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