In Kazakhstan the transfer of subsoil use rights and/or objects connected therewith is subject to a prior consent of the competent body. The RK Ministry of Energy serves as the competent body in the field of exploration and production of oil and gas, coal and uranium, while the RK Ministry of Investments and Development serves as the competent body in the field of exploration and production of other solid minerals. As the competent body's consent often becomes one of the key issues when conducting M&A transactions in the fields of oil and gas and mining, we would like to point out several issues related to this consent in the present note. These little nuances can become bigger issues if you ignore them.

1. The scope of objects, transfer of which requires the competent body's consent

The definition of objects connected with subsoil use rights (Objects) is broad and includes:

  • Participatory interests and shares in a legal entity holding a subsoil use right, as well as in a legal entity which may directly and/ or indirectly determine, and/or influence, decisions adopted by a subsoil user if the principal activity of such legal entity is connected with subsoil use in Kazakhstan.
  • Securities evidencing title to shares, or securities convertible into shares, of a legal entity holding a subsoil use right, as well as a legal entity which may directly and/or indirectly determine, and/or influence, the decisions adopted by a subsoil user if the principal activity of such legal entity is connected with subsoil use in Kazakhstan.

As seen from the above definition, participatory interests and shares in ultimate or intermediary holding companies (wherever incorporated) of a Kazakhstan subsoil user are also considered to be Objects, but only if the principal activity of such a holding company is connected with subsoil use in Kazakhstan. From Kazakhstan law perspective, transfer of such participatory interests and shares would require the competent body's consent only if they constitute Objects.

It is generally accepted that the activities of a holding company include those of its subsidiaries.

Unfortunately, Kazakhstan law does not contain any rules or tests for determining whether the "principal activity" of a given company is connected with subsoil use in Kazakhstan. Criteria for determining the level of activity in Kazakhstan is not clear: should it be such criteria as value of assets, level of profits, amount of reserves, number of employees, etc. This legal gap creates a lot of confusion in practice. In the absence of clear guidance, it is often difficult to reach a definitive conclusion on whether the principal activity of a foreign company is associated with subsoil use in Kazakhstan or not.

For the purposes of getting guidance on this issue, we applied for clarification to the RK Ministry of Investments and Development and the RK Ministry of Energy.

Pursuant to the clarifications provided by the RK Ministry of Investments and Development-, the first criterion to determine whether the entity's main activity is connected with subsoil use in Kazakhstan, is to analyze the wording of the foundation documents of the respective entity. If these documents mention that the purpose of the entity or its principal activity is to be engaged in subsoil use or associated operations in Kazakhstan, then such entity's principal activity should be considered connected with subsoil use in Kazakhstan. The Ministry further notes that if the entity's foundation documents do not allow to determine its principal activity, analogy with Article 192.1 of Kazakhstan's Tax Code should be made. It could be concluded based on this analogy that the entity's principal activity should be treated as connected with subsoil use in Kazakhstan if the assets of a Kazakhstan subsoil user constitute 50 percent or more of the value of such a foreign entity's assets or shares. We note that this is an unofficial interpretation of Kazakhstan law by the Ministry and does not have obligatory force for the State authorities.

The response provided by the RK Ministry of Energy1 is not clear at all and only contains a general reference to the fact that an entity's foundation documents shall reflect the description of its principal activity.

Therefore, as a practical matter, if it could be demonstrated that by each of the possible criteria all activities of a relevant entity worldwide on a country-by-country basis, as well as on an overall basis, are less than 50 percent, then it could be possible to invoke the exemption. However, even in such case there would be a risk of the competent body taking a different view. Therefore, if the parties would like to use this exemption, and there is any doubt, the risk could be avoided by receiving a prior view from the competent body in this respect.

The Subsoil Law also exempts certain types of transactions from the consent requirement. For example, transfer of a subsoil use right or Object between legal entities, in each of which not less than 99 percent interest (shares) are owned, directly or indirectly, by the same entity or person, does not require the competent body's consent, provided that an acquirer is not registered in a country with preferential tax treatment.

2. Notification requirement

Article 37.11 of the Subsoil Law requires a purchaser of a subsoil use right or Object to notify the competent body about a relevant transaction within five business days of the completion date. According to Article 36.14 of the Subsoil Law, failure to do so shall be reason to invalidate of the transaction. The law does not provide any exemptions from this rule and does not establish any inter-dependence between the notification requirement and the consent requirement.

However, it happens sometimes in practice that acquirers decide not to submit a notification simply because their transaction is not subject to the consent requirement.

In our view, the notification requirement applies in all cases of transfer of a subsoil use right or Object regardless of whether such a transfer is exempt from the consent requirement or not. Such conclusion follows from literal interpretation of the law which does not link the notification requirement and the consent requirement. An analysis of the historical background of enactment of the notification requirement also bears out this interpretation.

The notification requirement was absent in the initial draft of the Subsoil Law and was introduced only during the subsequent discussions of the draft in the Kazakhstan Parliament. According to the parliamentarian Zhamalov,4 this requirement was necessary for tax administration purposes and occasioned by Article 583.6 of the Kazakhstan Tax Code which requires the competent body in the field of subsoil use to provide the tax authorities with information on participants and parameters of a transaction that entails tax obligations in Kazakhstan within 10 business days of the completion date.

Therefore, any transaction on transfer of a subsoil use right or Object is subject to the notification requirement. As failure to comply with this requirement could invalidate the transfer, it is recommended that acquirers always notify the competent body about their transactions.

An additional notification requirement is envisaged by Article 76.1.30 of the Subsoil Law. This time this requirement applies to subsoil users and not to the parties of the transaction. A subsoil user has an obligation to, inter alia, notify the competent body within 5 days of the completion date about transactions on disposal of subsoil use rights by affiliated or other persons, as well as of participatory interests or shares in its charter capital.

3. Groundwater: a minor issue that can become a significant problem

When selling or buying Objects (for example, shares in an oil producing company or in its parent company), the parties must identify carefully all subsoil use rights pertaining to a Kazakhstan operating company. It happens sometimes in practice that oil exploration and production companies have, in addition to their main subsoil use rights, certain rights with respect to groundwater. In these cases, a separate consent would be required from the RK Ministry of Investments and Development for completion of a transaction. This consent would be in addition to the consent of the RK Ministry of Energy. Failure to obtain it would entail a risk of invalidating the entire transaction, although the value of an oil exploration or production company's rights to groundwater could be insignificant if compared with its oil exploration or production rights.

In Kazakhstan the subsoil use rights to groundwater are granted in different forms: (i) a subsoil use contract for exploration or production of groundwater; (ii) a permit for production of groundwater of drinking and industrial purpose with production limits from 50 to 2,000 cubic meters per day; and (iii) a permit for exploration or production of technical groundwater in volumes more than 2,000 cubic meters per day for their injection into the stratum in connection with extraction of minerals or for production of groundwater for the purpose of dewatering during the mining operations.

Under the Subsoil Law, all these rights to groundwater are considered to be subsoil use rights and, consequently, the consent of the RK Ministry of Investments and Development should generally be necessary for their transfer or transfer of Objects connected therewith. However, the problem is that in practice the Ministry provides consents only with respect to those subsoil use rights that are granted through execution of subsoil use contracts. This is because a contract for exploration or production of groundwater is concluded between the Ministry and a subsoil user, while the Ministry itself is not directly engaged in the process of granting the above mentioned permits (ii) and (iii). These issues require careful analysis on a case-by-case basis.

Similarly, if a Kazakhstan subsoil user also has the rights for exploration or production of wide-spread minerals, then the additional consent of local bodies would be necessary for transfer of participatory interests or shares in such a subsoil user or its direct or indirect holding companies. According to the Subsoil Law, wide-spread minerals include sand, clay, gravel and other minerals used in their natural state or with little processing and cleaning mainly for the satisfaction of local economic needs. The mentioned consent is not required if a subsoil use right is for production of wide-spread minerals for the satisfaction of the user's own economic needs.

4. Fields of strategic importance

Under the Subsoil Law, the Republic of Kazakhstan has a priority right to purchase subsoil use rights and Objects related to fields of strategic importance. In this case, a relevant transaction would also be subject to the waiver by the Republic of Kazakhstan of its priority right.

It is within the RK Government's competence to approve the list of fields having strategic importance. Therefore, when conducting M&A transactions in the field of subsoil use, it is always recommended to verify whether a relevant field falls within this list.

The waiver and consent are normally expressed in one letter issued by the competent body. However, the need to obtain this waiver complicates the overall process of obtaining the consent.

Footnotes

1 Available at http://blogs.e.gov.kz/ru/

2 Available at http://blogs.e.gov.kz/ru/

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.