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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