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Legislation

Tax Issues in Financing of Oil and Gas Projects in Kazakhstan

Andrey Kudyarov, LLM (Leiden),Tax Manager, PwC

Renata Adilova, Tax Consultant, PwC

Kazakhstan is well known for its substantial oil and gas reserves. Currently, there are more than 200 oil and gas fields in Kazakhstan and more to follow. The successful exploration and development of the fields requires significant initial capital investments which could be obtained via internal or external debt financing.

This article covers major tax issues to consider in internal debt financing of oil and gas projects in Kazakhstan, but it is also relevant for the external debt as well. It describes key tax issues to consider and discuss some ideas to create a tax efficient structure of financing in Kazakhstan from a Kazakhstan tax perspective.

Introduction

Many current structures for certain exploration and development projects were set before the current Tax Code was enacted in 2009. In that times lot of oil and gas projects usually involve an offshore parent company located in currently black-listed tax heavens[1] (like British Virgin Islands or Channel Isles) providing an internal debt-financing to its subsidiary located in Kazakhstan for the exploration and extraction stage. These subsidiaries are extremely leveraged: usually with minimum equity and huge debt (for example nominal amount of USD 500 as equity and USD 50m as debt). Generally, there are no interest payments until the production stage and sometimes debt is non-interest bearing or the price of the debt is below arm’s length.

The majority of such set-ups are not tax efficient due to current anti-avoidance and subsurface use related provisions in the tax legislation of Kazakhstan. These include following:

- Limited deductibility (if any) of interest for the corporate income tax (CIT) purposes and excess profits tax (at a rate up to 60%);

- Withholding tax on the interest;

- Pricing of the debt.

Timing of the deduction

Costs related to geological studies, exploration and preparatory operations before the production stage[2] cannot be deducted as incurred. Instead such costs form a separate pool of depreciable assets (pool), which are deducted from the aggregate annual income in the form of depreciation charges when the production starts. In other words, interest expense together with other abovementioned costs are capitalized and further depreciated by applying depreciation rates determined by the subsurface user, however, such rate shall not exceed 25 % per year. At the same time interest that would be capitalized in the pool is subject to thin capitalization and transfer pricing as discussed below. Interest accrued after the moment when the production stage starts can be deducted as incurred.