John BONjovy (junior)
almaty, May 26
(Specially for THE GLOBE for the Investment Summit)
A general decline in the attractiveness of the mineral and raw material sector of economy of the Republic, and of the Republic as a whole has been noticed by the Government, the Agency on Investments and financial bodies. The falling number of direct investments has led to a noticeable decline in the flow of direct and non-direct revenues to the State budget. While the Government and the Agency on Investments continue declaring their intentions to ease the severity of the tax regime, they simultaneously undertake concrete measures to further toughen that regime - therefore reducing the attractiveness of the state for investment.
The essence of these measures is represented by the law �On the introduction of regular amendments and additions to the Decree by the President of the Republic of Kazakhstan, having the power of law, On taxes and other obligatory payments to budget� # 355-1 ZRK and # 356-1 on March 31 1999. According to these amendments, the amount of payments for road and social foundations, the usage of land, and transport taxes were all slightly increased.
Especially important for investors was the introduction of a ban on deducting of interest payments on loans. The capitalization of these with consequent and compensation by means of amortization deduction which significantly increases the indexes of financial risks on projects. In a more disguised form, through taxation articles of contracts, the mechanism of exacting taxes on super-profits was also changed. For reasons of �simplification�, the extra tax is no longer assessed upon the amounts exceeding what are considered a �normal profit�, but on the net profit. The differentiated rate of royalty is now treated not as an increase of the rate that exceeds of agreed volume of product mined in the current year, but as the whole annual volume of product mined. The calculations show that the aforementioned recent amendments in the legislation on taxation lead to a decline of the profitability of projects of 1.5 to 2.0 percent.
Especially important for investors was the introduction of a ban on deducting of interest payments on loans
An extremely negative attitude of investors was noticed toward fashionable bureaucratic �monitoring� ideas of the Government. In addition to the legalized routine supervision and monitoring by tax inspectors, environment services, and the whole economic account in the state bodies of statistics; additional accounting and monitoring procedures were introduced for investors by the Ministry of Energy, Industry and Trade, the Ministry of the State Revenues, and as it appears from the report by the Chairman of the Agency on Investments A. Saydenov, by that Agency too. According to the Law on the State Statistics, all information needed for state bodies is to be submitted to the statistical bodies only once. The restrictions and additional payments being introduced by the Government on the hiring of foreign specialists and labor force by investors, the legislative rule on the obligatory sale of 50 percent of currency gain, stumbling stones and problems with compensation of the taxes for additional value in the case of export of goods to the external markets all have additional negative impacts upon the attractiveness of the Republic for investments.
Based upon the aforementioned problems and taking into account both the demand of the World�s raw materials markets and the real situation in the economy of the Republic of Kazakhstan, one could assert that the real attraction of the direct investments to the mineral and raw material complex of the Republic is being impeded by the inflexible actions of the Government. A financial investment into the exploration and development of the mineral and raw material base of the Republic of Kazakhstan is not currently justified from an economy in the overwhelming majority of cases.
Foreign investors very often reasonably point out that some of the above-mentioned negative features of the investment climate in the Republic were not reported at the numerous presentations in London, Houston, Dallas, San Diego, Tokyo and other events. The information was either deliberately hushed by the Heads of branches and of Government or not known by incompetent representatives of other states who participated in the presentations of the Republic.
Considering the negative medium-term forecasts in the demand for mineral and raw material good, one could confidently predict both a significant decline in the investment activity in that branch of economy and the closure of a number operations and cancellations of contracts to development of mineral reserves. To ease the negative impact the Government must undertake preventive measures by improving the legislation and decreasing the nonobjective tax and bureaucratic impact on users of mineral reserves and potential investors.
The legislative, legal and fiscal bases for the preparation and monitoring of the Contracts with Users of Mineral Reserves in the Republic of Kazakhstan are mainly worked out. Higher quality contract documentation must be prepared and the implementation of projects and of contract agreements must be better monitored. At the same time it should be noted that in the legislative base, Decrees by Government and regulatory bodies remain a whole row of well known barriers to investor activity; not only in the mineral and raw material sector but for any industrial activity in the state.
These include:
1. Lack of stability in the legislative and taxation regimes, contradictions and possibility for different treatment in some regulations and articles, the frequent changing and unspecified number and powers of (competent) supervising State bodies of management and control over the submission of the contract documentation and implementation of projects. The bureaucratisation and poor quality of state servants in the new branches of the market economy, features of corruption and forcing of bribes in the different levels of interaction with bodies of state management and control
2. Lack of distinct clear, understandable and developed system of regulation of the process of realisation of the projects of users of mineral reserves.
3. Lack of developed, methodical recommendations on a whole set of key issues in the preparation and monitoring of the economic indexes of projects, on the techniques for transfer of the enterprises under operation on a contract basis from a planned economy to market one.
4. Poor quality of specialists of the design institutes, of local consulting companies, of experts of the governmental bodies on the issues of market economy and tax regime.
5. The principal contradictions currently existing between the systems of taxation and bookkeeper accounting.
...one could assert that the real attraction of the direct investments ... is being impeded by the inflexible actions of the Government
The most concrete examples of poor system of preparing the contract documentation include:
1. The unique CIS practice of requiring payment for access to preliminary geological information needed to prepare contract documentation has been adopted in the Republic. In some occasions, the payment charged by the Ministry of Ecology and Mineral Resources has come to hundreds of thousands or even millions of dollars, which is a significant barrier for potential investors. Usually the state is interested in attracting significant means into the prospecting and development of its own mineral resources, the establishment of additional working places and the purchase of geological and other information from private firms for common usage. This is justified by the increased inflow into state revenues from production activity compared with the money received from the initial information. In the Republic of Kazakhstan, a reverse approach is employed and a geology information is used in the narrow sectors but not in the state interest. In the appendix 1 is presented a comparison of regimes in taxation and among the other Asian republics of CIS, showing the unique position of Kazakhstan in the issues of presentation of the geological information for attraction of an investment means and development of economy. Claims that information on Kazakhstan is being provided by the former All union Geology Fund (Moscow) are not objective in the strategic sense. The ready and inexpensive distribution from Russian Federation of the information necessary for potential investors to Kazakhstan could be regarded as indirect, but substantial assistance to the Republic in attracting investors. The Kazakh government continues to lack an understanding of the essence of this question.
2. The simultaneous usage of the License and Contract systems of regulation in the activity mining companies brings about a whole row of contradictions. According to the International Law, a single document should have juridical force on a single subject. In Kazakhstan�s case, there are two of them. A license could be regarded as an agreement of intentions, but in the regulations of former Ministry of Geology, in the article on Licensing, licenses have priority over Contracts. A Contract cannot contradict the articles of a license. However, in the preparatory stage of a license the informational base needed to work out the main items of a project is often lacking. A wide number of illegal payments and obligations by users of mineral reserves are usually included into a licence upon State bodies initiative. These include the financing of informational systems, the construction of presentation centres, the training of specialists who are not involved with the enterprise, payment to local bodies for the development of infrastructure, a specified royalty payment, other financial and economic obligations, etc. All these additional requests are a form of additional duties and contradict Article 2 of the Decree by the President �On Taxes and Other Obligatory Payment to Budget.� As practice shows, the content of some requirements of a Licence are observed in the final contract in rather rare occasions. All that adds more difficulties to projects realisation.
3. The insufficient working out and senselessness of some items in legislation on taxation bring about significant uncertainty and difficulties. In particular, the requirement for compensation of historical expenditures in essence has no sense. There are no examples of its application in the tax legislation of other countries. For example: expenses for prospecting could surpass by many times the cost of the resources discovered. In mining enterprises under operation the residual reserves of minerals could be less then expenditures for prospecting and development of the deposit and the creation of production and social infrastructure. Examples of such a contradiction are present virtually in all contracts and the payments for compensation of historical expenditures are usually arbitrarily set, depending on the viewpoint of certain state officials. However due to limits in the profitable part of projects, the increase in some part of payments results in a corresponding reduction in others (royalty, bonuses etc).
4. In accordance with the legislation in taxes, a user of mineral reserves pays more than 20 taxes and obligatory duties of different kinds. Whereas at working out of contract documentation and carrying out of a tax expertise in rare occasion the most important fact to be taken into consideration is that the amount of tax revenues on project is limited and fixed. Increasing the amount of taxes didn�t lead to an increase of revenues to budget, but only made more complex the general situation and financial accounting. Increasing in the tax burden over extreme evaluations which are determined by estimated internal rate of profit, simply stops investments into this project or into operating enterprise. For this reason the tax collection could be set in the limit of the only tax - for example by the article on profit on the tax on profit. Similar examples of tax systems exist in the World practice.
5. The legal ban on the possibility for capitalization of losses on Tax on Additional Value on the stages of prospecting and preparation for mining of mineral resources leads to significant increases of the indexes of financial risk for investors and to significant reductions in internal rate of profit � thus potentially endangering the project. This fact is not taken into consideration upon the assessment of individual tax rates for every mining project.
6. A substantial difference was noticed in the approach to the preparation of contract documentation among foreign and Kazakhstani users of mineral reserves. Foreign investors, especially major oil and mining companies are extremely careful in the working out of financial and economic obligations of Contract and of the economic model of project specifying the regime in taxes, trying to keep strictly with legislation requirements. The users of mineral reserves of Kazakhstan very often ignore the economical and marketing aspects of project or regard these just as formal ones. When supervised by the state bodies management and upon carrying out of tax expertise, these issues are often considered on a formal level as well. It is especially characteristic for the mining projects. As a result, in most occasions the Licences and Contracts issued turned out to be stillborn and unrealisable ones. The user of mineral reserves became unable to get credit resources nor even to realise (sell) his rights to sufficiently profitable properties. As a result wide number of properties (deposits of mineral reserves) were just removed from the turnover and development. According to a rough estimate, this number amounts to much more than 50 percent of the Licences issued and Contracts signed.
Increasing the amount of taxes didn�t lead to an increase of revenues to budget, but only made more complex the general situation and financial accounting
7. Until now an economic scheme to transfer the operations of mining enterprises to the Market and on a Contract basis. This eventually results in well-known consequences such as problems in finance and a re-concession of rights, mortgage of propriety, concealing of income and violations of tax legislation.
8. Enterprises in the mineral and raw material sector which supply their products to the domestic market are much more vulnerable to discrimination compared to exporters of raw materials. The most acute impact is felt by the enterprises of the oil industry, which are forced to supply their products for much lower prices of the domestic market. Additionally, these firms must pay the 20 percent VAT of gross sales and until recently excise duty of 3 ECU per tonne.
In order to a make more accurate summary of aforementioned, one must once again take into consideration the particularities of the investment climate in the Republic. (THE GLOBE has already remarked about these facts in its publications). Throughout the last 8 years, in spite of the continued active prospecting there were no information on the discoveries of new large or middle sized mineral deposits. The major potential of raw materials of the State is concentrated in the limited number of large deposits in which the development is economically justified. Among those are 11 oilfields with total recoverable reserves of 95 percent of the total prospected. As to the mineral ore reserves, the list includes some 30 deposits where are concentrated up to 80 percent of the prospected mineral potential of the country. At present virtually all major prospected fields have been transferred (either privatized or the management handed over) to private companies. The State has only managed to retain a significant share in a few of them. Thus the main potential for investment of mineral and raw material sector of the state economics is exhausted and a significant time interval is needed for research, prospecting and the development of new deposits and oilfields.
The contract conditions on the transfer of large properties to investors were worked out based upon individual schemes and individual terms on taxation, which differ from the current tax legislation. The information on subscribed bonuses and economic terms of large contracts of user of mineral reserves is classified.
Numerous Contracts of users of mineral reserves on small and middle sized properties, the preparation and signing of which is continuing, were prepared in the framework of the incumbent tax legislation and regime. According to the requirement of the Ministry of Finance, when applying variable components of tax regime on investors the established norm of profit was 14 to 18 percent. If positive changes in the prices of the market occur, or new highly efficient technologies are applied which substantially improve the economic indexes of projects, a tax on super profits was applied. This tax was applied on the portion on profit surpassing of the norm of profitability specified at the level of 20 percent.
The prices for the main raw material goods have steadily declined for many years. The main economic index of Contracts signed on raw materials that is the Internal Norm of Profitability, has declined sharply to 8 to 10 percent and is much lower than the credit rating BB- assigned to the Republic and also lower the refinancing rates of the National Bank, the State Short-Termed Obligations and Euro obligations. These rates consist of 22 to 24.5 percent, making investments into the projects of user of mineral reserves an uncompetitive and economically inefficient business. Apparently under such circumstances, only estimated profits higher than 24 to 25 percent would be of interest for investors into small and middle-sized deposits or fields.
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