On July 5, the State Duma adopted a bill that fundamentally changes the way the oil industry is taxed and shifts the tax burden to the later stages of oil production. The changes aim to foster the development of greenfields—pilot projects at early stages of production, and the better use of brownfields—developed fields with a potential contaminant.
The bill (No. 325651-7) requires oil companies to pay a tax at a rate of 50 percent of the difference between the estimated revenue from the oil sale minus the cost of extraction and transportation, minus export duty and the mineral extraction tax (MET), plus the coefficient of cost adjustment.
The bill may encourage foreign investment in the industry and have a positive impact on the companies that develop greenfields, practitioners said. But some companies may end up paying more at later stages of production, and could have fewer opportunities to claim tax exemptions under the new tax regime, they told Bloomberg Tax.
The new measure “makes it possible to increase the profitability of oil projects, reach a break-even point in a shorter period of time, reduce the amount of borrowing funds necessary for the project, thus increasing the production of hydrocarbons on a specific subsoil plot,” according to the explanatory note accompanying the bill.
The MET is calculated based on the volume of oil and gas extracted. While the companies must pay the MET regardless of the profitability of a project, the new tax will be linked to the profitability of a particular field.
The bill specifies certain subsoil plots, or “pilot projects,” areas in which developers will be obliged to pay the new tax. These plots are divided into four groups. Firms from groups three and four will be obliged to pay the new tax, while firms from groups one and two would have the right to choose either to switch to the new system or continue to pay MET and corporate income tax.
Among those obligated to pay the new tax are four major Russian oil companies: Rosneft Oil Co. PJSC, Gazprom Neft PJSC, LUKoil PJSC, and Surgutneftegas OJSC.
The companies didn't return requests for comment.
The bill applies only to pilot projects, so its impact on the companies’ tax burden will be limited, said Sergey Ezhov, chief economist at Vygon Consulting, a consulting firm for the oil and gas industry in Moscow.
“According to our estimates, the savings from switching” to the new tax in the first year will be about 100 billion rubles [$1.6 million], which is less than 2% of the total amount of oil companies’ tax payments,” Ezhov told Bloomberg Tax in a July 5 email.
Should Companies Switch to the New Tax?
Other companies can choose to switch to the new regime as long as they develop new oil fields that meet certain criteria with regard to their geographical position and depletion.
Russia has an extended system of tax incentives for oil companies, so the benefit of switching to the new tax will depend on the incentives companies already use, practitioners said.
Companies currently pay in taxes up to 60 percent of the price of the recovered oil, but using tax incentives sometimes helps them reduce that number to only 5 percent, Ezhov said.
Companies that don't currently use tax exemptions could pay less in taxes initially if they switch to the new regime, said Sergey Bachmanov, senior tax partner at PwC. And if the new fields aren't profitable, the company will save money compared to the current system.
Still, given that the tax rate for additional income tax is set at 50 percent, while the typical corporate income tax rate is 20 percent, companies risk paying more taxes than under the current tax regime, he said.
“The company will pay less in taxes at the first stage of production, but at later stages this new tax payment will be quite significant,” Bachmanov said July 5.
If the law takes effect on Jan. 1, companies will have three months to decide to switch to the new tax, according to the bill.
Reporter on this story: Natalia Suvorova