Vsevolod V. Markov. Foreign Investment in the Oil and Gas Sector of Kazakhstan

RusEnergyLaw JOURNAL • 2'2003/Table of Contents • Article

Foreign Investment in the Oil and Gas Sector of Kazakhstan

By Vsevolod V. Markov, Associate, (Michael Wilson & Partners, Ltd)

A foreign company may carry out its activities in the Kazakhstani oil and gas sector either through a branch or a locally registered company.

A "locally registered company" means a company registered in the Republic of Kazakhstan which can be 100% foreign-owned, but which would still be considered a Kazakhstani enterprise for the purposes of the laws regulating the oil and gas sector; as opposed to a branch office, which is a subdivision of a foreign company and not a separate entity.

Generally, the current Kazakhstani legislation contains no limitation for foreign entities to participate (through their branches) in tenders for the provision of goods and services associated with oil and gas operations. The relevant state authority supervising such tender as well as the tender committee are not required and/or entitled to refuse the participation by a foreign company in a tender on the ground that it is not established in Kazakhstan. Thus, as per the current legislation, all bidders in tenders, both Kazakhstani and foreign, are subject to the same bidding procedures, and terms and conditions of bidding in any tender.

However, under the legislation, Kazakhstani enterprises have a certain priority when bidding in tenders. Yet, the nature of such priority has not been clarified by the regulations. There may well be certain practical implications of such "priority" at the stage of choosing a winner, while, for example, deciding between equal tender proposals of a Kazakhstani and foreign company, both meeting the requirements and conditions of the tender. However, currently, no laws or regulations contain such recommendations, guidelines or provisions.

Another point to note is that should the tender bids of foreign companies be equal, then preference in choosing the best bid should be given by the tender committee to those bidders which: (i) produce their works, goods and services on the territory of the Republic of Kazakhstan; (ii) attract modern technology into Kazakhstan; (iii) use goods, works and services supplied by Kazakhstani enterprises; and (iv) offer to use foreign goods, works and services through a joint venture where the Kazakhstani enterprise’s share will be at least 50%.

Therefore, by having registered a 100% foreign-owned company in Kazakhstan, a foreign company would be in a better position to constitute the Kazakhstan content of purchased works and services of general contractor firms, although there are further qualifications as to what that content should be.

The most suitable form of a Kazakhstani company is a Limited Liability Partnership ("LLP").

Below we give a brief explanation of the concepts of a branch office and LLP under Kazakh law, the main distinctions between these two (2) and we also outline certain issues pertaining to the registration of each of a branch office on the one hand and an LLP on the other, currency regulations and the applicable tax treatment.

Legal Status

Of course, a branch of a foreign entity is not treated as a separate Kazakhstani legal entity but represents and constitutes an integral part of the foreign legal entity in Kazakhstan. A branch is a subdivision of a foreign entity, which may fulfil all or a part of the functions of its parent company, including income-generating activities. A branch office acts on the basis of a "Regulation" (similar to a charter or by-laws), and is typically managed by an individual authorised by the parent company and acting pursuant to a power of attorney.

A branch acts and assumes obligations in the name of the founding entity.

LLP is a separate legal entity acting in its own name pursuant to a charter approved by the founders/participants. An LLP is formed on the basis of contributions from its participants and such contributions form the LLP’s Charter Capital.

Liability

The participants in an LLP are not liable for the LLP’s debts and bear the risk of losses arising out of the LLP’s activity to the extent of the value of their contributions. An LLP is liable for its debts to the extent of all its assets and is not liable for the debts of its participants.

Where litigation is brought in a Kazakhstani court, a Kazakhstani legal entity can be a defendant. However, since a branch office is not a legal entity per se, of course, the parent company itself would be named as the actual defendant. In practice, Kazakhstani courts commonly reject a claim if it is brought against a branch office and not its parent company.

Management

A branch manager has to be appointed by the authorised body of the parent company and typically operates on the basis of a power of attorney. Within the powers granted by such power of attorney, a branch manager may appoint other management/ administrative personnel of the branch.

An LLP is managed by a general meeting of participants and its executive body (director, management board). An LLP’s Charter may also provide for the formation of a supervisory body and/or audit commission.

Charter Capital

Since a branch is not treated as a separate legal entity, there are no legal requirements to maintain the charter capital of a branch.

To get an LLP registered, the founders have to form the charter capital, which currently may not be less than 87,200 Kazakhstani Tenge (approx. US$590).

Currency Regulation

For currency regulation purposes a branch of foreign legal entity is not considered to be a resident of Kazakhstan whereas an LLP is such a resident. A branch, being a non-resident, is entitled to make payments in foreign currency to both residents and non-residents of Kazakhstan, while an LLP has to make payments to residents in Kazakhstani currency only, with some exemptions established by the legislation.

An LLP may purchase foreign currency for certain purposes listed in the relevant legislation, like payments to non-residents or repayment of loans extended by an authorised bank. In contrast, a branch can purchase foreign currency for any purpose.

Currency transactions involving the movement of capital from residents to non-residents (which include investments by residents abroad, payments of residents to non-residents in relation to import transactions providing for advance payments for goods (work, services) for a period in excess of 180 days and some others) must be licensed by the National Bank. If a Kazakhstani legal entity wants to open an offshore account, it will require a license to be issued by the National Bank of the Republic of Kazakhstan.

Tax Treatment

A branch of a foreign legal entity and an LLP are treated similarly for tax purposes. The only difference is the nature of taxes paid and method of tax collection. A branch is subject to a 15% net profit tax on its after-tax income as earned or accrued. This tax is essentially the same as the 15% withholding tax that applies to dividends distributed by a Kazakhstani legal entity. However, the ability of the Kazakhstani legal entity to retain its earnings without paying withholding tax until the earnings are actually distributed is the principal difference between the application of withholding tax to the distributions by an LLP and the branch profits tax, attributable to the net after-tax income of a branch. On the other hand, a branch office is required to pay tax on its profits when they are earned (i.e. on the date established by the tax laws for payment of profits tax), which lends a slight advantage to using an LLP instead of a branch. Furthermore, the relevant Double Tax Treaty to which the Republic of Kazakhstan is a party may reduce the rate of withholding tax on dividends.

With the distinctions described above, both a branch and LLP are subject to the following main taxes:

1. Income Tax, accrued with respect to the income to be calculated as the difference between the aggregate annual income and all and any applicable deductions. The regular income tax rate is 30%;

2. Value-added tax (VAT) at 16% calculated with respect to taxable supplies and services in Kazakhstan and imports.

3. Social Tax at 21 % for resident employees and 11% for non-resident employees;

4. Land Tax with respect to any land plots owned by a branch/LLP. It is calculated on the basis of annual fixed payments for a unit land area. The basic rates are subject to a co-efficient established
annually by the Government of Kazakhstan;

5. Property Tax applies with respect to the residual value of depreciable assets. It is paid annually at a rate of 1% of the value of any depreciable assets;

6. Vehicle Tax is assessed with respect to vehicles owned by the LLP. It is paid once a year and is calculated on the basis of engine capacity and year of production of the vehicle.

Registration Procedures

There are some minor differences in the registration process for a branch and for a legal entity, particularly regarding the documents, which must be filed with the Ministry of Justice. (There are also some differences in the filing requirements for a branch office and for an LLP).

The incorporation of an LLP or a branch in Kazakhstan requires registration with the Ministry of Justice (or City/Oblast Department of Justice), the Statistics Department and the Tax Inspectorate.

Registration fees payable for such registration currently amount to KZT 17,440 (approx. US$118).

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