USD/KZT 352.54 
EUR/KZT 415.15 
 KAZAKHSTAN International Business Magazine №3, 2002
 Issiue Deductibility of Interest on Foreign Currency Loans
Issiue Deductibility of Interest on Foreign Currency Loans
Bill J. Page, Partner Deloitte & Touche, Central Asia
Gaukhar Iskakbayeva, Senior Tax Manager Deloitte & Touche, Kazakhstan
On January 1, 2002, the Code of the Republic of Kazakhstan #209-11, Concerning Taxes and Other Obligatory Payments to the Budget, entered into force.
There are many positive changes in the new Tax Code including:
• Specification and detalization of taxable incomes and deductible expenses;
• Introduction of the concept of “tax agent”;
• Simplification of the Tax Treaty application procedure;
• Reduction of individual income tax rates;
• Introduction of “place of supply” rules for VAT purposes; and
• Introduction of the VAT registration threshold.
However, there are still a number of issues that require special attention of tax practitioners and financial management of the companies, for example:
• Tax treatment of transactions may be different from the treatment that applied prior to 2002;
• Provisions of the tax law are ambiguous in many cases;
• Tax treatment depends on the wording of the documentation that supports a transaction (not necessarily on the substance); and
• Different structuring can lead to substantial fluctuation of the tax burden on a taxpayer.
This is particularly true for the newly introduced limitations related to interest payable on foreign currency loans and financial leasing transactions.
Prior to 2002 the interest on foreign currency loans was deductible in the amounts not exceeding 2 LIBORs.
Now, in addition to 2 LIBOR limitation, there is an additional clause in the Tax Code stating that interest deduction should not exceed the actual amount of interest payable multiplied by the ratio of the income tax withholding rate on interest and the corporate income tax rate. This limits the interest deduction to half of the interest payable or even 1/3 in the case of interest payable to a lender in a treaty jurisdiction. The effect of this new restriction is to reduce tax deductions available to taxpayers other than financials institutions1 that borrow from foreign sources.
1 This restriction on interest deductions does not apply to financial institutions.
The structure of external borrowings of companies operating in Kazakhstan can be categorized as follows:
• Borrowings from local banks;
• Borrowings from foreign banks; and
• Borrowings from foreign companies.
Although the expansion of available credit in Kazakhstan has been mainly financed by domestic rather than foreign borrowings, the latter are vital for financing major developments in the industrial sector of the economy, since domestic banks do not have the resources to finance these transactions. The structure and quality of domestic banks’ loans have changed very little since January 1, 2002.
The additional limitations introduced under the Tax Code will negatively affect the ability to borrow from foreign lenders. This will heavily affect not only foreign businesses, but also major local companies that require loans from foreign sources.
On the other hand it is worth to make reference to the Foreign Investments Law, which states that foreign investments including providing loans shall be granted the terms that are not less favorable than those granted to local investors. Taking into account that sources of foreign currency loans are mostly foreign the new limitation on interest deduction in certain aspects contradicts the Foreign Investment Law. Amendments to the Foreign Investments Law will change the position in the future.
In addition the following negative consequences may occur:
• increasing of interest rates used by local banks as competition is reduced;
• decreasing of money supply in the country;
• weakening of local companies’ capability to create diversified borrowing portfolios (earlier with diversified borrowing portfolios local companies could minimize risks related to borrowing of funds, because they could borrow as from either abroad or locally); and
• deterioration of investment climate in the country (foreign borrowing is already low as a percentage of total borrowings).
Moreover, current world indicators on financial market development, particularly, such indicators like the ratio of the level of Brought Money to GDP and the ratio of Bank Credits to GDP will decrease; while these indicators are already too low in Kazakhstan in the opinion of experts. For example, Brought Money to GDP indicator stood at 15.3 percent at the end of 2000 (which is lower than the corresponding figures for emerging markets in Asia (79.9 % in South Korea and 105.9 % in Thailand), but also Russia (22.1%) and the Ukraine (18.1%).
Legislation of the other countries provides specific tax rules for interest on borrowings such as maximum debtequity ratios, limited deduction of interest paid to related parties; in some cases deduction may not be allowed for interest on back-to-back loans via third party financial institutions. However, the treatment of foreign and domestic loans is usually the same, whereas in Kazakhstan there is clearly now discrimination. Therefore in light of this and other negative consequences listed above we believe that the current status of the law on interest deduction should be carefully re-considered.

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