Oda Russian Commercial Law 2007-1

investor, or other juridical persons or a consortium of juridical persons established with the participation of this investor.

However, by the 2004 amendment, this rule has changed. Production sharing agreements can be concluded only with the successful bidder in an auction. A successful bidder is the person who offered the highest amount for the right to conclude a production sharing agreement (Art.6, para.1).

What is important is that since 2004, there is a requirement that the terms of the auction provide for mandatory participation of a Russian entity in the production sharing project. The share of the Russian entity in the project is to be determined by the Federal Government (ibid.). In the three ongoing production sharing projects, only Sakhalin I had signi cant Russian participation. However, this has changed by Gazprom forcefully joining Sakhalin 2.

In order to work out the terms of the use of sub-soil, prepare the draft agreement and to negotiate with the investor regarding each block, a special interagency commission is to be set up.

5)Terms of the Production Sharing Agreement

The Production Sharing Law has a provision which basically covers the duties and obligations of the investor. These include:

i)implementation of the work in accordance with the programme, projects and plans, budgets approved in the way provided in the agreement;

ii)implementation of the work in compliance with Russian law, standards concerning the safety of work, protection of sub-soil, environment and the health of inhabitants;

iii)implementation of measures for the prevention of any harmful in uence on the environment and elimination of the outcome of such an in uence;

iv)taking out of insurance for the compensation payable for the potential damage to the environment;

v)liquidation of all installations, structures and other assets after completion of the work based upon the agreement and clean up the environment.

Some onerous obligations on the investor have been introduced by subsequent amendments (Art.7, para.2).

Firstly, for the participation in the project as subcontractors, suppliers, and transporters, Russian juridical persons are to be given preferential rights. This provision had already been in the Law before the 1999 amendment, but there, the preferential right was limited to instances where “other terms were the same”. Russian companies were to be preferred only when the terms offered by them were the same as those offered by foreign companies. This part of the provision

or in cases of projects in the continental shelf, 90%. The determination of the ratio of pro t production is also to be agreed. The amount of pro t production is the total product deducted by the equivalent of tax payment for the extraction of mineral resources and the cost payment for the given accounting year.

It is also possible to agree on different methods of production sharing – e.g., direct sharing which was introduced to the Law by the 2001 amendment (Art.8, para.2). In this scheme, the total amount or value of the product is shared. However, the share of the investor may not exceed 68%.

The investor has the title to the share of the production which has been attributed to it. Mineral resources which have been transferred to the investor can be used as collateral.

In a production sharing scheme, the payment of taxes and other mandatory payments is replaced by the sharing of the production. In this regard, the original Production Sharing Law provided that with the exception of pro t tax and uni-ed social tax, the investor was exempted from taxes and duties for the period of the agreement.

With the exception of the pro t tax and the payment for the use of sub-soil, the investor for the period of the agreement shall be exempted from taxes and levies established by the legislation of the Russian Federation.

By the 2003 amendment, this part was deleted, and the Law now provides that in implementing production sharing, the manner of calculating and paying taxes and levies are to be determined by the Tax Code.

In 2001, Chapter 26 of the Tax Code Part Two, which covers the “tax on the exploitation of mineral resources” was enacted. A chapter on the “System of Taxation in Implementation of Agreements on Production Sharing”, which provides for a special tax regime for production sharing was nally introduced as Chapter 26-4 in 2003.

The Code has a lengthy list of taxes and levies which investors in a production sharing project are required to pay:

i)value added tax;

ii)corporate pro t tax;

iii)uni ed social tax;

iv)tax on the extraction of useful minerals;

v)levy for the use of natural resources;

vii)levy for the negative effect on the environment;

viii)levy for the use of water resources;

ix)state duties;

x)customs tariff;

xi)land tax;

xii)excise.

This is a long list, which makes the production sharing arrangement almost meaningless. On the other hand, the amount of value added tax, uni ed social tax, levy for the use of natural resources, levy for the use of water resources, state duties, customs tariff, land tax, excise, and payment for the negative effect on the environment are to be reimbursed (Art.346-35 of the Tax Code).

Investors are exempted from regional and municipal taxes by the decision of the relevant regional and municipal bodies.

In production sharing, investors are subject to the following payments:

i)lump sum payment (bonuses) for the use of sub-soil at the time when incidents determined by the agreement or license take place;

ii)payment for geological information;

iii)fees for the participation in auction;

iv)fees for issuing of license;

v)regular payment for the use of sub-soil (rentals);

vi)compensation of the cost of the government for exploration and development of mineral resources;

vii)compensation of damage caused to indigenous minority people.

Furthermore, if the project involves the use of the continental shelf, payment for the use of the continental shelf is required (Law on the Continental Shelf, Art.40).

7)Stability of the Production Sharing Agreement – Grandfather Clause

One of the important reasons for investors preferring production sharing to conventional licensing schemes lies in its relative stability achieved by eliminating the possible changes in law and unilateral action by the host government.

The Law provides that:

Terms of the agreement maintain their effect for the entire period of the validity of the agreement. Changes to the agreement are allowed only by the consent of both parties except by the request of one of the parties in cases of signi cant change of circumstances in accordance with the Civil Code (Art.17, para.1).

Furthermore, the Law has a “grandfather clause” which provides as follows (ibid., para.2):

If, within the period of validity of the production sharing agreement, a norm which worsens the commercial outcome of the activities within the framework of production sharing is established by the legislation of the Russian Federation, its constituent entities, or legal acts of the local self-governments, the agreement shall

mentals of the State Regulation of Foreign Economic Activities which allows the introduction of export quotas under certain circumstances.

This Law which was enacted in 2003 empowers the government to temporary prohibit or restrict export in order to prevent critical shortage of important goods in the internal market (Art.21, para.2, subpara.1). It also allows the introduction of necessary measures to prevent exhaustion of irreplaceable natural resources on the ground of national interest (Art.32, para.1, subpara.5). This Law has replaced its predecessor – the 1997 Law of the same title – with the accession to the WTO in view.

Under the current system in Russia, trunk oil pipelines are owned and managed by a single company – Joint Stock Company Transneft’, while gas pipelines are owned by Gazprom and its subsidiaries. Transneft is a state-owned company which manages, services and is responsible for developing the trunk pipeline system. The company is charged with ensuring the transport of crude oil in appropriate volumes and by routes speci ed in the transportation (export) schedule prepared by the Government Inter-Ministerial Committee. The schedule is based upon annual transport contracts which producing companies negotiate with Transneft. The contracts specify the amount and quality of crude oil to be transported, the starting and nal points of shipping, routes, and the terms and schedule of payment. Quarterly and monthly allotments are calculated using the oil companies’certi cates of their own annual production.

The Production Sharing Law guarantees the access of the investor to the oil and gas pipeline on a contractual basis.

In reality, access to the pipelines was not always easy for foreign operators due to the pressure on Transneft by Russian oil companies. The problem is that the system of allocating pipeline capacity in this way is not transparent, due to its bias towards the government-backed programmes and all sorts of side deals.

It should also be noted that the transportation of oil and gas through trunk pipelines is also regulated by the Law on Natural Monopolies.According to this Law, the right to access to trunk pipelines and terminals is granted to companies extracting oil and their parent companies.

6THE DEMISE OF THE PRODUCTION SHARING SYSTEM

The procedure for realising production sharing projects has been poorly regulated and is complicated. Various permissions are required before concluding the production sharing agreement. For example, if the project involves the use of the continental shelf, separate permissions are required for building arti-cial islands, installations and facilities (The Law on the Continental Shelf,

7PROSPECTIVE REFORM OF THE SUB-SOIL LAW

The history of sub-soil legislation in Russia can be seen as a struggle between two camps: those who support the use of sub-soil to be regulated by public or administrative law (the licensing system) and those who support this to be regulated by private law contracts. In an article entitled “the Development of contractual basis of the right to use sub-soil” published in 2004, the author pointed out that the proponents of the administrative law system start from the premise that the state, as a sovereign, is entitled not to assume obligations and not to be liable for the breach vis à vis the user of sub-soil by completely ignoring the interest of the latter. This is unsuitable in sub-soil use which involves high level of risk, an enormous amount of capital investment and a long period of recovering the cost.21 Obviously, the author is one of those experts who were behind the production sharing system, and then the concession law. However, the Concession Contract Law which was eventually enacted in 2005 expressly omitted upstream natural resources projects [for the Law on Concession Contracts, see Chapter 8].

As discussed above, the production sharing system has become marginalised in Russia. In the meantime, the replacement of the current Sub-soil Law by a completely new law came on the agenda. A government draft of the new Law was submitted to the Duma in May 2005. In November of the same year, the government withdrew this draft, ostensibly to revise the part involving strategic blocks, but this draft was never returned to the Duma.

The draft Sub-soil Law was a strange mixture of liberal and conservative ideas which seems to be the outcome of a political compromise. On the one hand, it introduced a new system of sub-soil use based upon contracts. A contractual system of sub-soil use was to replace the existing licensing system.As is the case with production sharing, the contract for the use of sub-soil is, in principle, a civil law contract. This contract is to be concluded between the Russian Federation (in small blocks, with constituent entities) and the investor. Investors are to bid for the status to conclude a contract with the State. The right to use sub-soil is in principle, transferable and pledgeable.

On the other hand, the draft law had some provisions on the increase of state control over sub-soil use. Parties to the contract of sub-soil use are, in principle, juridical persons established in accordance with Russian Law. Even those Russian juridical persons may be restricted to be a party, if they belong to a “group of foreign juridical persons”. The government is entitled to restrict the participation

21B.D.Kliukin, “O razvitii dogovornoi osnovy prava pol’zovaniia nedrami”, GiP 2004 No.9, p.47.