Kazakhstani Сontent in Procurement of Subsoil Users
Yerbolat Yerkebulanov, Senior Lawyer, Dariya Saginova, Junior Lawyer GRATA Law Firm
During the recent one and a half year we could view a sharp increase in the interest of subsoil users and their contractors to the issues of Kazakhstani content in the procurement of goods, works and services. In the first instance it is connected with changes of subsoil and subsoil use legislation, as well as with toughening of the policy held by the Kazakhstan Government with regard to development of Kazakhstani content.
It is worth noting that at the international level the term similar in the meaning of 'Kazakhstani content' is already known among subsoil users for several decades as the ‘local content’. In general, this term refers to the use and development of local production and labour force, as well as technology transfer. Such development is ensured through the creation of legal mechanisms obliging subsoil users to use local goods, works and services in their operations, as well as to increase the proportion of local employees in their staff and staff of their contractors. We will consider in this article how the ‘local content’ provisions are applied in the Republic of Kazakhstan.
Strictlyspeaking, the term 'Kazakhstani content' was first introduced to the subsoil and subsoil use legislation on 1 December 2004 together with the terms 'Kazakhstani manufacturer' and 'Kazakhstani origin’ (goods, works and services of Kazakhstani origin). However, until the adoption of the Law on Introduction of Amendments to Some Legislative Acts of the Republic of Kazakhstan on Kazakhstani Content Issues, dated 29 December 2009 (unofficially called 'Kazakhstani Content Law'), this term did not raise much attention, since the Kazakhstani content provisions were essentially declaratory by nature.
In particular, despite the fact that the rules for purchasing goods, works and services ('GWS') by subsoil users were first approved by the Governmental Decree in the summer of 2002, the majority of subsoil users did not apply these Rules and kept purchasing GWS at their discretion.
However, since the enactment of the Kazakhstani Content Law the rules of the game between the Government and subsoil users changed dramatically. Such a change is, for instance, reflected in the fact that since the second half of 2010, the vast majority of subsoil users proceeded to the GWS purchases under the state-regulated procedure.
We would like to give our view with respect to the causes of such developments. It is not a secret that the total investments of subsoil users in Kazakhstani economy amount to a significant sum. In the meantime, the mass media repeatedly gave examples that some subsoil users procured GWS from abroad at prices several times higher than the cost of similar GWS at the local market. It turned out that such subsoil users got the advantage twice or even triply.
First, they got the opportunity to purchase GWS from foreign companies, which are often registered in the same country as of the subsoil users (i.e. the funds did not go to the development of local content). Second, all such expenses were considered as execution of investment commitments under their contracts. And third, after commencing production operations, such subsoil users had the opportunity not to pay higher taxes for the amount of investments. Accordingly, the subsoil users had a direct interest to overstate their expenses in all ways at the exploration stage. In our view, the amendments introduced to the subsoil use legislation were adopted to prevent this trend.
Basic Concepts and Effect of the Law in Time
First of all, the Kazakhstani Content Law introduced the following concepts:
· registry of goods, works and services used in subsoil operations;
· Kazakhstani content in works, services;
· Kazakhstani producer of works, services;
Almost all these concepts have unaltered 'migrated' into the current Law on Subsoil and Subsoil Use, dated 24 June 2010 (hereinafter – the 'Subsoil Law'). It should be noted that the new Subsoil Law did not include the concept of 'Kazakhstani content' as introduced in 2004. This term as a matter of fact was defined depending on the area of application, whether it means goods, works (services), employees, status of an individual or legal entity as a manufacturer of goods or works (services).
In addition, Article 129 of the Subsoil Law provided that in respect of earlier concluded subsoil use contracts the parties shall be obliged to comply with the Kazakhstani content requirements established by the Subsoil Law.
By virtue of that Article, the relevant competent authority (Ministry of Oil and Gas of Kazakhstan for oil and gas contracts or Ministry of Industry and New Technologies of Kazakhstan for ore mining contracts) starting from the second half of 2010 proceeded to sign respective additional agreements with subsoil users. According to them, the terms related to the Kazakhstani content were introduced into the conceptual framework of all contracts. Moreover, the subsoil users should have undertaken certain obligations to increase the percentage of Kazakhstani content separately for goods, works, services, and staff as well as to liability for non-compliance with them.
One should note that under Article 30 of the Subsoil Law the rights of subsoil users are protected from any amendments to the legislation, except for the amendments referred to the national security, defensive potentialities, environmental safety, healthcare, taxation and customs regulation. However, at the same time, the retroaction established by Article 129 regarding the obligation of subsoil users to rely on the Kazakhstani content requirements of the Subsoil Law can be considered as a kind of additional exception.
In our view this is an indirect confirmation of the serious approach of the state to Kazakhstani content issues.
Calculation of Local Content Percentage
The calculation of Kazakhstani content in goods, works and services must be made in accordance with a specially developed Uniform Method of Kazakhstani Content Calculation by Companies when Purchasing Goods, Works and Services, the current version of which was approved by the Governmental Decree No. 964, dated 20 September 2010 (hereinafter – the 'Uniform Method').
Pursuant to Item 2 of the Uniform Method, it is meant for the calculation of Kazakhstani content when GWS are purchased:
· by the state authorities according to Law of the Republic of Kazakhstan on State Procurement, dated 21 July 2007;
· by companies where 50 percent or more of shares are directly or indirectly owned by NWF Samruk-Kazyna JSC;
· by subsoil users under the Rules for Procurement of GWS for Subsoil Operations approved by Government Decree dated 28 November 2007 (hereinafter – the 'Procurement Rules’);
· by companies where GWS procurement shall be subject to Kazakhstani content monitoring in accordance with the list approved by the Government of the Republic of Kazakhstan;
· by concessionaires.
It should be noted that despite of some apparent awkwardness of the formulas given in the Uniform Method, its practical application is not a particular difficulty.
For instance, the Kazakhstani content in goods will be zero, if in respect of a particular product there is no CT-KZ certificate of Kazakhstani origin. And in case of the availability of the latter the Kazakhstani content will be equal to the percentage indicated in the certificate.
CT-KZ Certificate is issued by the Committee on Technical Regulation and Metrology of the Ministry of Industry and New Technologies of Kazakhstan to Kazakhstani manufacturers/producers for a period of one year. This certificate gives the right for the conditional 20 % discount to suppliers when participating at a tender. The procedure for obtaining such a certificate is quite simple.
As to the Kazakhstani content in works and services, it is calculated by adding the percentage of Kazakhstani content in goods, as defined above, and the share of salary fund of Kazakhstani personnel in the general salary fund of employees of the supplier and its subcontractors (if applicable). For reporting purposes, the share of salary fund of Kazakhstani personnel in the general salary fund of employees of the supplier is determined by the supplier itself and is indicated as a percentage on the official letterhead with the certified director's signature and company seal. Similar requirements apply to subcontractors, if any. In fact, such a certification can be regarded as a kind of analogue of CT-KZ Certificate in respect of works (services).
One should distinguish the notion ‘Kazakhstani content in works and services’, calculated as stated above and the notion ‘Kazakhstani producer of works, services’. The latter is understood as either citizens of Kazakhstan or Kazakhstani legal entities, where employees-citizens of Kazakhstan exceed 95 % in the staff list. Such status as the status of Kazakhstani manufacturer of goods, also entitles to a conditional discount of 20 % when participating at a tender.
An interesting question is what measures are applied by the state for encouraging subsoil users to increase the share of Kazakhstani content.
First, in respect of employees (personnel), the state established limits to issuance of work permits for foreign employees. For the period from 1 July 2011 through 31 December 2011, work permits may be issued for 1st category employees (management) – no more than 50 % of the total number of employees, and for 2nd and 3rd categories (junior managers and qualified workers) – no more than 30 %.
Since 1 January 2012, issuance of such permits is limited by 30 %, and for junior managers and qualified workers – by 10 % of the total number of the company employees.
It should be noted that at present there is a draft Governmental Decree under consideration, which provides that these limitations will not apply to subsoil users of Karachaganak, North Caspian and Tengiz Projects, as well as to their operators, contractors and subcontractors until 1 January 2015.
Second, a statutory provision was introduced, under which all GWS purchases made by subsoil users within the frameworks of execution of contractual obligations shall be purchased strictly through one of the following mechanisms: (1) through open tender, (2) from single source, (3) by request for proposals (4) through e-purchasing system or (5) through commodities stock exchange. More details for the procedure for GWS procurement are set in the Procurement Rules.
Third, the legislation provides for the informational support of GWS procurement by subsoil users, that are required to place bids protocols and protocols on results in the on-line registry of GWS (reestr.kca.kz), as well as to place advertisements about forthcoming purchases and their results in periodicals, distributed in the territory of the Republic of Kazakhstan at least three times a week, in the Kazakh and Russian languages.
And, finally, fourth, Article 70.6 (Purchase of Goods, Works and Services for Oil Operations) of the Subsoil Law expressly states that the costs of a subsoil user for purchasing GWS made in violation of the Procurement Rules shall be excluded by the competent authority from the costs, accounted as performance by the subsoil user of its contractual obligations.
In other words, if, for example, a subsoil user having financial obligations under the contract for the respective year of $10 mln has acquired a part of GWS for the amount of $3 mln in violation of the requirements established by the Procurement Rules, the competent authority referring to the specified sanction shall be entitled to exclude this amount from the expenses of the subsoil user.
Accordingly, this exclusion causes the failure to perform contractual obligations of the subsoil user and increases the probability of early termination of the subsoil use contract.
Let us provide the following example already known to subsoil users. According to the results of three quarters of 2010, the state authority declared that it may exclude 159.85 bln Tenge from the amount of GWS purchases made by subsoil users equal to 1.61 tln Tenge from the obligations accounted by the competent authority as the execution of contractual obligations. Later, in early February 2011, the Executive Secretary of the Ministry of Oil and Gas of Kazakhstan met with the heads of several tens of petroleum companies that had major violations against compliance with the Kazakhstani content requirements.
In general, according to the official data, the number of violations of Procurement Rules by subsoil users has significantly declined. Thus the amount of such purchases was reduced from 22.9 % in 2010 down to 6.5 % and 5 % in the first and second quarters of 2011 accordingly.
In conclusion we would like to present the latest official data on the performance by subsoil users of their Kazakhstani content obligations in terms of GWS procurement. Thus, according to first quarter of 2011, the Kazakhstani content in goods was 6.4 %, in works – 44.5 %, and 75.5 % in services. As for the results of the first half year, the Kazakhstani content in goods was 7.1 %, in works – 56.7 %, and 68.1 % in services.
One should note that in general most of subsoil users have already been purchasing GWS under the Procurement Rules for several quarters with provision of the respective reporting to the authorities. Thus, some practice and common understanding of the rights and obligations of parties in the area of subsoil use has been accumulated with respect to Kazakhstani content.
We should also mention some challenges faced by subsoil users while increasing the share of Kazakhstani content in GWS and personnel. They include:
· absence of some required goods in Kazakhstan;
· poor quality of domestic goods, which do not comply with international standards and safety requirements, as stated by many subsoil users;
· use of Kazakhstani mediators as GWS suppliers instead of domestic manufacturers;
· lack of employees of respective qualifications.
However, provided the state would proceed to implement Kazakhstani content development policy and the subsoil users retain high interest in continuing operations in Kazakhstan, we believe that all these issues would be set down to mutual benefits of both parties.