• Protection of the Interests of Investors Operating and Those Who Intend To Invest In the Sphere of Subsoil Use in the Republic of Kazakhstan
  • May 5, 2010
  • Law Firm: Sovremennoe Pravo Law Firm, LLP - Almaty Office
  • Relations in this sphere of useful activity are governed by both subsoil legislation and other branches of law. There exists a whole system of statutory acts that directly or indirectly stipulate the rights and legal interests of investors ¿subsoil users.

    Analysis is due to the recently made announcements by Kazakhstan Energy Ministry about review of subsoil use contracts. Kazakhstan President Nursultan Nazarbayev said this year contracts protecting oil ventures from tax changes must be reviewed but did not name any of them. The most of these words concerning the development of Caspian offshore field Kashagan, the world's largest oil discovery in 40 years, that is covered by one of the contracts known as production sharing agreements (PSAs). However, most current legislation in Kazakhstan on subsoil use is guarantees investor interests.  

    It is worth mentioning that after Kazakhstan had acquired sovereignty and independence a number of important legislative acts were adopted to strengthen the political system of the state and to establish a favorable environment for investment and economic development based on market mechanisms.

    It should be noted that as this sphere of the economy attracted the most significant foreign investments, relations therein are also regulated by legal acts pertaining to the use and protection of investments. I.e. there exists a complex system of legal acts proper application of which determines successful development of the sphere of subsoil use.

    Hence it is difficult to agree with those who believe that there are no laws in the Republic of Kazakhstan that properly and efficiently regulate the relations in this sphere of economy. The focus of such discussions might be the improvement of legislation, its further systematization and proper application, minimizing the number of government and departmental legal acts that contradict each other and create conflict situations.
    During last several years numerous amendments (9 times) were made to the Laws of the Republic of Kazakhstan “On Subsoil and Subsoil Use” and “On Oil” , which were aimed at resolving economic and social tasks and secondary administrative issues. Thus, e.g. over a 3 years ago the Law of the Republic of Kazakhstan “On Subsoil and Subsoil Use” was amended three times within three months (on December 29, 2006 and January 9 and 12, 2007). At the same time the said tasks and issues were and are subject to economic market mechanisms by improving contracting practice rather than amending laws.

    What are the issues that were attempted to be resolved by amending the above laws? In general, these are the issues ¿ procurement of Kazakhstani goods and services; employment of Kazakhstani personnel; additional requirements to subsoil users that knowingly cannot be fulfilled for objective reasons (e.g. total prohibition to flare gas); the strengthening of the role of state agencies in controlling subsoil users’ activities, endless amendments regarding interpretation (construction) of certain terms and definitions.

    In December 2004 there were made changes on the initiative of the state agencies to Article 30-5 of the Law “On Oil” stating total prohibition of gas flaring. This legislative innovation was adopted regardless of the fact that no Kazakhstani enterprise operating in oil and gas sector had a process for utilizing gas without flaring.

    According to the provisions of Article 45-2 of the Law of the Republic of Kazakhstan “On Subsoil and Subsoil Use” that establish the procedure for amending and terminating a subsoil use contract. Specifically, part 1 of this provision of the Law states: “in case where actions of a subsoil user during subsoil operations in relation to subsoil areas (deposits) having strategic importance result in a material change of the economic interests of the Republic of Kazakhstan, which threaten the national security, the Government of the Republic of Kazakhstan may demand changes and/or additions to the terms of contracts”. In addition, the refusal of contractor (subsoil user) to amend the contract is one of the grounds for terminating the contract.

    According to the provision of the Law of the Republic of Kazakhstan “On National Security” of June 26, 1998 No. 233 (part 2, Article 18), where it is stipulated that when the State “for the purpose of protection of the national interests of the Republic of Kazakhstan, including preservation and strengthening the industrial potential” exercises “control over the condition and use of economic facilities of Kazakhstan managed or owned by foreign organizations and organizations with foreign participation”, it should do it strictly “complying with guarantees granted to foreign investors”. In addition, pursuant to the same Law (clause 1 of part 5 of Article 18), state agencies while “ensuring economic security” are prohibited “to adopt resolutions and to conduct actions preventing the inflow of investments into the economy of Kazakhstan”. The adoption of resolutions and conduct of actions in violation of the above provision shall result in the “liability” of these agencies and their officers.

    One of the key issues is the “stability of contract provisions”. As per subsoil use, in early 1990’s Kazakhstan attracted first significant investments into the sphere of subsoil use in conditions when the practice of regulating relations in the oil and gas sector and the legal basis for developing market economy were not well established and there were no sufficient resources both for developing industry and resolving important social issues.

    The Republic of Kazakhstan granted to foreign investors certain tax benefits and preferences, exclusive conditions for export/import and currency transactions, exclusive rules for employing foreign labor, etc. All said rules were fixed in contracts and contracts were generally approved by the resolutions of the Government of the Republic of Kazakhstan or special acts of the President of the country. Such approach allowed Kazakhstan to create a positive and attractive investment regime, which is one of the factors of rapid economic growth and industrial development not only in the oil and gas sector but also in non-oil and ¿gas sector of economy.

    According to the Article 383 of the Civil Code of the Republic of Kazakhstan stipulates that “An agreement should comply with the obligatory rules for the parties, which have been established by legislation (imperative norms), which are valid at the moment it is concluded. If, after an agreement has been concluded, legislation establishes obligatory rules for the parties other than those which were valid upon the conclusion of the agreement, the conditions of the concluded agreement shall retain their force, apart from those cases when legislation has established that its validity shall be extended to relations arising from previously concluded agreements”.

    It is stated in part 3 of Article 4 of the Law of the Republic of Kazakhstan “On Investments” of January 8, 2003 No. 373 that “the Republic of Kazakhstan guarantees the stability of the terms of agreements executed between investors and state agencies of the Republic of Kazakhstan, except for cases where an agreement is amended by agreement of the parties”. There are two exceptions when these guarantees do not apply to: “amendments to the legislation of the Republic of Kazakhstan and/or entry into force and/or amendments to international agreements of the Republic of Kazakhstan whereby the procedure and terms of import, production and sale of excised goods are changed”; as well as to “amendments to the legislative acts of the Republic of Kazakhstan to ensure national security and environmental safety , public health and ethic conduct”.

    Pursuant to the provisions stipulated in Article 71 of the Law “On Subsoil and Subsoil Use” “Subsoil users shall be guaranteed the protection of their rights in accordance with legislation. Amendments and additions to legislation, which deteriorate the position of subsoil users, shall not apply to the contracts concluded prior to the introduction of such amendments”. These guarantees “shall not apply to changes in the legislation of the Republic of Kazakhstan concerning providing for the defense capacity, national security, environmental safety and health protection”. A similar provision is contained in Article 57 of the Law of the Republic of Kazakhstan “On Oil” of June 28, 1995 No. 2350. The issues of stability of the agreements are regulated by the Law of the Republic of Kazakhstan “On Production Sharing Agreements (Contracts) in Offshore Oil Operations” of July 8, 2005 No. 68.

    Thus, the applicable legislation of the Republic of Kazakhstan stipulates a general rule on the stability of executed investment agreements and subsoil use contracts, and the State guarantees their stability. The existing exceptions to the general rule are not subject to wide interpretation and relate, first and foremost, to the issues of ensuring national security, environmental safety, health protection and ethic conduct, as well as to the issues of excised goods turnover.

    By the Resolution of the Government of April 8, 2008 No. 328 of customs rates on crude exported from the territory of the Republic of Kazakhstan. Although the said legal act states that the crude export customs rates “shall not apply to the export of crude produced by subsoil users under subsoil use contracts that stipulate exemption from crude customs duties”, however, I am aware that currently two subsoil users who has such “exemption” are compelled to make such payments as required by the Ministry of Finance and the customs authorities.

    Thus, pursuant to Article 516 of the Code of the Republic of Kazakhstan “On Taxes and Obligatory Payments” of June 12, 2001 (hereinafter referred to as the Tax Code of the Republic of Kazakhstan), customs duty is one of types of customs payments referred to a category of “other obligatory payments to the budget” stipulated in Section 16 of the Tax Code of the Republic of Kazakhstan.

    The official interpretation of the notion of customs duty is contained in sub-clause 32 of clause 1 of Article 7 of the Customs Code of the Republic of Kazakhstan of April 5, 2003 No. 401, it is understood as “a type of customs payment levied by the customs authorities of the Republic of Kazakhstan at the time when the goods are imported to the customs territory of the Republic of Kazakhstan or when the goods are exported from the said territory, and which is an integral term of such importation or exportation”.

    The rates of customs payments are established by the Government of the Republic of Kazakhstan (see clause 3 of Article 515 of the Tax Code of the Republic of Kazakhstan and clause 2 of Article 292 of the Customs Code of the Republic of Kazakhstan). Payment of such customs payments including customs duty is made, in particular, when the goods are exported (see Article 207 of the Customs Code of the Republic of Kazakhstan).

    The provisions of the above legislative acts allow concluding that crude “export customs duty” introduced by the governmental act is deemed to be one of the types of customs payments and relate to a category of “other obligatory payments” stipulated in section 16 of the Tax Code of the Republic of Kazakhstan. For this reason, “export customs duty” so introduced is to be considered as a new type of liability stipulated both by tax and customs legislations. Given that a number of subsoil use contracts and investment agreements executed in early 1990’s contain a provision of the commitment of subsoil users-investors to pay applicable taxes and obligatory payments, therefore the new type of obligatory payment in the form of crude “export customs duty” cannot apply to them. Such conclusion does not contradict the provision contained in clause 3-1 of the Resolution of the Government of the Republic of Kazakhstan of October 15, 2005 No. 1036 ‘On Collecting Customs Duties on Crude Oil and Oil Products Exported from the Customs Territory of the Republic of Kazakhstan”.

    As per future legislative acts regulating relations in the sphere of subsoil use, these approaches should not prejudice the stability of previously concluded subsoil use contracts and investment agreements.
    As per the new Tax Code, its provisions is a step forward. Thus, clause 2 of Article 307 of the Tax Code (as of December, 2008) states that “the tax regime stipulated in a production sharing agreement (contract) executed between the Government of the Republic of Kazakhstan or the competent authority and a subsoil user before January 1, 2009 and subjected to obligatory tax audit, as well as the tax regime of a subsoil use contract approved by the legislative act of the Republic of Kazakhstan shall be retained and shall apply exclusively to the parties to an agreement (contract) within its entire effective term, and shall not apply to the persons who are not the parties to an agreement (contract), and may be changed by mutual agreement of the parties”. It is an excellent provision to ensure the stability of tax benefits and preferences granted to a subsoil user.