You know that the government policy in the regulation of the raw material sector has changed recently. Particularly, the government which now interferes more with the activity of companies, has cancelled benefits and preferences to foreign investors to ensure equal rights with domestic companies, abolished the stability of law clause, and enhanced the dominance of national companies. This has been backed up by respective mining, investment, transfer pricing, taxation and other enactments.

We are not going to challenge the right of the state to set new requirements and provisions for investors; however such new requirements should be reasonable. For instance, the Parliament is currently considering amendments to the Mining Decree, which would virtually grant the government a preferential right to buy mining rights or an interest (shares) in mining companies. Although the government maintains that this does not infringe on any statutory provisions or the rights of investors, this appears as disrespect for private ownership. Therefore it is vital that the government adhere to the fair policy when amending mining contracts unilaterally, fulfill its obligations, and continue to establish and maintain conditions that would strengthen Kazakhstan's reputation as an attractive country for investors.

Main goal of my report is overview of existing to date problems of subsoil users related to fulfillment of tax obligations to the Republic of Kazakhstan on subsoil use contracts concluded prior to January 1, 2004, in particular, issues of tax regime stability.

My report will not cover issues of last amendments in tax legislation of Kazakhstan as a result of which state will not anymore provide contractors with guarantees of tax regime stability on subsoil use contracts except for the production sharing agreements. Therefore, all new subsoil use contracts will not actually provide for any special tax regime because subsoil users will be obliged to fulfill tax obligations in accordance with current tax legislation on the date of appropriate fiscal obligation.

New taxation regime considerably increases volume of fiscal proceeds into the budget but at the same time creates a real danger for investment attractiveness of Kazakhstan and puts a question about the economical benefit of earlier concluded investment agreements.

As we all pretty well understand, stability of contract legal regime is of primary importance for subsoil users and is one of major guarantees of investment activity of companies operating in the given economy sector. Though legally lawmaker has retained invariability of the tax regime on subsoil use contracts concluded prior to January 1, 2004, nevertheless the existing tax practice shows that the state has ceased to fulfill its contract obligations becoming rather a tax collector and bringing stability norms on such contracts into challenge, having applied new «rules of the game». Contract relations should remain unchanged for the whole period of subsoil use contract or until the moment when both parties express their intent to make appropriate changes and additions on the basis of principle of equality of contract parties.

The day before yesterday was a bad situation, yesterday was bad and today is the same — consequently the situation has stabilized. Many a true word is spoken in jest. For many investors obtaining any benefits and privileges in the course of contract conclusion is not as important as the tax stability of subsoil use regime.

In order to save potential investors from uncertainty and doubts the Republic of Kazakhstan at the proper time made a decision to establish an invariable tax regime for tax payers working in the subsoil use field.

Since 2002 year we were showed to what extent an investor may be confident in the future of Kazakhstan. Within this period state presented many tax surprises to subsoil users. Astronomical sums of taxes, fines and penalties, values of which not always can fit the cells of typical form of tax committees' notifications, were like a «cold shower» on the investment climate of Kazakhstan. What reason caused this situation?

We tried to find an answer to this question by analyzing, from a legal point of view, norms of tax legislation, judicial practice and subsoil use contracts.

First reason is a lack of clear definition of term «stability of tax regime». What norms of tax legislation should remain unchanged and what norms can be «flexible»? Lack of clarity in this issue allows tax bodies to use the gaps against interests of tax payers.

For example, tax bodies, in our opinion, mistakenly assume that only types of taxes, which are paid by subsoil users, and rates of such taxes are unchanged. At that the state is absolutely free in the issues of determining an object of taxation, procedure for calculation and deadlines for taxes payment.

With putting Law on State Control into effect while applying transfer prices, a new procedure was established for calculating a basis on corporate income tax, royalty and deductions into the road fund. For corporate income tax as a tax basis an adjustable income was set instead of actually earned income. For royalty an adjustable price was taken instead of weighted average sale price. The same happened to the deductions to the road fund.

Many of you know not just by hearsay what was the impact of above on tax burden of subsoil users.

Numerous, contradictory interpretations of term «stability of tax regime» create a favorable ground for increase of unlawful calculations of amounts of taxes and other compulsory payments. The only way is to define, in accordance with legislative procedure, what norms of tax legislation should remain unchanged for parties of subsoil use contract.

The second reason of violation of tax stability norms is a declarative nature of tax stability.

At hard times of development of Kazakhstan economy the state was ready to provide any favorable conditions to potential investors. Investment legislation consisted of just guarantees and numerous benefits. Let's take as an example Law «On Foreign Investments». Its main part enumerates obligations of the state before investor. However, lawmaker has not still worked out the measures to ensure guarantees given to investors by the state.

Today it becomes obvious that stability of tax regime is just a declarative norm. Decree on Taxes, Law on Taxes and current Tax Code contain only poor norms on invariability of subsoil user tax regime. Lack of mechanism of tax stability norms application had already caused and causing many court disputes between subsoil users and the state.

For example, during the period from 2002 year the following controversial situations appeared due to gaps in legislation:

1. Payments to extra-budgetary funds;
2. Payments of taxes on securities transactions;
3. Adjustments of aggregate annual income (minerals processing, etc.).

In connection with termination of extra-budgetary social funds, subsoil users were left on the crossroad. On one hand they were obligated to comply with stability norms and to make payments as per rates established for them (as a rule rates were 32% range from salary fund), on the other hand — they had nobody to pay to and nowhere.

Apparently the state itself did not know a way out of this situation at that time, since it did not solve this situation but just included a simple wording in Law «Оn state budget of 1999», which stipulated that «indebtedness on payments to the extra-budgetary social funds should be paid to the budget as per social tax code». I would like to draw your attention to the fact that namely «indebtedness» had to be paid. The question of forthcoming (future) payments remained open till recently. This gap was filled by court precedents, which is not good index of effective managing these norms by tax legislation.

Thus, instead of directing the taxpayers to the right course and judicially regulating and settling the payment procedure of social payments, the state itself provoked the chaos, after which everybody but the initiator were punished.

One more example can demonstrate how declarative norms of stability are being executed. Many of subsoil users signed their contracts during the validity period of tax on securities transactions.

I should remind that this tax was collected from

1) securities issues and 2) transactions. Tax on securities transactions was paid according to the following order: the buyer transfers the tax amount to the seller's account, after that the seller (being, in fact, a tax agent) transfers the indicated tax to the budget. At that the seller is recognized as the tax payer. What should the subsoil user do in such situation when this tax is not effective, and he cannot obtain it from his buyers Legislation does not give an answer. According to stability norms tax payment obligation is borne on «shoulder» of subsoil user, who sells his securities. At the same time he cannot pay the tax because this tax was cancelled for buyers and buyers do not transfer it to subsoil user's account. And we again face these issues.

Many of you know how Law on state control influenced subsoil users' activities during application of transfer prices. However I would like to return to this topic once again. Being a citizen of the Republic of Kazakhstan I agree with the necessity of preventing drain of money and ensuring returns to the state budget. But why these objectives should be achieved through such painful methods. Even before the law was enacted tax legislation already contained provisions on state control over application of transfer prices. Instead of making those norms be effective, we replaced them by new ones, but inefficient. Apart from the fact that this action did not bring results expected by the state, to certain extent it discredited it. The most vivid example of this was demonstrated to us, that in no way the tax regime is stabilized for subsoil users. Moreover it became obvious that the Republic did not refuse from the method of imperative directives, inherited from the Soviet past.

Such disputable situations will appear constantly if mechanism of their prevention and rules of conduct of subsoil users in case any amendments to tax legislation are introduced which impact stability norms will not be elaborated.

The third reason is incorrect understanding of tax regime stability by subsoil users themselves.

Some contractors believe that stability of tax regime means its invariability only towards aggravation. It is incorrect. Stability of tax regime is one of the measures of ensuring the balance of interests of subsoil user and the state. It follows that improvement of condition of one party of subsoil use contract entails aggravation of condition of another party.

Presently there is a tendency toward decreasing of a tax burden. Rates of social tax and value added tax were decreased. However, in order to use existing tax relieves the subsoil user should conduct negotiations with the competent body, pass tax expertise of proposed amendments to the contract, carry out calculations of the projects economics.

Thus, one-sided application of improving norms by subsoil users entails violation of stability of tax regime and of original balance of interests of the parties of contract, and state authorities in this situation could use establishes mechanisms of punishment.

In summary, I would like to point out that the current laws still have inconsistencies and ambiguities which cause disputes. Particularly the tax legislation of the Republic of Kazakhstan requires appropriate amendments and addenda aimed at giving a more precise definition of tax regime stability and elaboration of mechanism of observance of this stability.