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PSA Developments Greeted With Moderate Optimism - International Law Office

International Law Office

Projects & Procurement - Russia

PSA Developments Greeted With Moderate Optimism

March 05 2002

Tax Developments
Recoverable Costs
Other Developments

Production sharing agreements (PSAs) are widely viewed as one of the more attractive investment vehicles in the petroleum sector, and have been formally adopted in Russia. The implementing legislation, which has been found to be greatly inadequate by both potential and actual investors, is finally showing signs of positive development.

To date, the Russian Federation Law on Production Sharing Agreements (Law FZ-225 of December 30 1995) has done remarkably little to attract foreign investment and technology into the Russian petroleum sector. Indeed, past amendments to the PSA Law and related legislation since 1996 have probably made PSAs less attractive to foreign capital.

However, in recent months some positive trends have emerged: legislation and normative acts relating to PSAs have become more rational and, taken as a whole, can be considered a step forward.

Tax Developments

First, the second part of the new Russian Federation Tax Code abolished a variety of tax-related normative acts, and clarified issues surrounding the payment of VAT and excise taxes for parties to a PSA. In particular, Article 178 of the Tax Code now confirms the right of parties to a PSA to pay expenditures (contractual costs) to suppliers and contractors free of VAT. Where VAT was paid (eg, where a contractor insisted despite the new Tax Code), Article 178 requires the state to refund the VAT payment promptly. Second, Article 206 of the Tax Code confirms the exemption from the excise tax on hydrocarbons. Although both of these benefits were purportedly available under the PSA Law before the adoption of the new Tax Code, the tax inspectorates and tax agents often refused to honour them in practice.

After the Federal Law on Amendments to the Federal Law on Production Sharing Agreements (Law 75-FZ of June 18 2001) was signed and came into force on June 23 2001, the PSA Law was brought into conformity with the Tax Code. Thus, the current version eliminates in-kind (ie, hydrocarbon) payments to the state for profit taxes. Moreover, the procedure for payment of VAT and excise taxes is currently covered exclusively by norms of the Tax Code.

Recoverable Costs

Also of interest is an attempt to deal with a consistent criticism of the PSA Law - a lack of clarity on what constitutes 'recoverable costs'. Production to be shared between the host government and the investor is usually divided into 'cost oil' and 'profit oil' (or 'compensation production' and 'profit production', in the terminology of the PSA Law). The investor recovers its costs from the sale of compensation production, and then the investor and the host government share in a percentage of the remaining profit production. Article 8.2 of the PSA Law addresses the investor's right to compensation production; the criticism is largely centred on the lack of normative acts interpreting and directing the bureaucracy in relation to the compensation production. While the PSA Amendment Law does not provide additional procedural guidance, it does provide for an alternative sharing of the production from a PSA hydrocarbon field, in which all production would be shared. In that case, the investor would be exempted from all taxes, except for the Unified Social Tax (Article 13.1 of the PSA Law). So far, investor reaction to this innovation is difficult to gauge.

Other Developments

Other developments of note include the ability to 'convert' a licence (non-PSA) arrangement for subsoil use into a PSA, even if the licence was granted after the PSA Law came into effect. Previously, only arrangements predating the PSA Law could be 'grandfathered' into PSAs.

Finally, the Russian government recently adopted Regulation 1155-r, which appoints the State Unitary Enterprise "Russian Foreign Trade Amalgamation 'Zarubezhneft'" and the state owned Open Joint Stock Company "Oil Company 'Rosneft'" as the authorized bodies to assist in securing the interests of the Russian Federation in preparing and implementing PSAs with respect to subsoil plots and hydrocarbon deposits. The framework for such preparation and implementation will be established through agreements between these two companies and the Russian Anti-monopoly, Finance, Energy, Natural Resources and Economic Development Ministries. Critics have noted that the representation by Rosneft and Zarubezhneft could create conflicts (since they also participate as parties to PSAs), although the regulation bans Rosneft and Zarubezhneft from representing the government in PSAs to which they are parties.

Therefore, despite continuing wariness by investors, the latest legislative initiatives on PSAs are at least cause for optimism.

For further information on this topic please contact Shane DeBeer at Chadbourne & Parke by telephone (+7 095 974 2424) or by fax (+7 095 974 2425) or by email (sdebeer@chadbourne.com).

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