Kazakhstan’s New Oil Tax Regime Two types of contracts

Mineral exploration and extraction activities are permitted only to those who

have an appropriate contract with the Republic of Kazakhstan, termed a subsurface user contract. The Tax Code offers alternative tax regimes for taxpayers involved in mineral exploration and extraction activities, which the legislation terms “subsurface users”.

Model 1 offers a regime under which the subsurface user is subject to all the

taxes which affect ordinary taxpayers (corporate income tax, social tax, vehicle tax, property tax, land tax, etc) and, in addition, certain specific taxes applicable to mineral extraction activities:

• Bonuses (both on signature of the contract and following a commercial discovery)

• Royalties

• Excess Profits Tax

• Rent Tax on Export of Crude Oil

Of these taxes, the first three existed prior to the 2004 tax changes, but the

reform package includes major changes to the way they operate which are described later in this article. The fourth, Rent Tax, is a completely new tax. This is also described in more detail below.

Royalties and Rent Tax apply to gross income and are deductible in calculating both corporate income tax ("CIT") and Excess Profits Tax. СГТ is deductible in computing Excess Profits Tax.

Model 2 offers a production sharing regime of the type familiar from other hydrocarbon provinces around the world. Though not explicitly confined to hydrocarbon extraction activities, the mechanism for allocating production between the State and the subsurface user is written with hydrocarbon liquid extraction activities in mind and may not be easily adapted to other kinds of minerals, including gas. Subsurface users which sign up to Production Sharing Agreements ("PSAs") are obliged to share production with the Republic in accordance with formulae set out in the PSA itself, and to the other taxes prescribed in tax legislation, excluding, however:

• Rent Tax on Export of Crude Oil

• Excise Tax on Crude Oil (including gas condensate)

• Excess Profits Tax

• Land Tax

• Property Tax

The gross income of the contractor for CIT purposes includes both cost recovery oil and the contractor's share of profit oil. The base for calculating the contractor's royalty obligation is the gross amount of crude oil produced before production sharing.

In 2003, the possibility of a third model was extensively discussed. This was to be based around a rent tax similar in concept to that discussed below, but the idea was abandoned, apparently following discussions with state oil company Kazmunaigaz.

Bonuses

The Tax Code continues to provide for 2 types of bonuses:

• Signature Bonus

• Commercial Discovery Bonus

The major change in respect of Signature Bonuses is an explicit statement that the amount will be set by competitive tender. The framework of the competitive tender is to be prescribed by a proposed new PSA law.

The calculation of the amount of Discovery Bonus continues to be based on the officially approved estimate of recoverable reserves. The rate is now fixed at 0.1 percent of the value of recoverable reserves, rather than this figure being specified as the minimum amount as previously.

Royalty

The most important change to the royalty regime is the introduction of a fixed

scale of royalty rates for oil production based on tons produced. In the past, royalty rates (except for those applicable to "commonly occurring useful minerals" which were specified in the Tax Code) have been subject to negotiation within broad parameters and in at least two cases have not been applied to a project on economic grounds.

Associated gas is to be converted to equivalent using a formula of 1,000 cu. m. equals 0.857 t.

The new rules provide that the Government may publish separately, rates for

solid minerals, but is completely silent on how the base for dry gas will be calculated. Presumably, one should apply the conversion factor specified for associated gas and then apply the sliding scale for oil, but this is not clearly stated anywhere. There is also considerable uncertainty about how the sliding scale should actually be applied.

For example, what rate would be applied if the amount extracted was exactly 2 min t? Once the production passes 5 min t in the year does the scale operate to subject all production, since the beginning of the year, to the 6-percent rate?

Rent Tax on the Export of Crude Oil

The most fundamental change introduced by the recent amendments is the

creation of a completely new tax which applies to exports of crude oil. The tax will apply to taxpayers who export crude oil, apart from those who are parties to PSAs. It is not clear whether the tax will apply to an oil trader who purchases crude from the producer in Kazakhstan and then exports it.

Reflecting government concerns about transfer pricing, the tax base is not the actual sale price of the exported crude, but a formula which applies an average price for a basket of widely-traded benchmark oil prices, to the volume of oil sold. There is provision to adjust this deemed price for quality differentials as a result of mixing the oil in pipelines, though it is not completely clear how this is to operate. The components of the basket will be fixed by the Government. Transportation costs should be deducted to arrive at the base for calculating the tax. Which transportation costs is not explained, nor is it indicated whether these are only the costs incurred by the producer or whether one can take into account the costs of shipping crude to a location comparable with one where the benchmark crudes are traded.

In the rather likely event that the deemed price is not a round number of dollars per barrel, the legislation is silent on how the resulting fraction will impact the rate, e.g., if the deemed price is $25.57 per barrel, then should the rate be 16 percent or 17 percent or somewhere between the two?

The tax period is to be a calendar month, and the taxpayer will be required to

pay tax for a particular month by the 10th day of the month following. A tax declaration will be due by the 15th of the following month. Like all turnover taxes, the rate of rent tax has no relationship to profitability, and will, therefore, tend to depress the economic viability of projects in the hostile conditions of the North Caspian.