Taxation of subsurface users in Kazakhstan
Oil, gas and mining companies in Kazakhstan are referred to as subsurface users and enter into subsurface use contracts to acquire the rights to exploit the mineral resources of the country.
This report describes the tax legislation amended as of 22 July 2011. It is vital to realize that there are many uncertainties in the legislation as it now stands and these were increased by the introduction of a new Tax Code on 1 January 20091(“The Tax Code”).
1. Law No. 99-IV of the Republic of Kazakhstan of 10 December 2008
Consequently, this guide cannot be a substitute for taking professional advice before attempting to model tax regime and contracts should not be negotiated based upon it.
There are two types of subsurface use contracts in Kazakhstan, a production sharing agreement (PSA), and an excess profit tax (EPT) contract. There were only a limited number of PSAs concluded prior to 2009. Currently concluded and future contracts are expected to be EPT contracts.
Two major laws in Kazakhstan govern the economic terms established in a subsurface use contract. They are the Subsurface Use Law2 which contains the basic legal framework for the granting, using and assigning or terminating of the rights to be a subsurface user and the Tax Code which is discussed in detail below.
2. Law No. 291-IV of the Republic of Kazakhstan On Subsurface and Subsurface Use of 24 June 2010. Law No. 2350 of the Republic of Kazakhstan On Petroleum of 28 June 1995 that had been in force previously was abolished in 2010.
The tax regimes of the small number of PSAs existing at 1 January 2009 are stabilized provided that they have undergone a “tax expert evaluation” – essentially a review by the tax authorities to ensure that the tax terms in the PSA comply with the law in force at the time the PSA became effective. Contracts specifically approved by the President of Kazakhstan are also stabilized, but it is not currently anticipated that this power will be used in future.
The tax regimes of EPT contracts are not stabilized except for cases where such contracts are approved by the President of the Republic of Kazakhstan.
Stabilized contracts can be changed by mutual agreement between the parties.
The tax regime of a subsurface use contract applies to activities that are carried out within the framework of the contract and that meet the definition of subsurface use in the Subsurface Use Law. The Tax Code implies that the tax boundary occurs after the extraction and primary processing stages, i.e. initial stabilization.
In a consortium, each subsurface user is responsible for its own tax affairs including tax accounting, tax reporting and settlement of tax liabilities. However, some aspects of these may be delegated to the operator of the consortium provided that the correct arrangements are put in place. The special administrative provisions are effective with respect to some consortiums acting under PSAs, for example, VAT compliance.
The Tax Code contains detailed requirements for a tax policy and a set of tax registers that provide the bridge from the underlying accounting records to the tax returns.
Accounting records are maintained in accordance with the Law On Accounting and Financial Reporting, under which certain companies should prepare financial statements under IFRS.
Legislation governing the establishment of tax terms in a subsurface use contract
The Tax Code states that it alone may establish provisions concerning the payment of taxes and levies relating to subsurface operations in Kazakhstan. Separate agreements with the government should not do so.
Fiscal regime. This section describes the fiscal regime in force for almost all existing, and all new contracts from 1 January 2009. This regime is applicable to all contracts except PSAs that became effective prior to 1 January 2009 and contracts specifically approved by the President of Kazakhstan.
The generally applicable fiscal regime that applies in Kazakhstan to exploration and production contracts in the petroleum industry consists of a combination of corporate income tax, rent tax on export, bonuses and mineral extraction tax. Oil and gas production activities are ring-fenced from downstream activities and from each other (i.e., contract by contract) for tax purposes.
Mineral extraction tax. The mineral extraction tax (MET) is a volume-based royalty type tax applicable to crude oil, gas condensate and natural gas. Rates escalate depending on volume. Different tables of rates and tax bases apply depending on what is produced and whether it is exported or sold domestically.
Bonuses. Subsurface users are expected to pay a signature bonus and a commercial discovery bonus.
Corporate income tax (CIT) rate. CIT is applied to all companies at a rate of 20 % of taxable income in 2011.
Rent tax on export. The tax base is determined as the value of the exported crude oil and gas condensate based on the same tax valuation as for MET upon export. The tax rate ranges from 7 % to 32 % and is applied once the world price for crude oil and gas condensate exceeds US$40 per barrel.
Excess profit tax (EPT). EPT is calculated annually. The tax is paid at progressive rates applicable to the portion of net income that exceeds 25 % of deductions. The taxable tranches are derived by applying ratios to the deductible expenses.
Carry forward of losses. Tax losses relating to subsurface use contracts can be carried forward for up to 10 years.
Crude oil export duty. From 1 January 2011 the rate is US$40 per ton of crude oil.
The taxes applicable to subsurface users and their rates are presented in Table 1.
EPT is calculated annually. The taxable object is the portion of net income (if any) that exceeds 25 % of “deductions”. The net income is calculated as aggregate annual income less “deductions” less CIT and branch profits tax, if any. For EPT purpose “deductions” are the expenditure deductible for CIT purposes plus additional deductions such as accelerated depreciation for fixed assets. The tax is calculated by applying the following rates to the tranches of excess income, each tranche being allocated the marginal net income determined as a percentage of “deductions” until total net income is allocated. (Table 2)
Special rules apply to determine the taxable object if the hydrocarbon production is processed prior to sale, for example by refining crude oil into gasoline, diesel etc. In such cases it is unlikely that an EPT liability would actually arise.
Payment for compensation of historical costs. Since 2009, the payment for compensation of historical costs has been included in the list of obligatory payments to be made by a subsurface user to the state budget. It is a fixed payment to compensate the state for geological survey and development costs of the contact territory incurred before the subsurface use contract is concluded.
The obligation to compensate historical costs arises from the date when the confidentiality agreement is concluded between the subsurface user and authorized state body on subsurface study and usage.
MET applies to crude oil, gas condensate and natural gas. The taxable base is the value of the production. On export sales, the value is based on world prices without adjustments.
The world price of crude oil and gas condensate is determined as the arithmetic mean of daily quotations for each of the Urals Mediterranean (Urals Med) or Dated Brent (Brent Dtd) brands in the tax period on the basis of information published in the Platts’ Crude Oil Marketwire3.
3. Published by The McGraw-Hill Companies Inc.
If that source does not provide price information for those brands, the Argus Crude4 source should be used.
4. Published by Argus Media Ltd.
The world price for natural gas is determined as the arithmetic mean of daily quotations Zeebrugge Day-Ahead in the tax period on the basis of information published in the Platts’ European Gas Daily. If that source does not provide price information for natural gas, the Argus European Natural Gas source should be used.
The rates of tax are determined by the annual volume of production. The tax rates for crude oil including gas condensate are provided in Table 3.
These rates are reduced by 50 % if the production is processed domestically in Kazakhstan either by the producer or by a purchaser. There are special rules for the calculation of tax bases in such cases.
In the case of natural gas that is exported, a fl at rate of 10 % applies. If the gas is sold to the domestic Kazakhstan market then rates are reduced to between 0.5 % and 1.5 % depending on the annual production.
Bonuses. The subsurface users are expected to pay two types of bonuses:
Signature bonus. The signature bonus is a lump-sum payment paid by a subsurface user for the right to use the subsurface.
For oil exploration contracts where reserves have been approved, the bonus is a fixed amount of 2,800 MCI,5 which is equivalent to approximately KZT4,233,600.
5. As of 1 January 2011 monthly calculation index is established in the Law on the Republican Budget for 2011–2013 dated 29 November 20010 No. 357-IV at KZT1,512.
For oil production contracts where reserves have not been approved, the bonus is a fixed amount of 3,000 MCI, which is equivalent to approximately KZT4,536,000. If reserves have been approved, the bonus is calculated by a formula which applies a rate of 0.04 % to the approved reserves and 0.01 % to the provisionally approved reserves but not less than 3,000 MCI, which is equivalent to approximately KZT4,536,000.
Commercial discovery bonus. The commercial discovery bonus is a one-off payment paid by subsurface users when a commercial discovery is made on the contract territory.
The base for calculation of the commercial discovery bonus is defined as the value of the extractable minerals duly approved by the competent state authorities. The value of the mineral resources is determined using the market price established at the International (London) Petroleum Exchange in Platts Crude Oil Marketwire. The rate of the commercial discovery bonus is fixed at 0.1 % of the value of proven extractable resources.
CIT is applied to all companies at the rate of 20 % of taxable income. Taxable income is calculated as the difference between aggregate annual income (after certain adjustments) and statutory deductions.
Deductions. All expenses incurred by a taxpayer and related to conducting activities aimed at generation of income are deductible for CIT purposes. Examples of expenses that are allowed for deduction can be found below (this list is not exhaustive):
2. Contributions to the decommissioning fund. The procedure for making such contributions and the amount are to be established in the subsurface use contract.
3. Expenditure on geological studies, and exploration and preparatory operations for extraction of mineral resources.
4. Expenditures on research and development , scientific and technological works.
5. Expenses incurred under a joint operating agreement are deductible based on information provided by the operator.
6. Business trip and representative expenses (per diems are deducted in full based on taxpayers’ internal policy, whereas representative expenses are deductible in the amount up to 1 % of payroll).
7. Foreign exchange losses when a foreign exchange loss exceeds a foreign exchange gain.
8. Insurance premiums except for those paid according to accumulative insurance contracts.
9. Amounts paid as redemption of doubtful payables previously written off as income.
10. Doubtful receivables not redeemed within three years.
11. Taxes paid (except for the taxes already excluded prior to determining aggregate annual income, income tax paid in Kazakhstan and in any other states, and EPT).
12. Fines and penalties, except for those payable to the state budget.
14. Capital repair (within the statutory limits).
15. Expenditure actually incurred by a subsurface user with respect to training Kazakh personnel and the development of the social sphere of rural areas, within amounts stipulated in subsurface use contracts.
Geological studies, exploration and preparatory operations for production of useful minerals incurred prior to the start of production following the commercial discover y include the following: appraisal, preparatory work, general and administrative expenses, and costs associated with the payment of the bonuses. These costs, together with expenditure on the purchase of fixed assets and intangible assets (expenditure incurred by a taxpayer while acquiring the right to geological exploration, development, or extraction of mineral resources), form a separate depreciation group. These costs may be deducted by declining balance depreciation at a rate not exceeding 25 % after production start following the commercial discovery. Expenses incurred after production start following the commercial discovery are included in the same group to increase its residual value if under IFRS such expenses are capitalized into the value of assets already included in the group.
In the case of a farm-in, the cost of acquiring a subsurface use right should be capitalized. Upon farm-out, the subsurface user is liable for tax on capital gains.
The Tax Code also provides for certain expenses to be deducted directly from taxable income up to 3 % of the taxable income