On 19 July 2018 Federal Law No. 199-FZ* (“Law”) came into force, which introduces a tax on additional income from the extraction of hydrocarbon raw materials (“Tax on Additional Income”) in Russia.
The new tax regime drastically changes the regulation for the taxation of companies in the oil and gas sector. The implementation of the Tax on Additional Income is primarily aimed at stimulating the development of deposits with hard-to-recover hydrocarbon raw material reserves. It will allow companies to reduce the tax burden in the early stages of development of a subsoil plot. In turn, this will result in a reduction in the payback period of the hydrocarbon deposit.
The Law connects the level of Tax on Additional Income with the profitability of each separate subsoil plot, rather than taxing the volume of production of hydrocarbon materials or the cost of extracted hydrocarbons, as stipulated in the tax on extraction of mineral resources (“Extraction Tax”).
The Law only applies to four groups of subsoil plots with a low degree of depletion, which are named and geographically defined in the Law.
The first group includes subsoil plots with a low degree of depletion within the borders of the Republic of Sakha (Yakutia), the Irkutsk and Krasnoyarsk Regions, the Nenetsky Autonomous District, north of 65 degrees latitude of the Yamalo-Nenetsky Autonomous District and within Russian territorial waters of the Caspian Sea bottom.
The second group includes subsoil plots, which are located in the territory of the Russian Federation and include hydrocarbon reserves of the fields specified in note 8 of the Commodity Nomenclature for Foreign Economic Activities of the Eurasian Economic Union as of 1 January 2018.
The third and fourth groups include subsoil plots with certain degrees of depletion located in the Tyumen Region, the Khanty-Mansiysky and Yamalo-Nenetsky Autonomous Districts, the Komi Republic, whose geographical coordinates are precisely defined in the Law.
Users of the first and second groups of subsoil plots have the right to opt out of the application of the Tax on Additional Income, while users of the third and fourth groups have no such right.
The additional income from the extraction of hydrocarbon raw materials on subsoil plots defined by the Law is subject to the Tax on Additional Income. The tax base is calculated as the difference between the estimated revenues and the amount of actual and estimated expenses for the extraction of hydrocarbon raw materials.
The additional income depends on market prices and the volume of extracted hydrocarbon raw materials. Actual expenses consist of the costs closely related to the extraction of hydrocarbon raw materials on the subsoil plots, provided that such expenses meet the production costs deductibility criteria defined by Chapter 25 of the Russian Tax Code* for the purposes of calculation of corporate income tax. Actual expenses borne on the subsoil plots include actual costs (excluding VAT and excise duties) for purchase, construction, production, delivery, making amortised usable property operational, and actual costs connected with production and sale according to the rules provided by the Law.
Estimated expenses consist of the costs of transportation of hydrocarbons and export customs duties.
The companies applying the new regime of taxation by the Tax on Additional Income are required to keep separate accounts of actual expenses incurred for each subsoil plot that is subject to the Tax on Additional Income.
Taxpayers paying the Tax on Additional Income can apply the rules for carrying forward losses of previous periods, including some losses received before the switch to the Tax on Additional Income (i.e. historical losses).
The Law establishes the tax period for the Tax on Additional Income as the calendar year, and quarterly reporting periods are also provided for. A tax return should be submit by 28 March of the year following the expired tax period.
The tax rate is 50% of the tax base.
Taxpayers paying the Tax on Additional Income still have to calculate and pay the Extraction Tax. However, the formula for calculating the Extraction Tax for these taxpayers changed by the application of a specific lowering coefficient, which decreases the amount of the Extraction Tax.
In addition, the Law introduces new grounds to recognise transactions as controlled transactions. In particular, a transaction (or group of transactions) between Russian related parties is a controlled transaction under Russian transfer pricing rules if at least one of the parties of the controlled transaction is a taxpayer of the Tax on Additional Income, and if this party accounts for the income (or expenses) of the transaction (or group of transactions) in its tax base, provided that the amount of income for such a transaction (or group of transactions) is at least RUB 60m (EUR 789,500).
The application of a new tax regime on pilot projects will begin from 2019.
If the implementation of the Tax on Additional Income on pilot projects is successful, the number of sites applicable to the new tax regime may be extended.
Points to note
We recommend that companies using the four groups of subsoil plots subject to the new tax regime assess the necessity and attractiveness of applying the Tax on Additional Income tax regime. (This is highly recommended for users of subsoil plots included to the first and second groups.) Companies (particularly users of subsoil plots in the third and fourth groups) should begin preparation for calculation and payment of the new tax from 2019.
We will monitor the effect of the implementation of the Tax on Additional Income on pilot projects both for the Treasury and subsoil plot users. If the outcome is positive for the Treasury, the Tax on Additional Income regime may be extended to a larger number of sites in the medium term.
We would like to note that in addition to the introduction of the Tax on Additional Income, the Law introduces changes in thin capitalisation rules provided by Article 269 of the Tax Code. Our tax Alert on these changes will be available in the near future.
* In Russian