Leasing in Kazakhstan: Legal Aspects of Development
Tatyana Issyk, ?hairperson of the Kazakhstan Leasing Association Co-ordination Council
A maximum growth rate for gross domestic product is the main objective of economic development which, when achieved, will help the state to solve important social problems. However this growth should be accompanied by qualitative structural changes, including replacement of outdated fixed assets by new high-tech equipment. For Kazakhstan-which has been demonstrating high economic growth rates, leasing should become one of the basic mechanisms for realizing this task. Internationally, leasing is not just a crucial means of introducing new technologies, or renewing and increasing fixed assets, but also an effective way to stimulate business, ease social tensions, create additional jobs, attract investment, etc. In a government session on 8th August 2002, Kazakh President Nazarbayev stressed that leasing is acquiring a special importance as the form of business that best meets scientific and engineering progress requirements, and combines private and public interests harmoniously.
The history of the introduction of leasing in Kazakhstan can be divided into three stages. The first stage is characterized by the emergence of businesses and the institution of private property, which are crucial for the development of leasing. The second is the era of practical application of leasing in certain economic sectors. The third stage is marked by a number of basic legal and standard acts being passed, such as the Civil Code of Kazakhstan (Special Section) in 1999, the Law On Financial Leasing in 2000, and the Tax Code in 2001.As a result, seven private leasing companies are operating in Kazakhstan today; altogether the leasing portfolio comes to at least $200m on unofficial estimates. At the same time, the growing interest in creating new leasing companies both fosters demonopolisation of the Kazakh market in leasing services and makes leasing increasingly in demand as a financial instrument. It requires neither a large starting capital nor additional security, as the purchased rental property is also the property pledged.
Still, there are a number of problems exerting a negative influence on the development of domestic leasing and implementation of important state programmes in the field of import substitution and development of small businesses.
This is on top of all the problems related to the imperfection of Kazakh legislation on leasing. The latter needs amendments and corrections in order for it to meet international law provisions. It is also necessary to take measures to preserve and improve the institution of tax exemptions for all types of leasing. For this purpose, an identical approach is required in defining the terms ‘financial leasing’ and ‘interest on financial leasing’ in both taxation and civil legislation. There are clear terminological discrepancies in certain legal and regulatory acts; a number of the provisions that they contain should be either eliminated or amended.
Under the Civil Code of Kazakhstan and international provisions, leasing is a form of lease agreement (article 540 reads that: “property renting agreements also include leasing agreements”). However, for taxation purposes, the Tax Code of Kazakhstan considers leasing as a sale agreement (under article 74 “such a transaction is considered as a purchase of fixed assets by the lessee. The lessee is viewed as the owner of the fixed assets and the lease payments are viewed as payments under a loan provided to the lessee”), although the lessee has the option to purchase the rental property, or return it to the lessor. There are no grounds for this discrepancy between taxation and civil legislation, since leasing and sale transactions are equally subject to VAT and the taxable base is the same in both cases.
Although there are over 50 types of leasing, Kazakhstani legislation currently deals only with financial leasing. The Civil Code of Kazakhstan defines ‘leasing’ as financial leasing (article 565: “Under a leasing agreement the lessor undertakes to purchase the property indicated by the lessee from the seller, and rent this property to the lessee for temporary use and ownership of the property for business purposes and for an indicated payment”), which generally limits the possibilities of applying other types of leasing.
A type of leasing with wide international use at present is that in which, after the expiry of a lease agreement, the parties to the deal sign an agreement on replacing the outdated equipment by a new, more modern version. Although this type of leasing is very profitable-it allows constant replacement of fixed assets to make sure that they meet modern international standards-it cannot be used in Kazakhstan at the present time.
The problem is that, under the Law On Customs in the Republic of Kazakhstan of 20th July 1995, rental property is “property defined in compliance with the legislation of Kazakhstan on leasing and imported into Kazakhstan under a leasing agreement.” However, Kazakhstani legislation deals only with the concept of ‘financial leasing’ (provided in the Tax Code and Law On Financial Leasing), but the above type of transaction is not covered by this concept and the equipment replaced is not covered by the temporary import regimen provided for items on lease.
It should also be noted that tax legislation binds the lessee to buy up the rental property (article 74: “Transfer, under a leasing agreement signed in compliance with the legislation of the Republic of Kazakhstan, of fixed assets subject to depreciation is considered financial leasing if it meets the following requirements: 1) under the provisions of the leasing agreement the lessee receives the fixed assets into his property and/or receives the right to purchase the fixed assets at a fixed price.”), which contradicts the provisions of the civil law. This limits the rights that the parties possess under the Civil Code of Kazakhstan and the Law On Financial Leasing.
Yet another discrepancy of Kazakhstani legislation is the impossibility to use accelerated depreciation of leased items within the term of the corresponding agreement. This measure is used actively worldwide in order to promote introduction of new equipment. A small business entity will not be able to lease premises, since the depreciation coefficient of 8, provided for by the Kazakhstani Tax Code, will only allow purchase of these premises after 11 years, whereas the term of depreciation under a financial leasing agreement makes up at least 80% of the life-span of the rental property (article 74: “Transfer, under a leasing agreement signed in compliance with the legislation of the Republic of Kazakhstan, of fixed assets subject to depreciation is considered to be financial leasing if it meets the following requirements: 2) the term of financial leasing surpasses 80% of the useful life-span of the fixed assets.”) Given the existing annual interest rates of 20-25%, businessmen will have to pay double or triple the amount paid for real estate acquired in this way, as compared to simply purchasing it.
This restriction significantly impedes the development of real estate leasing including land, which is not subject to depreciation at all. This is because the purchase of certain premises also comprises the purchase of the land lot on which they stand, and that is impossible under the definition of leasing provided for by the Tax Code (article 74 reads that: “Transfer, under a leasing agreement signed in compliance with the legislation of the Republic of Kazakhstan, of fixed assets subject to depreciation is considered to be financial leasing.”)
Article 82 of the Tax Code holds that the following assets are not subject to depreciation:
• land lots;
• unfinished construction sites;
• uninstalled equipment;
• fixed assets and intangible assets which are not used by a taxpayer in production of goods, implementation of work or provision of services;
• a share in a legal entity under any form of ownership;
• fixed assets whose cost is fully charged to deductions under the tax legislation of the Republic of Kazakhstan effective until 1st January 2000;
• fixed assets commissioned beyond an investment project whose cost has been charged to deductions under articles 138-140 of the Code.
Therefore, land lots, unfinished construction sites, uninstalled equipment, etc. cannot be obtained through financial leasing.
It is crucial to introduce so-called ‘secondary leasing’ and to correct the definition of financial leasing as regards obligatory transfer to the lessee of the equipment previously purchased from the seller. This would facilitate the use of a flexible approach to purchasing equipment (seasonal, wholesale and other discounts offered by sellers; the possibility of taking account of production details, supply and demand of equipment in high demand, as well as the possible employment of professionals to select and purchase equipment). This will also help to save time during supply, pre-sale preparation and assembly of equipment. Potential lessees will have the chance to assess directly the quality of a product, its condition, technical characteristics, etc. The lessors may be able to purchase the leased items from certain suppliers at wholesale prices. As opposed to purchasing each unit through a specific order from the lessee, this approach will be more profitable for both lessors and lessees.
There are also certain restrictions in protecting the property rights of the lessor to the rental property and limiting the right of the lessor to withdraw the rental property in case the lessee acts in bad faith. Under article 48 of the Tax Code of Kazakhstan regulating decision-making on limitation of property disposal on account of a tax debt of a taxpayer, “in the event that the tax debt is not repaid within ten working days from the issue of an instruction to suspend expenditure transactions on the bank accounts of a legal entity, a limitation on disposing of property will be introduced on account of the tax debt. When a decision to limit the taxpayer’s disposal of the property under financial leasing and/or pledge is made, it is prohibited to withdraw this property and change the terms of the agreement from the time when the tax authority made its decision on this property until such time as it is cancelled.” Therefore, if the tax debtor is a lessee, the lessor cannot withdraw the rental property, even if the lessee fails to pay the rent provided for by the agreement and legislation.
On the other hand, if the lessor acts in bad faith regarding tax payments under the existing tax legislation, the lessee is limited in his ability to buy up the rental property.
In addition, the Law On Financial Leasing contains a number of discrepancies as regards the term of a lease and the point at which the property rights to the rental property are transferred from the lessor to the lesser, i.e. after expiry of the term of the leasing agreement, or after redemption of the rental property.
As regards the term of a lease, it should be noted that article 74 of the Tax Code of the Republic of Kazakhstan reads that: “Transfer of fixed assets subject to depreciation, under a leasing agreement signed in compliance with the legislation of the Republic of Kazakhstan, is considered to be financial leasing if it meets the following requirements: 2) the term of financial leasing does not exceed 80% of the useful life-span of the fixed assets.” At the same time, under the Law On Financial Leasing, the term for which the rental property is handed over to the lessee must either be proportional to the term of depreciating the total or the bulk (at least 80%) of the cost of the rental property, or exceed it.” Of course, this may seem relatively unimportant, but legislation must make everything absolutely clear.
As for transfer of property rights, under article 2 of the Law On Financial Leasing “the rental property becomes the property of the lessee after a leasing agreement expires, or earlier in the event that the lessee repays the full sum provided for by the leasing agreement, if the leasing agreement provides for this measure.” However, under article 5 of the same law “the property rights to the rental property passed into temporary ownership and use by the lessee is retained by the lessor for the entire term of validity of the leasing agreement.”
It should be stressed in connection with all this, that the above term of depreciation limits the rights of the lessee to early redemption of the rental property. If the term is less than 80%, a state authority controlling this type of transaction could claim that this is not financial leasing, but a sale or other type of agreement. Therefore, the parties have to extend the term of the lease agreement, whereas they have the right to define this term independently under the Civil Code of Kazakhstan.
In addition, the legislation does not strictly define the point at which risks related to the transfer of the right to own and use rental property are assumed by the lessee. Either this transfer of risks is carried out after entry into, or reception of, the rental property (as common sense and business rules dictate), or in compliance with the law from the time of registering a leasing agreement (article 5 reads that: “the right to temporary ownership and use of rental property is transferred to the lessee in full after state registration of the leasing agreement.”)
Yet another problem arising when effecting a number of leasing transactions (for instance, international or reversionary leasing) is double taxation of the rental property when paying VAT. This is a heavy burden on the lessee, increasing the cost of rental property by 32%, which of course does not encourage the development of small and medium sized businesses in the country.
It is also unclear why the use of leasing should be limited to purely business purposes. Under article 565 of the Civil Code of Kazakhstan, “under a leasing agreement the lessor undertakes to purchase the facility to be leased for business purposes.”
For unknown reasons, point 9 of article 140, which concerns possible issue of a court award on leasing agreements, has been eliminated from the Civil and Procedural Code (the version effective before the amendments of 11th July 2001). This considerably narrowed the opportunities of a lessor to withdraw rental property lawfully from a neglectful lessee. As a result, though the lessor retains the ownership right to rental property, he will have to appeal to court and pay 3% of the claim amount to withdraw the rental property from the lessee who acted in bad faith (leasing is as a rule an option for purchasing expensive equipment). What then is the use of the constitutional article declaring ‘the inviolability of property rights’?
There are also certain problems with registering rental property with customs. Only the rental units listed by the government of Kazakhstan are covered by the temporary import regimen. However the list (governmental enactment #1092 of 21st August 2001) is clearly incomplete, for some 80% of imported equipment is not produced in Kazakhstan. In addition, customs legislation does not regulate temporary import for sublease, the opportunity of redeeming the rental property at its residual value, payment of customs duties at this residual value, etc.
It is also necessary to consider ratification of the UNIDROIT Convention on International Financial Leasing (Ottawa, 28th May 1988), which will provide foreign investors with essential guarantees when effecting leasing transactions in Kazakhstan.
Given that socio-economic reforms are a crucial direction of state policy, the members of the Kazakhstani Leasing association believe it is necessary to make corresponding amendments and corrections to the legal and regulatory acts regulating leasing relationships, while making maximum use of the experience accumulated by Kazakh specialists studying leasing who are familiar with the practical aspects of its development.
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