Kazakhstan

Author: | Published: 9 Oct 2001
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In the 10 years since its independence the Republic of Kazakhstan has enacted an impressive body of commercial and fiscal legislation to govern foreign investment. These steps have been designed to win the confidence of the foreign investment community, which is eager to tap into the enormous natural resource wealth of the country.

General

The principal legislation governing petroleum operations in Kazakhstan is the Petroleum Law dated June 28 1995 and the Subsoil Code dated January 27 1996.

The Subsoil Code and Petroleum Law

The Subsoil Code, relating to all subsoil resources, is the principal legislation for the granting of subsoil rights in Kazakhstan. It concentrates on the contracting and subsoil rights aspects of a hydrocarbon project, while the more narrow Petroleum Law applies specifically to subsoil users conducting petroleum operations. The legislation establishes that the subsoil, including resources in their underground state, are state property, while resources brought to the surface belong to the subsoil user, unless otherwise provided by the applicable contract.

Subsoil use rights

The government maintains the primary role in defining the rules and procedures by which subsoil rights are granted and exercised. The designated competent body, at present the Ministry of Energy and Mineral Resources, is responsible for negotiations with the subsoil user over the terms of the subsoil rights and for the conclusion of a contract setting forth those terms. Local government bodies are responsible for the granting of surface rights and ensuring compliance with ecological requirements.

The contracting process

Subsoil use rights become effective upon conclusion of a contract with the competent body. (Although, formerly, such rights arose based on both a contract and a licence from the competent body, the licensing requirement was abolished in August 1999).

The government is annually to establish a list of subsoil blocks for tender. Parties wishing to participate in the tender may apply to the competent body. The terms for open tenders are published, and those for closed tenders are communicated to the interested participants. The application is considered by a government commission after payment of a deposit. The participants are also entitled to purchase geological data. The winner of the tender is selected on the basis of a number of criteria, including the period for the commencement of exploration and the intensity of exploration, the anticipated amounts of production and payments to the budget, the amount of investment and the nature of the financing and capital investment programmes.

Oil and gas contracts may be awarded for exploration and/or production, production sharing and construction of underground facilities. Exploration contracts are granted for up to six years, with the possibility of two extensions of two years each. In the event of a discovery, an extension is possible to allow an appraisal of commercial feasibility. In case of a commercial discovery, the holder of exploration rights has an exclusive right to negotiate a production contract with the government.

A production contract may be granted for a period of up to 25 years (40 years in the case of large deposits). The term may be extended, by application submitted 12 months prior to expiration, with the agreement of the competent body.

The minimum work programme and terms of subsoil use are defined in the contract. The work programme may be changed only by agreement with the competent body, based on a showing that fulfilment of the obligations is unreasonable under the circumstances.

Petroleum operations carried out in Kazakhstan are governed by the laws of Kazakhstan. However, international arbitration of disputes concerning the conclusion and performance of the contract is permitted by the Petroleum Law.

The approval process

The contract requires the approval of various bodies, including the tax authorities, and is registered with the competent body. Certain additional documents are required, including a project report and field development plan. The subsoil user also must procure a state study on appraisal of the reserves and undergo a state ecological study.

Stabilization

The subsoil legislation contains important stabilization guarantees, providing that changes and amendments to legislation that worsen the position of the subsoil user are not applicable. The guarantee does not extend to the areas of national defence or security or ecological safety and public health.

Rights and obligations of subsoil users

The subsoil user has various rights, including the exclusive right to conduct petroleum operations; to erect necessary production and social facilities; to dispose of its share of production freely, and to conduct on a priority basis negotiations for the extension of the contract.

The subsoil user is required to use the most effective methods and technology; to use the contract territory solely for the purposes specified; to conduct such operations in accordance with law; to observe requirements for environmental protection and worker safety; to give preference to Kazakhstan personnel, equipment and subcontractors; to observe tax obligations; to participate in the development of local infrastructure; to preserve the environment and objects of historical significance; and to restore the contract territory.

The Petroleum Law requires mandatory application of generally applicable currency, tax and customs legislation. This fact has virtually excluded the possibility of obtaining tax or customs duties exemptions under a contract, since both the Tax Code and the Customs Code preclude such a possibility, except where such laws are specifically amended to provide for the exemption.

Revocation, suspension or termination of rights

Both the Subsoil Code and the Petroleum Law contain specific grounds on which the government may revoke, suspend or terminate subsoil rights. These include the giving of false information, collusion with officials, and violation of the contract or environmental or subsoil law. The contract may be amended or terminated if the conditions of the contract are not met, or if the contractor becomes bankrupt.

Transfer of subsoil use rights

A subsoil right may be transferred, with the permission of the competent body. Moreover, a subsoil right may be freely pledged. However, the financing must be used exclusively for the project.

Tax Legislation

The Tax Code, in force since July 1 1995, is to be replaced by a new code by 2002. The Tax Code confirms the applicability of various taxes, including: income tax; withholding tax on dividends, interest, royalties/rentals and service fees; VAT; securities tax; excise taxes; and local taxes (land, property and vehicle tax); as well as business registration fees and fees for certain activities.

It also contains a section governing taxation of subsoil users. The tax regime for subsoil users is defined in the contract. However, it must comply with the general tax regime in effect on the date of conclusion of the contract.

There are two specific tax models that may apply under a subsoil use contract. The first model simply provides for the payment all taxes of general application.

The second model envisages the transfer of a defined share of the production pursuant to a PSA, together with the payment of income tax and an extended list of other taxes, including withholding tax; VAT; bonuses; royalties; registration fees and other assessments that are not envisaged under articles 3 and 4 of the Tax Code.

VAT applies to all domestic and imported goods, work and services, and subsoil users are subject to the payment of signature, commercial discovery and production bonuses, royalties, and excess profits tax.

Bonuses and royalties are deductible for the purpose of determining income tax and excess profits tax. However, a subsoil user having activities under separate contracts may not consolidate revenues and losses specific to the separate contracts. Loss carry forwards are permitted for subsoil users only for a maximum period of seven years. Moreover, income received from an assignment of rights under a contract is taxable in the manner provided therein.

The mandatory excess profits tax is assessable in all cases where the subsoil user's IRR is in excess of 20%. The applicable rates range from 4% of net profit (for IRR between 20% and 24%) to a maximum of 30% of net profit (for IRR in excess of 30%).

Environmental claims

The conduct of a state environmental study is a prerequisite to obtaining subsoil use rights. However, such a study will not necessarily protect a subsoil user from subsequent environmental liability. Moreover, given the financial state of many of the local production associations, agreements to indemnify a subsoil user against claims for pre-existing environmental damage are not an adequate protection.

If a subsoil user conducts offshore petroleum operations, a strict liability standard applies to environmental damage. The subsoil user is responsible for all damage to life, safety and the environment, irrespective of fault.

Conclusion

The legislative activity that has taken place in the Republic of Kazakhstan since independence has been largely positive, and, as a result, the basic legal elements necessary for hydrocarbon exploration and production projects are already in place. However, the viability of projects should be carefully assessed on the basis of technical and commercial feasibility, rather than favourable legislation, which will change throughout a project. Project terms should be negotiated strictly within the parameters of existing legislation, bearing in mind that special benefits that are inconsistent with existing laws are vulnerable to a determination of invalidity or revocation.

Foreign investors should protect themselves through thoughtfully developed provisions related to arbitration, adverse changes, force majeure and sovereign immunity. Other measures for reducing risks include reliance on external financing, security and home country export guarantees, as well as the procurement of political risk and convertibility insurance.


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