Laws and regulations governing the extraction of oil and gas in Russia can befuddle Western investors who lack sufficient knowledge to comprehend the convoluted tax structure. Expert help is required to negotiate the maze.

Nataliya Larina, Tax Attorney, Moscow

Foreign investment in Russia is encouraged, yet the government unintentionally continues to erect obstacles that make it less attractive to outside entrepreneurs. One of these unintended obstacles is the complicated set of tax laws with regard to the extraction of mineral resources, including oil and natural gas.

With a little assistance from professionals who are well informed about these laws and regulations, it is possible to operate profitably in Russia and avoid any fines or punishment due to unintended tax violations.

The government of Russia placed a tax on the extraction of various mineral resources in 2002 and has since amended some of the rules and changed the tax rates. Overseas investors in Russia often have questions with regard to calculating and paying this tax, so I will attempt to explain how the tax is calculated and levied in this article.

The tax laws related to mineral extraction, including oil and gas, can be difficult for foreign businessmen and even their Russian consultants to comprehend, so this article will provide clarification. Being aware of the tax regulations on the extraction of mineral resources will help businesses in their preparations to do business in Russia.

Who pays the tax

All companies and individual entrepreneurs who use entrails in Russia must pay the tax on extraction of mineral resources (Article 334 of the Tax Code of the Russian Federation). Who is a user of the entrails? We must read the Federal Law “On Entrails,” dated Feb. 21, 1992, No. 2395-1, to get the answer.

According to Article 9 of this document, a company (foreign or Russian) possesses the status of user after the following moments:

• its license on using the entrails was registered; or

• its PSA (production sharing agreement) with the state went into effect.

The PSA is a special contract between the state and the investor, according to which the company extracts mineral resources. The investor that participates in the PSA will pay taxes in accordance with Chapter 26.4 of the Tax Code rather than any other national legislation that governs taxpayers.

If the company doesn’t have the proper license, this means that it must not pay the tax on extraction of mineral resources. However the investor is obligated to pay the state “damages” for using the Russian entrails without permission. The amount of damages is calculated by a formula based on the rate of tax on extraction of mineral resources. Therefore, the damages paid will be an amount equal to or greater than the actual tax.

How to register with the Tax Inspectorate

There are two types of registration. The first is registration with the local Tax Inspectorate where the Russian company or the permanent representative of a foreign entity is situated. This registration is important in all relationships between the taxpayer and Tax Inspectorate.

For example, the company will submit the tax report (declaration) there. If the taxpayer paid more that he was obligated to pay, he would be entitled to a refund. At that time, the taxpayer must submit an application for the refund to the Tax Inspectorate where he is situated.

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The second type of registration is the following: As a general rule, every taxpayer of the tax on extraction will be registered with the Tax Inspectorate where the entrails are situated for the 30-day period after his license on using entrails is registered (Article 335 of the Federal Tax Code). No further application or information is required. Licensing bodies will transmit the information about the taxpayer to the Tax Service, and afterwards the company will receive notification that it is properly registered.

This registration forms the basis of the relationship between the Russian state and the taxpayer with regard to any future questions or concerns about tax issues.

If the company conducts business in more than one location, it may be registered in two or more Tax Inspectorates (provided the places where it is situated and where the entrails are situated are different).

In such situations, it is proper to ask which Tax Inspectorate is the controlling authority over the taxpayer. According to the Russian Tax Code, tax inspectors are entitled to conduct a wide spectrum of controlling measures. For example, they can conduct an on-site tax audit when inspectors are on the company’s premises during two months, they check the taxpayer’s business activity and may fine the company if they find any indications of tax violations.

With respect to investors, the rules will be the following: The inspectorate where the taxpayer is situated plans and organizes the controlling measures. But the inspectorate where the entrails are situated participates in the on-site tax audit - the Letter of the Ministry of Taxes and Fees (now the Federal Tax Service) dated Mar. 22, 2002, No. AS-6-21/337.

How to compute the tax

To figure the tax, the company must multiply the tax base by the tax rate. The tax base is:

• the value of the mineral resources that the taxpayer extracted in Russia; and

• the amount of extracted oil, associated gas, and combustible gas.

Importantly, any production that was processed (for example, benzine) cannot be a recognized mineral resource.

Also, the company must not pay the tax if it extracts:

• widely current mineral resources;

• collecting materials; or

• underground water.

How is the value of the mineral resources extracted calculated? There is not an easy answer to this question. The taxpayer may choose one of three ways:

1. The company determines the value of the proceeds from its monthly sale prices (receipts from sale). State subventions are not taken into account.

2. If the taxpayer does not have subventions, he determines the value of the proceeds from the monthly sale prices on extracted mineral resources.

3. If the company didn’t sell the extracted mineral resources, it uses a calculated value of the extracted mineral resources.

What is the tax rate

There are different tax rates for the extraction of different mineral resources. Let’s see what they are.

If a company participates in a PSA, the tax rate must be multiplied by 0.5, as written in Article 346.37 of the Tax Code. The exception is set forth only for the cases of the extraction of oil and gas condensate.

How to pay the tax

The taxpayer must pay the tax every month, no later than the 25th of the following month. For example, if the company extracted the mineral resources in February, it is obligated to pay the tax no later than the 25th of March (Article 341 of the Tax Code).

In this regard, the taxpayer must submit the tax declaration no later than the last day of the month (in this case, the 31st of March). In the tax report, the company should gather and document all the relevant information about the mineral resources that it extracted, even if they are in multiple Tax Inspectorates.

As already mentioned, the taxpayer submits the declaration to the local Tax Inspectorate where it is situated (but not to the inspectorate where he is registered as a payer of the tax on extraction of mineral resources).

Conclusion

Russia is extremely rich in many mineral resources, but it is no secret that the most attractive resource for foreign investors is the country’s oil and gas deposits. Many huge oil and gas fields remain to be discovered and exploited.

Unfortunately, many non-Russian investors are hesitant to organize a business and invest in Russia because of the perceived political risks. The highly publicized Yukos Oil case illustrates that even a huge and widely respected company can become the target of the state’s controlling measures.

For this reason and others, wise businessmen and investors will familiarize themselves with Russian tax laws or retain advisors and counselors that are experts in the field. Being honest and paying all the taxes correctly will keep a company in good standing, help avoid problems, and enable it to share in the profits obtained from the extraction of Russian mineral resources. $

The author

Nataliya Larina is an independent tax lawyer and tax analyst in Russia.

Russian taxes on mineral extraction explained

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