Sub­soil tax rates are prob­a­bly il­le­gal, but look like they’re here to stay

Kyiv Post Legal Quarterly - - Contents - By Evan Ostryzniuk evanos­

Pri­vate ac­tors on Ukraine’s en­ergy mar­ket are do­ing all they can to chal­lenge in­creased sub­soil tax rates im­posed dur­ing Ukraine’s eco­nomic down­turn. They ar­gue that tem­po­rary tax hikes in­tro­duced on July 31 vi­o­late the tax code, which re­quires that changes can­not be made later than six months be­fore the end of the fis­cal pe­riod in which the new rules and rates will ap­ply.

In­dus­try play­ers and legal ex­perts ar­gue that with­out this re­stric­tion to en­sure the core prin­ci­pal of sta­bil­ity in rules and reg­u­la­tions, in­vest­ment into do­mes­tic oil and gas devel­op­ment will dry up.

On July 31 par­lia­ment voted to raise the roy­alty rate for ex­tract­ing gas up to 5 kilo­me­ters be­low the sur­face from 28 per­cent to 55 per­cent and from 15 per­cent to 28 per­cent for gas taken more than five kilo­me­ters be­low the sur­face.

Mean­while, the oil sec­tor saw its tax rate grow to 45 per­cent for drilling be­neath 5 kilo­me­ters, from 39 per­cent. Iron ore min­ers had to pay 3 per­cent more to 8 per­cent for the priv­i­lege.

The stated pur­pose of the in­creases was to help pay for the war against Rus­sia in the Don­bas. The gov­ern­ment promised to lower them by the end of 2014, but mar­ket par­tic­i­pants fear the rates will stay in force well into 2015.

“Many bad things were said about pre­vi­ous Ukrainian gov­ern­ments, but none of them did any­thing like this to the gas in­dus­try,” said Robert Bensh, man­ag­ing direc­tor at Peli­court, a com­pany in­volved in gas ex­trac­tion in Ukraine, dur­ing the Dec. 3 con­fer­ence in Kyiv.

Com­pa­nies need time to plan for tax changes, which was one of the rea­sons they re­acted with fury to sub­soil roy­alty amend­ments. “If the prin­ci­ple of sta­bil­ity had been abided by, then the rental rates im­posed in 2014 would have come into ef­fect from the new bud­get year – Jan. 1, 2015, not from the cur­rent one,” says Inna Pleskatch of Felix Law Firm.

“The tax bur­den that was placed on the gas in­dus­try has re­sulted in a 14 per­cent de­crease in gas pro­duc­tion, while the com­pet­i­tive­ness of Ukrainian min­ing com­pa­nies has suf­fered be­cause of the global re­duc­tion of iron ore prices,” Pleskatch added. “This could even­tu­ally re­sult in the ces­sa­tion of ore min­ing and pro­cess­ing ac­tiv­ity.”

“From a for­mal point of view, th­ese amend­ments are il­le­gal,” agrees Olek­siy Kot of An­tika law firm. “They are a di­rect vi­o­la­tion of the tax code.”

Such vi­o­la­tions of the fun­da­men­tal laws of the land are com­mon­place in Ukraine, says Kot, es­pe­cially in the tax field.

“There are for­mal legal grounds to chal­lenge the ex­ist­ing amend­ments in­creas­ing sub­soil tax rates as well as any such fur­ther ini­tia­tives,” adds Yuriy Dra­ganchuk of Sayenko Kharenko law firm.

Some hope that the new par­lia­ment will change the sit­u­a­tion. Felix’s Pleskatch notes that the pro-west­ern rul­ing coali­tion wants to fol­low global prac­tices on the is­sue.

“It has to be car­ried out by es­tab­lish­ing equal rental fees for the sub­soil use in gas pro­duc­tion for all kinds of com­pa­nies at an eco­nomic level, pro­vid­ing prof­itabil­ity for the in­dus­try.”

A ques­tion mark re­mains, though, as to how to ac­com­mo­date the gov­ern­ment’s needs while pla­cat­ing the in­dus­try. In an ideal world, ac­cord­ing to Baker & Mcken­zie’s Gordiyenko, the rules for sub­soil use “should es­tab­lish a bal­ance be­tween the in­ter­ests of the state and the com­mer­cial con­cerns of sub­soil users, pro­vide for an ef­fi­cient tax regime and demon­strate com­pli­ance with pro­claimed tax leg­is­la­tion prin­ci­ples.”

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