Recent Developments of Regulatory Framework of Doing Business in Kazakhstan
Aigoul Kenjebayeva is a partner with the international law firm, SALANS, Director of its Almaty office, PhD in Jurisprudence, LLM (US)
Yuliya Mitrofanskaya is a senior associate with the international law firm, SALANS, PhD in Jurisprudence and LLM (US)
The legislation regulating business in Kazakhstan is still under development. In only the 2002-2003 Parliament year, the Kazakhstan Parliament adopted nearly 100 laws. The aim of the present article is to direct the attention of the readers to certain amendments to the legislation affecting foreign investors’ choice of a business vehicle for doing business in Kazakhstan. In particular, with reference to the recently adopted Laws on Investment and on Joint Stock Companies, and to legislation regulating purchases by oil and gas and State companies, we will determine what factors should be taken into account when deciding on a legal form of representation in Kazakhstan.
Prior to 2002, we usually advised our clients to act in Kazakhstan either through a branch of a foreign company or a Kazakhstan subsidiary. The most obvious advantage of using a branch for work in Kazakhstan was mildness of Kazakhstan legislation regulating activities of foreign companies. This allows branches to effectuate payments in Kazakhstan in any currency, to freely transfer capital abroad and to reduce the total tax burden on a company. Previously, if a foreign company intended to create a Kazakhstan subsidiary, we suggested establishing either a closed joint stock company or a limited liability partnership, which were considered less-regulated business vehicles with respect to corporate governance, the registration of shareholdings and the amount of the authorized capital. At present, the legal situation has changed. As a result, investors should now consider acting through a Kazakhstan subsidiary rather than a branch of a foreign company. Concerning the selection of a form of Kazakhstan subsidiary, the legal entity known as a closed joint stock company was eliminated in May 2003, thus shortening the list of possible options open to foreign companies for a Kazakhstan subsidiary.
Branch of a Foreign Company vs. a Kazakhstan Subsidiary
In 2002-2003, Kazakhstan adopted legislation that makes carrying on business in Kazakhstan through a branch of a foreign company less attractive in comparison with carrying on business through a Kazakhstan subsidiary.
It has been an overall policy of the Kazakhstan government in recent years to support local providers of goods and services. Requirements to purchase goods and services from local providers, if such goods and services meet applicable standards, were recently strengthened by petroleum legislation, as well as by legislation regulating state purchases. A foreign company which intends to provide goods or services to oil and gas companies or State companies needs to take these requirements into consideration.
In subsoil use and petroleum legislation, the requirement to purchase goods and services from local providers, or the so-called “local content requirement”, is contained in the Petroleum Law, which provides:
When conducting operations under a Contract, a Contractor shall be obliged to:
6) mandatory use of materials and finished products produced in the Republic of Kazakhstan, if they meet the standards and other requirements by holding a tender in the territory of the Republic of Kazakhstan in accordance with the procedure established by the Government of the Republic of Kazakhstan;
7) mandatory to involve Kazakhstan enterprises and organizations for carrying out work and services for petroleum operations including the use of air, railway, water and other types of transportation, if these services meet the standards and other requirements by holding a tender in the territory of the Republic of Kazakhstan in accordance with the procedure established by the Government of the Republic of Kazakhstan.1
1. Edict of the RK President having the force of law dated 28 June 1995, On Petroleum (the Petroleum Law), Article 41.
These provisions were introduced into the legislation on 11 August 1999.2 The Petroleum Law provides that “amendments and additions to legislation which worsen the position of the Contractor shall not apply to Contracts concluded prior to such amendments and additions.”3 Therefore, oil companies that concluded their subsoil use contracts before these amendments took effect in 1999 may argue that they may comply with requirements of the previous legislation, under which oil companies need only “give preference” and “give priority”4 to Kazakhstan companies.5 However, those oil companies that concluded their subsoil use contracts after these amendments took effect, will have no choice and will be obligated to use Kazakhstan suppliers of goods, and involve Kazakhstan service providers in their operations.
2. RK Law On the Introduction of Changes and Additions into Certain Legislative Acts of the Republic of Kazakhstan on the Issues of Subsoil Use and the Conduct of Petroleum Operations in the Republic of Kazakhstan dated 11 August 1999, Article 1.
3. Petroleum Law, Article 57.
4. Id., Article 41, version in force before 11 August 1999.
5. Please note, however, that this argument is not decisive and another interpretation of the law is possible.
Before 2002, the requirements to purchase goods and services for oil operations from Kazakhstan companies were rarely complied with in practice. However, during the last year, the RK government started a vigorous enforcement of these requirements. For this purpose, the government adopted the Rules for the Acquisition of Goods, Work and Services for Petroleum Operations in June 2002 (the Procurement Rules),6 and established a special State-owned company called Kazakhstan Contracting Agency, in November 2002. One of the aims of this Agency is to protect the interests of local Kazakhstan producers in petroleum operations.7
6. Rules for Acquisition of Goods, Work and Services for Petroleum Operations adopted by the RK government Decree dated 7 June 2002 (the Procurement Rules).
7. RK Government decree dated 14 November 2002 On Measures for Strengthening State Support of Local Producers, section 3.
According to the Procurement Rules, oil companies must generally procure goods and services through tenders held in Kazakhstan,8 and Kazakhstan entities that satisfy the tender conditions must be informed about the tender.9 The Rules reiterate the provisions of the Petroleum Law that stipulate that, when conducting oil operations, a company must acquire goods, work and services from Kazakhstan companies if they meet the relevant standards and other requirements.10 Kazakhstan suppliers of goods enjoy priority over foreign suppliers if they present a certificate that the goods have originated in Kazakhstan.11 Priority of Kazakhstan providers of work and services is established depending on the percentage of Kazakhstan labor or Kazakhstan sub-contractors attracted in order to provide work or services.12 Since the Procurement Rules do not stipulate what percentage of Kazakhstan labor or sub-contractors is necessary to be characterized as a “Kazakhstan provider,” such percentage is left to the discretion of the relevant tender commission.
8. Procurement Rules, section 14.
9. Procurement Rules, section 46.
10. Id., section 5.
11. Id., section 69(3).
The Procurement Rules presume that oil companies may purchase goods and services from foreign suppliers only when Kazakhstan suppliers cannot provide goods and services to the applicable standards and requirements. If the bids of foreign companies are considered, priority is given to those potential suppliers who:
• produce goods and services in Kazakhstan;
• attract high technology to Kazakhstan;
• use goods and services of Kazakhstan producers; and
• offer to use foreign goods and services on the basis of creating a joint venture with a Kazakhstan company in which a share of the Kazakhstan company is not less than fifty (50) percent.13
13. Id., section 70.
The Procurement Rules stipulate that they apply to the activities of a Contractor under a Contract for Petroleum Operations, when such Contractor acquires goods and services for petroleum operations in the Republic of Kazakhstan.14 If the Contractor assigns its right to acquire goods and services to a third person, the Procurement Rules will apply to the activities of such person when it acquires goods, work and services for the benefit of the Contractor.15 Under a reasonable interpretation of the law, this provision requires that subcontractors who acquire goods and services for petroleum operations comply with the Procurement Rules.
14. Procurement Rules, Section 2.
Another recently adopted law that articulates the priority of Kazakhstan providers of goods and services over foreign providers is the Law on State Purchases.16 The requirements of the Law on State Purchases are mandatory for State bodies, State institutions, State enterprises and joint stock companies controlled by the State, as well as their affiliated legal entities, when they acquire goods and services from the funds which are at their disposal.17 This effectively means that the Law on State Purchases governs, inter alia, purchases of such huge national companies as Kazakhstan Temir Zholy, KazMunaiGaz, Kazakhstan Electricity Grid Operating Company, Food Contracting Corporation, Air Kazakhstan and Kazakhstan Postal Service. Since these companies are big players in the Kazakhstan market, the requirements applicable to State purchases might be of interest to foreign investors.
16. RK Law dated 18 May 2002 On State Purchases (the Law on State Purchases).
17. Id., Article 1.
The Law on State Purchases and related legislation has created a scheme for granting priority to Kazakhstan suppliers, which significantly differs from the one set forth in the petroleum legislation. Unlike the Petroleum Law, the Law on State Purchases does not contain any obligation to use goods and services of Kazakhstan suppliers. It merely states that potential suppliers that are local entities shall have priority when a State purchaser determines a successful bid.18
18. Law on State Purchases, Article 26.1.
All priority conditions are set forth in the Rules for Organization and Conducting State Purchases of Goods and Services adopted by the RK Government on 31 October 2002 (the State Purchases Rules).19 The Rules provide that a potential supplier is recognized as a “local supplier”, if it:
• is a resident of the Republic of Kazakhstan;
• produces finished products in Kazakhstan; and if
• eighty five (85) percent of its employees are local.20
19. Rules for Organization and Conducting State Purchases of Goods, Work and Services approved by the RK Government Decree dated 31 October 2002.
20. Id., section 37.
According to the State Purchases Rules, when determining a successful bid, a tender commission may reduce prices offered by local suppliers by as much as twenty (20) percent.21 Of course, such price reduction represents significant assistance to local providers in securing a State contract.
In addition to this preference granted to all local suppliers of goods and services to the state, additional preferences are provided for small enterprises. In particular, on 9 April 2003, the RK Government adopted a list of goods and services that should be purchased by the State from small enterprises in 2003.22 The list of goods to be purchased from small enterprises includes, inter alia, food, furniture, constructing materials, equipment. The list of work and services includes, inter alia, refurbishing and constructing work, printing, transport and logistics services, and legal and notary services. By way of background, the legislation considers an entity to be a “small enterprise” if it: (a) is organized in Kazakhstan in the form of a partnership or in the form of a producers’ cooperative, (b) has no more than fifty (50) employees, and (c) the total value of its assets does not exceed sixty thousand of monthly calculation indexes (which is in 2003 approximately $324,868.00 per year).23 Accordingly, Kazakhstan entities organized in the form of a joint stock company are not considered to be “small enterprises.”
22. Nomenclature of Goods, Work and Services, Which State Purchase Is Carried Out from Small and Medium Enterprises for 2003, approved
by the RK Government Decree dated 9 April 2003.
23. RK Law dated 19 June 1997 On State Support of Small Enterprises, Article 3.
In addition to the foregoing, Law on Investment adopted in early 2003 also suggests the necessity of creating a Kazakhstan legal entity for business activity in Kazakhstan. The Law on Investment provides for the possibility of obtaining investment incentives, such as the reduction of corporate income tax, land and property tax for the period not exceeding a 5-year term, the exemption from customs duties, and the receipt of in-kind grants from the State.24 An investor considering such investment incentives must satisfy the conditions stipulated by the above law to be eligible for such incentives. These conditions include the following:
• the planned investment activity must be included in the list of priority kinds of activities;
• the investment must be made to fixed assets of a Kazakhstan legal entity in order to create new, expand or renovate existing production with use of modern technologies;
• the provision of documents verifying financial, technical, and managerial capacities of the investor sufficient to implement the project to the competent body.25
24. RK Law dated 8 January 2003 On Investment, Article 13.
25. RK Law on Investment, Article 15.
As follows from the above, the investment incentives provided for by the Law on Investment are available only to those investors who invest in legal entities established under Kazakhstan laws. Accordingly, those investors who intend to invest in Kazakhstan through a branch office would not be eligible for the investment incentives provided by the Law. The Law on Investment provides that the particular incentives to be granted are decided on a case by case basis between the investor and the RK government represented by its authorized body, and are stipulated in an investment contract.26
26. RK Law on Investment, Article 14.
Since this article concentrates only on recent developments of the regulatory framework, we will not go into a detailed explanation of the local content requirements contained in legislation adopted before 2002. However, we note that certain types of businesses in Kazakhstan, including banking, insurance, auditing and appraisal activities, may be carried out only by Kazakhstan legal entities and that these legal entities must be incorporated in a particular form (e.g., banks must be incorporated as joint stock companies). In addition, the ratio of foreign capital in Kazakhstan entities that are engaged in certain types of business may not exceed a determined percentage (e.g, banks and insurance companies).
In summary, under Kazakhstan legislation, certain business activities can be only carried out by Kazakhstan legal entities. Although certain types of activity is not the sole purview of local companies, a foreign company which produces goods or services for the Kazakhstan market may encounter problems with selling such goods or services since priority is given to local providers. Furthermore, different legal acts set out the different characteristics required in order to be viewed as a “local provider” and to be eligible for respective benefits. This leads to the conclusion that before commencing any activity in Kazakhstan, a foreign company needs to carefully consider two questions: (a) What particular activities it would carry out? and (b) Who would be potential buyers? On the basis of the answers to these questions, a company would be able to select a suitable business vehicle for work in Kazakhstan.
Limited Liability Partnership vs. Joint Stock Company
If a foreign company has decided to establish a Kazakhstan subsidiary, the next question will be what type of an entity is preferable. In general terms, until recent times the most common types of business entity selected by foreign companies for Kazakhstan subsidiaries were the limited liability partnership and the joint stock company. Joint stock companies were frequently established in the form of a closed joint stock company, because this form was less complex and did not have burdensome requirements with respect to: corporate governance, the amount of the authorized capital, public reporting and registration of shares. However, this changed with the adoption of the new Law on Joint Stock Companies in May 2003. The Law on Joint Stock Companies brought significant changes to the regulation of joint stock companies, which changes include:
• the elimination of the distinction between open and closed types of joint stock companies. The Law provides for only one form of a joint stock company which resembles previous open form;
• an increase in the amount of the minimum charter capital to approximately $287,000.00;
• the elimination of the concept of par value for shares which remains only for initial placement of shares among the founders;
• the mandatory registration of the issuance of all shares; and
• the abolishment of private and closed share placements. Shares may now be issued only by open placement.
Since the form of joint stock company known as a closed joint stock company was eliminated, one must now decide between the incorporation of an entity as a limited liability partnership or as a joint stock company. Under the law, a joint stock company is a legal entity that issues shares with, amongst other things, the aim of raising capital.27 Therefore, companies who do not intend to raise capital in Kazakhstan and desire a less regulated entity may be inclined to establish a limited liability partnership.
27. RK Law on Joint Stock Companies, Article 3.1.
Some of the positive features generally attributable to limited liability partnerships are:
• limited liability for members;
• comparably small amount of the minimum charter capital which is as low as $550.00;
• except State registration as a partnership, no other registration is necessary; and
• less burdensome reporting requirements, in comparison with those applicable to joint stock companies.
Among the peculiarities of limited liability partnerships, we note the following:
• the necessity to be significantly involved in management of a partnership;
• the possibility for members with small percentage of participating interest to block certain decisions;
• the possibility to forcefully buy out a participating interest;
• the necessity to offer a participating interest to other members, if it is intended for sale; and
• the necessity to re-register a partnership each time of the membership change or change in the members’ ratio (in partnerships with less than a hundred (100) members).
As on overall conclusion, our analysis suggests that the constant development of Kazakhstan legislation in different spheres requires a higher degree of attention from foreign companies when selecting a business vehicle for doing business in Kazakhstan. This step will help to ensure that the company is entitled to all benefits and privileges provided for by Kazakhstan legislation.
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