Mining Taxation:the Government Stance
A round table devoted to mining taxation in Kazakhstan was held in Astana on 17 March 2004. The participants were heads of the ministries, members of parliament, mining companies, and representatives of consulting and legal companies. The Minister of Economic and Budget Planning Kairat Kelimbetov, the Minister of Finance Yerbolat Dosayev, and the Vice-Minister of Energy and Mineral Resources Bakhytkozha Izmukhambetov set the pace of this discussion. They represented the Government’s stance regarding the changes in the Kazakh mining laws on taxation of oil operations. In accordance with the joint statement ‘the Government of Kazakhstan supports sustainable business relations on the basis of balanced economic interests of the state and investors, observance of the principle of equality before the law as defined in the Constitution, and equal conditions for all taxpayers’. The article below is a summary of the major thesis and arguments discussed by the Ministers.
The New Concession
A great deal of research in the area of the international taxation of oil operations has been carried out prior to the adoption of amendments to the Tax Code of Kazakhstan. Analysis of the laws of such countries as the USA, Great Britain and Australia has shown that production sharing agreements (PSA) are not necessarily used in countries with a sustainable economy. These countries apply for concessions in most cases, when the tax rates are set by the law and are not discussed in the course of negotiations. The receiving party aims to receive the maximum profit possible in the national currency via taxes when signing a concession agreement. With PSAs, the government can collect taxes in kind (e.g. oil), thus reducing the currency risk. This is very important if the national currency of the receiving party is non-convertible. This is why PSA’s are mostly used in developing countries and states with a transitional economy.
At present, there are two mining tax models in Kazakhstan. The first is based on concessions and licensing, whilst the second on the principles of PSAs. The taxation terms of the mining contracts have been set on an individual basis with regard to the project structure. The taxation norms for oil producing companies have not changed significantly since 1995.
However, the active development of the Kazakhstani sector of the Caspian has made apparent the necessity to amend the Tax Code in order to make it congruent with the economic realities of modern Kazakhstan. In this regard, the first model of mining taxation does not provide stability to the contracts, but is based on current laws. It should be noted that mining contracts signed before 1 January 2004, and having completed tax inspection, are still in effect until their expiry date.
At the same time, amendments did not interfere with the second model, which is still based on stable taxation conditions. A PSA can be amended only by mutual agreement of the parties. It is still obligatory for a PSA to undergo tax inspection in order to analyse and assess the project.
A rental tax on exported crude oil (or simply a ‘rental tax’) has been included into the new mining contracts, which are to be executed on the basis of the first taxation model. The Government expects this tax to stabilise tax payments in the state budget, facilitate tax administration, and solve a number of problems with transfer pricing.
Today, individuals and legal entities that export crude oil pay the rental tax, except for those with contracts signed before 1 January 2004. The rental tax is calculated on the basis of the cost of exported crude oil. It is calculated on the volume of oil for export, market price, and quality, minus transportation fees. The transportation expenses and quality of oil are taken into consideration when paying the rental tax in Kazakhstan, unlike in Russia. It is noticeable that no duty is charged for oil prices less than $15 per barrel in Russia, but in Kazakhstan the index is $19.
As the first model is unstable, the law defines the royalty rates to be calculated on a sliding scale basis. The royalty may reach 2-6%, depending on the oil accumulated during each calendar year of mining operations. The excess profits tax calculation has also been improved in order to simplify charging procedures.
In addition an amendment to the Tax Code is being planned with regards to the provisions on the calculation of fixed assets depreciation and deduction of reconstruction expenses out of aggregate annual revenue. The Government proposes to keep the existing depreciation procedures, but to increase depreciation rates for the subgroups of fixed assets.
The income and expenditure balance deductible by the taxpayer as a lump sum in the end of a tax period will be increased 100-300 times the monthly estimated index. This will accelerate the depreciation of the fixed assets book value.
The draft law will eliminate the spread between the depreciation sums in accounting and depreciation sums for taxation.
Production Sharing Agreements
In view of the future Kazakhstan-Russian operations on the Caspian shelf, a draft law On Production Sharing Agreements for Offshore Oil Operations has been developed and is now under consideration by the Parliament of Kazakhstan. This draft law was worked out on the basis of Kazakhstani experience in the conclusion of PSAs and the Russian law On Production Sharing Agreements.
It provides a definition of ‘production sharing agreement’ as a type of contract on joint offshore exploration and development, or the production of hydrocarbons. In addition, it secures national companies’ rights to have a share (not less than 50%) in all Kazakhstani production sharing agreements.
The Kazakhstan’s part in the production sharing is the total cost of products to be shared between the state and the contractor, minus the contractor’s operational expenses under the contract.
Kazakhstan’s part in production sharing, taxes and other budgetary payments should be not less than 20% of total production during a tax period, beginning from the start of production to the recovery of money invested, and not less than 60% of total production in the following period.
In addition, the threshold values determined for production sharing between the state and the contractor make up three triggers. These triggers are to increase the state revenue in line with the growth of yield from the project, internal rate of return and oil prices.
The draft law reduces the period of offshore facilities use under the PSA. The parties will define this period in accordance with the applicable Kazakh law as of the date of agreement. It should not be more than 30 years for joint exploration and production, and 25 years for production. Another agreement can be signed on the expiry date, taking into account the new project economics.
There are new regulations for tenders on oil operation rights under the PSA. A number of provisions in the draft law are devoted to the contractor’s rights and the stability of such contracts guaranteed by the state. Under the specific article introduced in the law, the contractor will be able to keep its accounting in the national and foreign currency.
The majority of mining contracts (licences) were signed earlier, and are not subject to the new taxation amendments, so there are no grounds for the Government Operators to worry about the rental tax, the amount of royalty and Kazakhstani part under the PSA (received in kind and exported in the name of the Government).
An adjustment to Article 304-1 of the Tax Code is expected in the future, which specifies the rental taxpayers, in order to remove Government Operators from this list.
The draft law provides offshore blocks to the companies (it is obligatory that the national company has a share in the capital under such projects), which guarantees implementation of modern technologies in different areas, including petrochemistry and construction of new processing facilities. This benefit is included in the respective articles of the State Programme for the Development of the Caspian.
Benefits and Preferences
On 1 January 2004, in order to develop the facilities for enhanced processing of minerals produced in Kazakhstan, the Government introduced a benefit in the form of corporate income tax exemption. This provision will be implemented during the 5 years from the date of commissioning the processing facilities, including the petrochemical plants.
A set of requirements for mining companies exists. These are as follows:
1) a processing facility must be constructed during 4 years or less, the cost should not be more than 5 million of the monthly estimated index, as defined by the Law on the National Budget for the respective fiscal year ($30 million);
2) not less than 90 % of the aggregate annual income of the taxpayer should consist of receivables from selling goods of their own production, manufactured on the basis of the enhanced processing of raw materials produced in Kazakhstan, and in accordance with types of activities defined by the Government of Kazakhstan.
Special tax regulations have been introduced in order to facilitate investment in the development of new information technologies, software, and in the development of the Aktau seaport. It reduces the assessed corporate income tax, and exempts taxpayers from property and land taxes, if they are operating within the special economic zones (Information Technology Base, and the Aktau Seaport).
Amendments to the Mining Law
Currently the Parliament is considering a draft law of the Government on Amending Statutes on Mining and Oil Operations in Kazakhstan. In accordance with this draft law, the functions of a licensing body in the mining sector will be granted to a competent authority. This authority will efficiently notify mining companies if there is a necessity to correct any violations found during the monitoring, without a special decision by the Government. In addition it will facilitate the amendment of existing licences and contracts.
This draft law is planned to liberalise the financing of geological surveys by the national budget. In addition, the Law on State Purchases in accordance with the new standard will regulate such contracts.
The existing Mining Law will be substantially amended, in order to avoid tax losses by the state if no useful components are found in the recovered ore, the suitable processing technology does not exist or it is unprofitable. For instance, the development of the technogenic minerals owed by a mining company will be allowed only after the state inspection of the reserves and the signing of the contract.
In accordance with another new regulation, if any danger occurs to the life and health of the people living within the zone of mining operations, a mining company must provide for their safety or eliminate this danger. If this appears impossible, the mining company must resettle the people from such a zone and only then it will be permitted start operations again.
The draft law also includes the creation of a Liquidation Fund to liquidate the consequences of the mining company’s operation. This was caused by the fact that some companies halt their exploration or/and production operations, but do not fulfill their obligations regarding liquidation of their facilities and re-cultivation of land due to the fact that they have no remaining funds. The mining company’s obligations will be guaranteed by a special fund collecting financial assets and keeping them on a deposit in one of the Kazakhstani banks.
The term ‘construction and/or use of underground structures not exploited for exploration and/or production operations and the procedure of granting the rights for such operations have been amended substantially.
It is obvious that the laws On Mineral Resources and On Oil (saying that mining companies must use products, operations and services produced in Kazakhstan) do not fully provide mutually beneficial relations between the domestic enterprises/contractors and foreign investors beginning its business in the country. This is why the new draft law submitted for approval by the Parliament includes Kazakhstani participation in every phase of work with a mining company: in a tender, when selecting the most optimal proposal, and in the provisions of mining contracts.
In order to set up the system of using domestic products and services, the initiators of this draft law took into account the peculiarities of oilfields and of the mining contracts, and did not simply establish a strict limit of Kazakhstani participation as was done in Russia.
These facts lead to the conclusion that the estimated and contracted limits should be specified under the contract by the mining company itself, which will result in positive attitude to government control among such companies.
Mining contracts are expected to be amended in order to preserve the balance of interests that was upset to the detriment of Kazakhstan’s tax revenue by the reduction of the social tax and VAT rates since 1 January 2004. To this end, the Government requests mining companies to contact the Ministry of Energy and Mineral Resources for initiating tax examinations and the revision of royalty rates.
The introduction of the new rental tax to be levied mainly on traders (i.e. individuals and companies who export oil but are not mining contractors themselves) made it necessary to take certain measures in the area of tax administration. For example, the Ministry of Finance has already completed a list of such traders and proceeded to collecting the rental tax.
Bearing in mind that a draft Government Resolution on approving the list of similar oil grades is now in process of discussion, the Ministry of Finance issued an explanatory note. This note stresses that Urals quotations should be used (source: Platt’s Crude Oil Marketwire), with subsequent corrections in the tax amount, based on information from additional tax statement forms.
The fact that a number of existing mining contracts feature stabilization clauses and sometimes provide for exclusive tax treatment gives birth to disputes between the Government and mining contractors and poses problems in tax administration. The Government maintains that this problem can be eliminated by the inclusion of a special provision in the existing contracts. Any mining company operating in Kazakhstan may request the Ministry of Energy to make the necessary amendments to its contract, and some companies have already done so.
The Ministry of Finance proposes to elaborate on the contractual provisions governing tax treatment with due regard for the conditions bearing on tax obligations and the balance of economic interests. This measure is expected to enhance the stability of tax computation methods and rates, which might not be the case with administrative provisions even though the latter are amended in such a manner so as not to affect the balance of economic interests established by tax examination.
There is another crucial issue that calls for a conclusive solution. This item relates to the companies’ obligation to submit certain tax statement forms. At present, the Ministry of Finance is introducing information systems intended to improve tax administration, and to allow chamber control to be executed and the number of tax audits to be reduced. It is now planned that contract-specific statement forms will be developed and the rules for filling them will be adopted.
Many problems are posed by a lack of a clear policy towards separate tax statements. Some companies have more than one mining contract, and their taxes are registered on a single account, which impedes chamber control, monitoring and analysis. Such a practice also makes it possible to carry excess tax amounts from one contract to another. The Ministry of Finance proposes to assign a registration number (and an account) to each mining contract following the rule “one contract - one taxpayer”. As a result, a clear procedure for calculating contractual income and expenditure for taxation purposes and statement submission will be established.
As for the cases where more than one company (consortium) is granted a mining contract, amendments are being discussed to the Tax Code aimed to enable separate tax registration in the event that the members of a consortium engage in activities other than mining.
Since the law does not provide a definition for historical costs and problems are being encountered in administering this item, the Ministry of Finance proposes to class historical costs as a special nontax contribution to be collected in accordance with Government instructions.
At present, the Ministry’s specialists are developing an electronic form for computing excess profit tax, which will automatically perform calculations of the tax, based on figures entered. The electronic form will simplify the administration of this item, and ensure that the tax is collected in a timely manner. When the form is completed and approved, it will be available from the Tax Committee’s web-site with necessary explanations.
Due to the fact that no clear mechanism exists for exemption from VAT of geological exploration activities, the Ministry of Finance proposes to supplement existing contracts with contract-specific lists of such activities and VAT exemption procedures. It is also proposed to remove the VAT exemption clause from the Tax Code.
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