Taxation of sub oil user is a serious issue for those who invested in the newly independent Kazakhstan. After concluding oil contracts and securing by stable guarantee of Tax Legislation, foreign investors come up with an active development of the largest oil and gas fields in Kazakhstan without realizing that issues may arise in the future. One of the issues for today is an issue of tax computation and discharge of tax on excess profit. What is the reason for this last additional fining which is carried out by the Kazakhstan Tax Body? Is this an omission on the part of the drafters of the contract, or is it a decision taken by the tax bodies' At the instance of the Petroleum magazine Almat Daumov, a Partner at GRATA Law Firm and the Director of Tax Department, answers these and other issuers of sub oil use in Kazakhstan.
General tendency of tax policy related to sub oil users
Most of the contracts regarding sub oil use according to the first-rate oilfield in Kazakhstan were signed in the 1990s. One of the basic issues of these sub oil users have been imperfections in the Tax Legislation which is effective at the moment of signing contracts on sub oil use. So, up to the moment of leading in to the systematized Tax Code in Kazakhstan (dated 1 January 2002) acted the Legislation on Taxes and scores of legal standard acts, which contradict each other often, have referencing type problems and many others legislative gaps. At the same time, situations of sub oil contracts regarding tax treatment were very simple and had referencing type as rule. After all, lots of precedents were emerging when various issues of sub oil taxation were not regulated by conditions which are pointed in the contract of tax treatment and rules of the Tax Legislation.
Court practice of the last five years has shown that the state guaranties to sub oil users stable tax treatment and legislation which is acted for the moment of signing contracts on sub oil use. At the same time, principal issues are decided in the state's favour. In particular, these are issues of control on transfer pricing, issues of tax computation on ‘excess'profit, ease of performance in accordance with changes which have been inserted in to the current tax legislation. So it has uniquely decided that the issue on double types of stable tax legislation. It means that a sub oil user being guided by the rules of tax legislation acting at the moment of concluding the contract has no right to use the current legislation. In other words, stability of the Tax Legislation is guaranteed concerning interests of the Republic of Kazakhstan too in interrelation with investors.
Analyzing changes in tax policy in relation to sub oil users should include a mention that 2006 has been a remarkable year. At the beginning of the year, the superior court of the republic admitted a number of precedent decisions on issues of sub oil taxation which call for the performance by the state, a guarantee of stable tax treatment, from the point of view of the author. So at the beginning of 2006, the Supreme Court of the Republic of Kazakhstan provided its opinion on the vexed question of issues of tax computation on ‘excess' profit, which had previously been a headache. Some of sub oil users became victims of formal approach and legal collisions arose in the relevant Tax Legislation.
2006 also saw the admittance of an important standard act on issues of using norms of the Tax Legislations in the sanctioning of tax disputes. So, on 23 June 2006, in connection with the necessity for an explanation of separate norms of the Tax Legislations, the Supreme Court of the Republic of Kazakhstan passed the normative Decision «On Court Practice regarding the Use of Tax Legislation». This decision of the judicial branch of authority has once again confirmed the legitimacy of realization with tax bodies of the control over using transfer pricings without dependence on positions of contracts on sub oil use regarding the stability of tax treatment. The Supreme Court has also designated its point of view on questions of using standard acts. So, in the decision, it is mentioned that letters from tax service bodies of an explanatory character on issues of occurrence, execution and termination of tax obligations are not concerned with normative standard acts and courts, when considering tax disputes, have no right to use them. The court should consider such explanations and comments taking into account their conformity to norms of the tax Legislation. Under the contents, the decision according to which affairs with participation of taxpayers, who are carrying out activities under contract on sub oil use, concluded during the period of being in force, the Law on taxes and the established stability of tax treatment, the substantive rules of the tax legislations working on the effective date on which such contracts are applied, are very interesting. Last time, very often there were situations when positions of the contract on sub oil use contradicted certain tax laws in effect at the date of signing the contract. In this connection arises the quite reasonable question about how the court should be guided when sanctioning the tax dispute if positions of the contract on sub oil use regarding tax treatment contradict norms of the tax laws in effect on the date that the contract was signed. By literally interpreting these positions of the specified decision, it is possible to believe, that norms of the tax laws are subject to use. At the same time, according to the tax laws all contracts on sub oil use until the moment of their conclusion should pass an obligatory tax examination determined by Government of the Republic of Kazakhstan. The coordinated tax treatment is subject to an obligatory inclusion in the final text of the contract. As contracts have been signed, it follows that they have passed a corresponding tax examination, and that the text of the contracts does not contradict legislative norms. Now, there is a risk that for the mistakes admitted by the state at the time of carrying out the tax examination of contracts, the responsibility will be carried by the sub oil user.
And, perhaps, the as yet unequivocal aspects of display of tax policies in relation to the sub oil users, began creation of a system of executive authority of the state of the specialized department regarding work with the largest sub oil users of Kazakhstan at the end of 2006. The task of these Specialized departments of Tax Committee of the Ministry of Finance of the Republic of Kazakhstan is to restore the balance of interests of the state and sub oil users when during Kazakhstan's early independence long-term contracts were concluded, which were favourable with the existing tax preferences. It is necessary to mention, therefore, that now, not absolutely have pointed the purposes, tasks and the most important powers of the new specialized division on work with the largest sub oil users.
Issuers of tax computation on tax profit
As one of vivid examples of the changes in the tax policy in relation to sub oil users in Kazakhstan, it is possible that a situation arises with the sanction of a question on issuers of tax computation on tax profit.
Since the second half-year of 2005, tax bodies of Kazakhstan under the leading of the Tax Committee of the Ministry of Finance of the Republic of Kazakhstan, have carried out a number of thematic tax checks concerning the largest sub oil users. It is the first time in the history of an independent Kazakhstan that thematic checks on excess tax profit have been carried out. Sub oil users have been perplexed by the huge sums of additional tax placed on profits, as well as fines and penalties.
Tax profit for the first time has been stipulated by the tax laws in effect at the beginning of 1995. Payers of tax profit are made by all sub oil users, carrying out mining operations and receiving additional incomes from activity in relatively better natural conditions or realizing extracted minerals (production) in favourable market conditions.
The law on taxes contained general provisions regarding payers of the tax profit, the form of payment, in the subsequent editions rates of the tax profit tax have been determined. A subordinate legislation regulation regarding the calculation and payment of the tax profit of the sub oil users did not see long time. Most likely, it concerned the early stage of development of the oil industry. Oil deposits were still being investigated; accordingly there was no real profit, let alone this so-called ‘excess profit'.
On December 29 1997 the Order of Chairman of Tax committee of Ministry of Finance of the Republic of Kazakhstan # 1 approved the Instruction # 41 «Regarding taxation of sub oil users». For the first time in details the design calculations of the tax profit has been fixed in the Instruction # 41, positions of the instruction also provided examples of how to calculate tax on profits, the formula and calculations. From the moment of passing the Instruction # 41 sub oil users were guided by these instructions.
Sub oil users in Kazakhstan started to make ‘excess profits' by the end of 1999/beginning of 2000. Accordingly, this was the moment for the calculation and payment of tax profit. Rules for drawing up the tax reporting were authorized and sub oil users carried out a number of negotiations with representatives of tax bodies with a view of reception of consultations by rules of calculation and payment of the tax profit.
Accuracy, correctness and according legitimacy regarding the calculation and payments of the tax profit spent by the sub oil users were confirmed with results of complex tax checks of sub oil users from 2000-2004. The results of the last thematic tax checks which have been carried out in the second half-year of 2005 showed that sub oil users incorrectly estimated their tax profit. Moreover, there were inconsistent checking conclusions: results before the carried out complex checks concerning the tax profit essentially differ from the thematic checks carried out by 2005 on tax profit; formulas of calculation of the tax profit, fixed annually (since 2000) rules of drawing up of the tax reporting confirmed by tax organs also were broken a set with the formulas applied during thematic checks.
Tax Bodies used design procedure of the tax profit essentially new to many Contracts.
According to positions of effective legislation working during the conclusion by the sub oil users of oil contracts, and developed practice the tax profit paid off as follows:
The income after payment CIT (Corporate Income Tax) — tax on dividends — tax profit paid for the last year = the net profit multiplied by the rate of the tax profit = the sum of the tax profit.
The above mentioned formula was used according to the Instruction # 41 «On taxation of sub oil users» and Rules regarding the drawing up of Declarations on tax profit.
Tax bodies in the middle of 2005 accepted the internal act providing other orders for the calculation of tax profit, namely an order for defining net profit. So, tax bodies, being guided by positions of item 30 of item 5 of the Law on taxes, providing, that under the net profit, it is necessary to understand the taxable income behind a minus of the surtax paid under this income, expect the excess profit tax as follows:
Income after payment of CIT = net profit multiplied by the rate of the tax profit = sum of tax profit.
Tax bodies considered, that with calculation of the net profit, sub oil users groundlessly found the sum of the paid tax on dividends and the sum of the excess profit tax paid for the last year.
The basic argument of the tax bodies regarding calculation of the tax profit under the above mentioned formula are positions of item 30 of an item 5 of the Law on the taxes, determining the net profit as income minus only corporate surtax.
Apparently from above mentioned, being guided by an extremely formalistic approach, despite the positions of the Contracts on the sub oil use precisely fixing a design procedure of the excess profit tax, tax service bodies have designated a new technique for the calculation of tax profit, essentially changing the economic balance of interests of the state and the sub oil user.
According to item 94 of the Law on Taxes regarding the requirement on the payment of taxes and other obligatory payments (tax treatment), established for sub oil users, are determined in contracts on the sub oil use between the sub oil user and the Competent Body authorized by the Government of the Republic of Kazakhstan. According to an item 94-3 of the Law on Taxes, the tax treatment established by the contract on sub oil use, made when due hereunder and with past obligatory tax examination, operates invariably before the termination of the validity of the contract.
Thus, positions of the contract on sub oil use concerning tax treatment have primary force before the provisions of tax legislation, and a sub oil user is obliged to pay taxes and other obligatory payments in the budget according to the tax treatment established by the contract of the sub oil use.
Despite the abovementioned, as of today, the judicial authority in this question is backing the tax bodies. Thus, the final point in this question is not complete. The first sub oil user, faced with this problem, has the right until January/February 2007 to appeal against the judgements given for the benefit of tax organs on excess profit tax. It is necessary to note also, that each contract regarding sub oil use and the tax treatment is fixed individually. With this in mind, it is quite possible, that in subsequent judiciary practice on different sub oil users will differ.
Summarizing the above mentioned, it is necessary to note, therefore, that a principal cause of occurrence of similar tax disputes is the differing understandings of the tax bearer and the state of the maintenance of tax stability and the stability of tax treatment. The taxpayer — the sub oil user — interprets all discrepancies and blanks to its own advantage; the state on behalf of tax bodies widely and frequently groundlessly is formally interpreted with some norms of the applicable tax laws, without consideration of the positions of the contract on sub oil use. All these questions here already during last 10 years are ongoing and extremely urgent for the sub oil user in Kazakhstan. With regard to the sanction of the above questions, the fair approach is necessarily systematized and is most important from the point of view of the balance of economic interests of all sides.
