions. Whereas the Act On Taxes was principally separate from other law, particularly civil law, the Tax Code embodies a vast legal background of fiscal functions and therefore upgrades Kazakhstan's tax system to a new level, a development that is expected to facilitate growth in production and state budget revenue.
The Tax Code has readopted the taxation philosophy for mining that had been laid down by the former national tax law and is supported internationally. Its underlying principles are:
· the incorporation of terms of taxation in the mining contract;
· preserving agreed taxation terms and the balance of interests of the contractor and the government throughout the contract period;
· imposing customised royalties apart from normal taxation;
· tax demarcation, that is, separate taxation of income and expenditure related to mining and those related to other operations;
· imposing separate models for calculating income tax and VAT pursuant to mining terms and conditions.
In addition, the Tax Code has incorporated a number of modifications and new provisions.
For the first time the Tax Code has come to regulate the taxation of entities that undertake mining without any mining contract. As per Article 281, those involved in mining without a mining contract are subject to royalty at a rate as may be decided by the Kazakh Government, the eligibility and payment time being pursuant to the Tax Code.
Another new provision demands that any amendments to the tax law enforced since the completion of the tax assessment be reflected in the tax provisions of a contract before it is signed. Although this provision necessitates the revision of any taxation terms that had been agreed during tax assessment, it removes any potential lack of clarity regarding the validity of contract terms.
The Tax Code effectively makes defunct the practice of agreeing all contract terms by the parties, which used to be a core principle. Namely, Article 286 stipulates that a taxation scheme that may be developed based on tax assessment must be included in the contract without any amendments, whereas the former Act On Taxes provided for the inclusion of an agreed taxation scheme.
In our view, one of the weaknesses of the new tax law is that it falls short of any provisions for the stability of taxation terms for mining contracts. The only mention of the stability, albeit indirect, is in Article 285, which sets forth the following:
1. Any amendments to the contract tax scheme to mutual agreement of the parties may be incorporated only following changes in the tax law. Formerly, amending the tax scheme by the parties to their mutual agreement was permitted at any time regardless of change of the lax law.
2. If the tax law changes in favour of the contractor's interests, the tax scheme under the contract must be amended so as to restore the economic interests of the state.
3. If any taxes are abolished, the contractor must continue paying the same until the contract is duly amended.
All these developments appear expressly one-sided, i.e. protecting only the interests of the state, whereas a contract is a bilateral document meant to uphold the balance of interests.
In general, the exclusion of stability provisions from the tax law may adversely affect the new mining contracts to be signed, as well as existing ones. It implies certain risks for all mining companies, as the government may at any time initiate the revision of taxation terms concerning mining contracts.
Similarly, problems for contractors may be caused by the absence from the Tax Code of a provision for transferring a tax scheme from an existing contract to a new one. This is particularly relevant for production contracts that follow on from fulfilled contracts for exploration. Since the contractor's exploration costs are normally compensated for by income in the production phase, they should be taken into account while levying corporate income tax and any excess profit tax under a production contract.
Changes in Taxation Scheme Models and the Abolition of Historic Costs
The Tax Code envisages the preservation of the first and the second tax scheme models for mining contracts. Only minor amendments have been made to the list of taxes for the first or the second model.
Whereas the former law incorporated a list of taxes payable under the second tax scheme model, the new Tax Code specifies taxes that are not to be levied. This change has no significant impact, but implies that the second model embraces such taxes and fees as a tax on vehicles, a fee for chattel mortgage registration, a fee for the state registration of radio-electronic and high-frequency equipment, fees for state registration of vehicles, sea and river vessels and aircraft, a fee for car passage through the territory of Kazakhstan, etc.
Despite a material increase in the number of payable taxes and fees, many of them are negligible in fact or classed as "charges for services by governmental bodies", and as such cannot be eliminated for administrative reasons.
An important development aimed at improving the investment climate is that the new tax law no longer provides for the reimbursement of historic costs. Moreover, Paragraph 2, Article 2 of the Tax Code stipulates that no taxpayer may be forced to pay any taxes or fees other than those imposed by the Tax Code.
However, it should be noted that amending the tax law alone does not eliminate obligations regarding historic costs. For this practice to be discontinued completely, any acts containing provisions for the reimbursement of historic costs should be abolished.
In addition, it is deemed fair that the "unlawful payment" that has never been stipulated by any law be cancelled for previously concluded contracts.
Kazakhstan's Share in Production Sharing Agreements
For the first time the Tax Code sets out the procedure for determining and payment of Kazakhstan's share of production, whilst formerly these issues were exclusively the matter of parties' agreement. The principles incorporated in the Tax Code are compatible with international and Kazakh practice of production sharing.
However, some restrictions relating to recoverability of costs appear to be unfair. For example, since contractor's spending on transportation and sales of his production is part of his direct costs related to generating income and product pricing, it should be included in recoverable costs.
The exclusion from recoverable costs of spending on audit and arbitration, and payable interest on credit, is also deemed unfair. As for the latter, the maximum restriction should be the ban on inclusion in recoverable costs of interest on credit payable by the parent company, as well as sums by which the limit is exceeded while calculating corporate income tax.
Change in the Procedure for Establishing a Commercial Discovery Bonus and Its Rate
The Tax Code partially amends the procedure for establishing a commercial discovery bonus, and doubles its minimum rate. Whereas formerly a commercial discovery bonus could be stated as a fixed amount or percentage of the estimated value of recoverable reserves in the contracted area being explored, the new tax law permits only the latter option. Raising the rate of the bonus can also hardly be called a measure that improves the country's investment image.
Change in the Procedure for Calculating Royalties
The Tax Code introduces a uniform method of calculating royalties for all minerals, which definitely represents a positive development. For example, whilst formerly transportation costs could be excluded from the royalty subject only for hydrocarbons and generally found minerals, this now applies to solid minerals except gold, silver and platinum.
In addition, an indirect conflict is eliminated that existed between the Act On Taxes and governmental Resolution #1330 of 12 September 1997 regarding the determination of the royalty subject. The Tax Code defines the royalty subject under a contract as either the quantity of minerals produced or the first commercial product. This provision is critical for contractors producing solid minerals, as they are entitled to calculate royalty based on the amount of concentrate or minerals after pre-processing.
Setting the minimum royalty rate of less than 0.5% for all minerals, in our view, appears well-grounded and unlikely to bring about any negative impact. An overview of contracts concluded in Kazakhstan suggests that a royalty rate of 0.5% is rather unusual.
Potential Difficulties in Calculating Excess Profit Tax
The procedure for calculating excess profit tax has remained generally intact. However, the formula for the internal rate of return has been amended slightly in the Tax Code, which may entail negligible losses for the state.
In addition, there is a question that some contractors might have faced by this time, and which has never been answered by Kazakhstan's tax law. In some cases a contractor might have positive cash flows as early as the first year of the contract. Under such circumstances, an internal rate of return, which provides the basis for calculating the tax rate, is simply not calculated.
This problem might arise, particularly in deposits where exploration and the necessary construction were completed prior to signing the contract. In such a case, it is deemed fair to allow the contractor to add the depreciated cost of fixed assets (as of the date of signing the contract) to the negative cash flow of the first year.
In order to improve tax administration, new forms for tax reporting were introduced in Kazakhstan on 1 January 2002, simultaneously with the Tax Code. These forms allow the control of taxpaying to be completely automated.
However, these forms are not always applicable to contracts that have been concluded before 1 January 2002, since they are designed to comply with the tax calculation techniques of the new Tax Code.
One of the remedial options is to develop, if necessary, individual recommendations on filling the new forms for each mining contract, taking into account the tax calculation procedures incorporated in such contracts.
Issues that Need to be Addressed
Finally, there are some issues related to improving the taxation of mining.
1. In our opinion, contractors that produce exclusively generally found minerals should be classed as a separate group, and be set the following taxation terms:
A fixed subscription bonus rate;
Fixed royalty rates, as is current practice,
All other taxes levied on such contractors should be calculated as per current laws, i.e. the laws that are in force at the time of levying taxes.
This will allow those companies for which generally found minerals are the source of raw materials to introduce unified tax accounting for all their operations. Accordingly, contract-making and tax assessment in situ by tax authorities will be simplified, and disputes will preclude whether the mining-related income is to be taxed as per current laws or the laws that were in force when the contract was signed.
2. Introducing flat royalty rates based on the average contract figures for each particular mineral would represent another incentive for investing in the exploration and production of solid minerals. Assuming the equal technical capacities of companies bidding for a contract, the proposal containing the highest subscription bonus should be chosen.
3. Tax demarcation still represents a major problem for mining companies. Of course, the complete abolition of tax demarcation would be too early a step, in the light of the taxation philosophy implicit in the Tax Code. However, some modifications might be necessary in order to make mining projects more attractive for investment, which is especially critical for solid minerals.
We maintain that there should be no tax demarcation within an entity having more than one mining contract for the same mineral. The only exclusion may be an excess profit tax and royalty. This provision would simplify tax administration considerably and reduce the workload of local tax authorities and the companies' personnel handling tax issues.
Furthermore, tax demarcation should be eliminated from combined projects for the mining and processing of minerals by a single company, for example, the development of a gold mine and launching a facility for extracting gold from ore. At present this restriction is hampering growth in the processing industry, which is one of the goals of the national development programme approved by the President and the Government.
4. The law should enable the national-level tax authorities to issue occasional instructions on tax administration procedures for selected contracts. The rationale for this proposal is that the taxation scheme for each individual contract reflects the requirements that have been applicable at the time of signing, and the longer a contract exists, the further it deviates from the tax administration provisions of the current law.
The situation is complicated in that before 1 January 1997 mining contracts incorporated international requirements that differed substantially from those of Kazakh law.
In addition, some existing contracts contain no time schedules for the payment of taxes or the submission of tax declarations. For these cases, individual instructions on taxation schemes agreed with the contractor would be the best solution, preventing disputes which often arise during document audits of large mining companies and resulting in losses of time and money on arbitration.
We believe that solving these problems would improve the investment climate and simplify tax administration in the mining sector.
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