Recently, many companies operating in Kazakhstan, including in subsoil usage, have encountered new local content legal requirements when procuring goods, works and services. This article discusses legal regulation of local content and proposed amendments to law on this matter. This subject will only grow in important, given the Kazakhstan government’s policies of import substitution and increasing the volume of goods, works and services purchased by investors in Kazakhstan.
What is “Kazakhstan content”?
The term “Kazakhstan content” refers to a level of goods, works and services of Kazakhstan origin, purchased from Kazakhstan companies, and specified in investment contracts, subsoil usage contracts, or the law. Kazakhstan content also includes the percentage of Kazakhstan employees that should be employed in a project. Before these legal requirements entered force, Kazakhstan content requirements for investors were specified in investment contracts and subsoil usage contracts. Contracts determined either a percentage ratio of goods, works and services of Kazakhstan and foreign origin, or, more frequently, provided a general obligation to prefer goods, works and services of Kazakhstan origin without specifying a percentage.
There have previously been legal requirements supporting domestic producers, however, these rules only applied to purchases within the scope of the Law on State Procurements, that is, procurements by state agencies, state enterprises, state institutions, or legal entities owned by the state. Local content rules for investors were only introduced in 2004, when the RoK Law on Subsoil and Subsoil Usage included definitions of “Kazakhstan content”, “Kazakhstan producer”, and “Kazakhstan origin”. Subsequent legislation has gradually established new rules strengthening control over compliance with local content rules. As the numerous subsoil usage contracts concluded before these rules were enacted did not specify actual percentage ratios of Kazakhstan and foreign goods, works and services, at the beginning of 2009 the state authority for subsoil usage (RoK Ministry of Energy and Mineral Resources) began the process of amending subsoil usage contracts. The purpose of the amendments is to establish a clear percentage ration between Kazakhstan and foreign goods, works and services, and the percentage of Kazakhstan employees to be employed in projects. Although most subsoil using companies have agreed to the amendments, some companies have rejected the amendments, given the stabilization of the legislative regulation of their contracts.
Kazakhstan content is governed by several laws: the Law on Subsoil and Subsoil Usage, Law on State Procurement, and the Law on the National Wealth Fund. The Government has also approved a number of secondary acts to provide more detailed regulation on this matter.
The Kazakhstan content rules can be divided into three categories:
a) Kazakhstan content requirements for subsoil usage operations;
b) Kazakhstan content requirements for procurements by state authorities, state institutions, and legal entities in which the state owns 50 percent or more shares, and their affiliates; and
c) Kazakhstan content requirements for procurements by companies affiliated with Samruk-Kazyna.
The law provides different procurement rules for each of these three categories.
The general requirements for Kazakhstan content in subsoil usage are primary contained in the RoK Law on Subsoil and Subsoil Usage.
The Law on Subsoil and Subsoil Usage defines the terms “Kazakhstan content”, “Kazakhstan producer”, etc. Kazakhstan producers are natural persons and legal entities of the Republic of Kazakhstan that produce goods, works, or services of Kazakhstan origin. Kazakhstan origin means production of goods, works or services in the Republic of Kazakhstan by natural persons or legal entities of the Republic of Kazakhstan. Recently, the term “good of Kazakhstan origin” was added to the Law on Subsoil and Subsoil Usages, meaning a good certified as produced in the Republic of Kazakhstan.
Art. 63.1 of the Law on Subsoil and Subsoil Usage contains mandatory requirements for subsoil users to use equipment, materials and finished products made in Kazakhstan, provided they comply with Republic of Kazakhstan technical regulations. Subsoil users must also engage Kazakhstan organizations to perform works and services during subsoil usage, including air, rail, water and other forms of transportation, provided such services correspond to the standards, prices, and quality characteristics for such services provided by non-residents of the Republic of Kazakhstan. These provisions therefore allow subsoil users to avoid purchasing Kazakhstan goods, works, and services if they do not conform to technical regulations, or meet the standards, price, and quality criteria for such goods, works, and services.
In accordance with art. 63-2 of the Law on Subsoil and Subsoil Usage, a contractor and its subcontractors engaged in subsoil usage in the Republic of Kazakhstan are required to purchase goods, works and services from Kazakhstan producers. Unlike art. 63.1, described above, this provision obligates subsoil users to purchase goods, works and services from Kazakhstan producers without allowing for such purchases to be rejected on the basis of quality, price, or other reasons.
The Law on Subsoil and Subsoil Use grants considerable advantages to Kazakhstan companies when bidding against foreign companies and their Kazakhstan branches in tenders. The tender organizer must reduce the price offered by Kazakhstan bidders by 20 percent, provided their goods, works and services correspond to the tender requirements and Republic of Kazakhstan technical regulations law.
In our view, the tender discount rule has certain drawbacks. First, the discounted price in no way means the goods, works, or services will actually be purchased by the subsoil user at the lower price. In fact, where a Kazakhstan and a foreign company submit bids in which the actual price of the Kazakhstan good is higher, the subsoil user may be forced by the discounted price to purchase the good from the Kazakhstan producer at a price is actually higher than that offered by the foreign company. Second, the use of the purchase of the cheapest good is not a criterion for ensuring the purchase of quality goods, as quality is not the decisive criterion in determining the tender winner. If the investor buys poor quality goods it may end up with additional expenses to repair or replace such equipment.
The procedure for subsoil users to purchase goods, works, and services is governed by the Rules on Purchasing Goods, Works and Services for Subsoil Usage, approved by Government Resolution No. 1139 of November 28, 2007. The Rules on Purchasing Goods, Works, and Services for Subsoil Usage provide that in certain circumstances goods, works, and services may be purchased from a single source, for example, if the goods, works and services can only be purchased from a specific supplier (Kazakhstan or foreign).
The requirements of the Law on Subsoil and Subsoil Usage and the Rules on Purchasing Goods, Works and Services for Subsoil Usages do not apply to subsoil users in which Samruk-Kazyna holds 50 percent or more shares, directly or indirectly. The purchase of goods, works or services by such companies is governed by special rules (see below).
State authorities, state institutions, legal entities in which the state owns 50 percent or more shares, and their affiliates, are required to purchase goods, works, and services in accordance with the RoK Law on State Procurements. It is expressly established that the Law on State Procurements does not apply to national management holdings, national companies, and their affiliates. Procurements by these companies are governed by the Law on the National Wealth Fund, and the rules described below. The Law on State Procurements defines a “domestic supplier of goods and services” as a natural person or legal entity that is a Kazakhstan resident, and which employs at least 95% local workers to supply the goods and services. “Domestic manufacturers” are Kazakhstan residents producing goods entirely made in Kazakhstan, or goods sufficiently processed in Kazakhstan in accordance with the sufficient processing requirements. A Kazakhstan resident is a legal entity founded in accordance with Kazakhstan law.
Under art. 26.5 of the Law on State Procurements, if the prices are equal the tender winner is the domestic goods manufacturer, or domestic supplier of goods and services.
As can be seen above, the conceptual framework of the Law on State Procurements concerning local content differs considerably from that in the Law on Subsoil and Subsoil Usage. The differences in terminology and definitions of Kazakhstan content are to be resolved by amendments to a number of laws, including the Law on State Procurements.
Kazakhstan content in procurements by Samruk-Kazyna companies
In accordance with the RoK Law on the National Wealth Fund, the Government of Kazakhstan is the sole shareholder in the National Wealth Fund. The Government has transferred to Samruk-Kazyna shares and equity in most companies owned by the state (such as National Company KazMunayGaz).
As noted above, the national management holdings, national companies and organizations in which the fund holds 50 percent or more shares, directly or indirectly, are subject to a special procedure for procuring goods, works, and services. Purchases by such companies are made on the basis of the Consolidated Procurement Rules of Samruk-Kazyna and legal entities in which Samruk-Kazyna holds fifty percent or more shares, directly or indirectly.
The Consolidated Procurement Rules, like the Law on Subsoil and Subsoil Usage and the Law on State Procurements, contain certain provisions favoring Kazakhstan companies over foreign companies in tenders. However, unlike the Law on Subsoil and Subsoil Usage, and the Law on State Procurements, the Consolidated Rules may reduce or increase the starting price, depending on the situation. If the potential supplier is a domestic manufacturer in the register of the fund’s group, the price is reduced by 10%. The price is reduced by 1% for each 10% of Kazakhstan content in the potential supplier of goods, works, and services. The Consolidated Rules provide other cases in which the price may be increased or reduced. The Consolidated Rules therefore allow for greater flexibility in determining the winner of the tender than the Law on Subsoil and Subsoil Usage and the Law on State Procurements.
The Consolidated Rules provide that the winner of an open tender is determined on the basis of the lowest price offered. If the bid prices are the same, the domestic manufacturer is the winner. However, unlike the Law on State Procurements, if the price of works or services is the same, the winner is the potential supplier with the greatest experience supplying the works and services, i.e., there is no requirement concerning domestic suppliers.
Calculating Kazakhstan content
In order to improve regulation and monitoring of Kazakhstan content in the purchase of goods, works and services, in March 2009 the Government approved the Uniform Method for Calculation by Organizations of Kazakhstan Content when Purchasing Goods, Works, and Services. This method applies to all purchases under the Law on Subsoil and Subsoil Usage, Law on State Procurements, and purchases by companies in the Samruk-Kazyna group.
According to the method, the more Kazakhstan employees are involved, and the more goods, works, and services are purchased from domestic producers, the greater the Kazakhstan content. Therefore, hiring Kazakhstan staff and purchasing domestic products increases the chances of winning tenders.
Amendments to various laws on Kazakhstan content were submitted to Parliament in 2009. The principal aims of the amendments are to make legislation on Kazakhstan content consistent, reinforce state supervision of compliance with Kazakhstan content requirements, and to increase the penalties for violating Kazakhstan content rules in purchases of goods, works and services. In particular, proposed amendments to the Administrative Penal Code establish penalties for violation of Kazakhstan content requirements by national holdings, national companies and organizations in which national holdings or national companies own 50 percent or more shares, directly or indirectly. Proposed amendments to the Law on Subsoil and Subsoil Usage revise the definitions of “goods of Kazakhstan origin”, “Kazakhstan content”, etc, and introduce a requirement for submission of an annual goods, works and services procurement program, and quarterly reports on its implementation, to the competent authority. Provisions are also to be introduced so that expenditure on the purchase of goods, works and services in tenders outside Kazakhstan, and in tenders declared invalid, will not be considered as performance of contractual obligations, and such expenses will not be compensated. Amendments will also be made to the Law on State Procurements, Law on Joint Stock Companies, and the Law on Private Entrepreneurship.
The amendments to the Law on Subsoil and Subsoil Usage concerning Kazakhstan content that are currently under consideration in Parliament are particularly noteworthy. The new draft law focuses on securing state interests with regard to Kazakhstan content. The draft law provides for establishing minimum requirements for Kazakhstan content when concluding subsoil usage contracts. Furthermore, when transitioning from exploration to extraction the competent state authority is entitled to unilaterally set requirements for Kazakhstan content with regard to goods, works, and services. If the contractor rejects these requirements it loses its preferential right to the extraction contract. The draft law as a whole is intended to provide more detailed and stricter regulation of Kazakhstan content.
Kazakhstan content law is developing quickly. Work is in process to consolidate the legislative and regulatory framework; more detailed rules and regulations are being introduced. However, despite the considerable changes in law, at present Kazakhstan industry is not capable of supplying a full range of goods that meet international quality and safety requirements. Goods produced in Kazakhstan are frequently either unable to meet the standards customers require, or are more expensive than equivalent foreign goods, which has a significant impact on the customer’s expenses.
Thus, it is necessary to consider improving the quality of Kazakhstan goods, works and services, as well as amendments to the law.
This article is provided by International Law Firm Salans