Guide to the Russian Oil Gas Sector Deloitte

8/12/2019 Guide to the Russian Oil Gas Sector Deloitte

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Energy & Resources

Tax and Legal Guide

to the Russian Oil & Gas Sector


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Contents

Overview of the Russian Oil & Gas sector 3Key facts and general statistics 3Crude oil industry 3Natural gas 6Key players and foreign investments 7Recent and proposed development projects 7

Legislative framework in the Oil & Gas industry 12General requirements for the use of subsoil resources 12Continental shelf projects 17Production Sharing Agreements 17

Taxation of Oil & Gas companies 18Prots tax 18Tax incentives 26VAT 27Transfer pricing 32Mineral extraction tax 33Employment 35Property tax 40

Other taxes 41Customs payments 43Currency control 44Tax administration 46Production Sharing Agreements 51

Appendix 52 Our team 53 Ofce locations 54


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Key facts and general statisticsRussia is one of the major players in the worldsnatural resources market. It has the largest reserves,and is the largest exporter of natural gas. It is alsothe worlds largest producer of crude oil, and i ts territorycontains the seventh largest oil reserves on the planet.

The energy sector is, historically, one of the maindrivers of the Russian economy, amounting to roughly25% of the countrys GDP. The exports of crudeoil, oil products and natural gas made up over 60%of all Russian exports in 2009. The exports of mineralproducts accounted for 68.8% of total exports in 2010.

The Russian oil & gas sector is also characterisedby the high share of state-controlled companiesand its tough administrative restrictions.

All these facts should be taken into accountand an optimal strategy developed before carrying

out business.

Further description and analysis of the oil & gasindustry is presented in this guide.

Crude oil industryReserves and productionRussia was the worlds largest crude oil producerin 2010, with 12.9% of the world share, aheadof Saudi Arabia in second place with 12%. AlthoughRussias proven oil reserves accounted for only 5.6%of global reserves (compared to Saudi Arabias 19.1%)at the end of 2010, it is expected that considerableadditional reserves will be located offshoreand in the less-explored areas of Eastern Siberia.

Throughout the last decade, crude oil productionin Russia was generally on the increase,and the countrys share in total global productiongrew from 8.95% (2000) to 12.9% (2010). A slightdecrease in production in 2008 was primarily causedby the depletion of oil elds in the Western Siberiaregion. Contrary to the expectations of many expertsand analysts who predicted that production wouldonly continue to decrease, Russian production of crude

oil and gas condensate increased by 1.5% to 494 MTin 2009, and by a further 2,2% to 505 MT in 2010.According to reports by the Federal Statistics Service,Russian oil production increased to 509 MT in 2011.

This recent increase in production comes as a resultof beginning production on a number of new elds,especially in Eastern Siberia, such as Verkhnechonskoyeeld in 2008 and Vankor eld in 2009. Recentand proposed developments in oil productionare discussed in more detail under the Recentand proposed development projects section.

Overview of RussianOil & Gas sector

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02000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

US

Russian Federation

Saudi Arabia

Iran

China

Canada

Top 5 Crude Oil Producting Countries 2000 2010, mln tons


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Further development of the transportationinfrastructure is a strategic priority for marketdiversication, rather than increase of the transportationcapacity. Some recently completed projects (includingthe Eastern Siberia-Pacic Ocean and Purpe-Samotlor oil pipelines), as well as some currentlyin development (such as ESPO2 and Baltic PipelineSystem 2) are discussed in the Recent and proposeddevelopment projects section of this publication.

The Eastern Siberia-Pacic Ocean (ESPO) pipeline routehas been delivering oil to northern China since 2011.

Renery sectorFor decades, the Russian oil sector focusedon the production and export of crude oil. However,Russia is currently working to change its export focusfrom raw materials (such as crude oil) to oil products.

Russia currently accounts for roughly 6% of the worlds

crude oil processing capacity, which exceeds domesticdemand for the majority of rened products. Despitethe large volumes of oil undergoing processing, the qualityof oil products is low. The production structure of Russianreneries has a high share of heavy fuel oil and diesel fuel,and domestic production capacity can meet only a partof the countrys demand for high-octane gasoline.

The countrys largest oil companies are introducingnew technologies to upgrade the existing reneries.New facilities are being installed with the goalof increasing the processing depth and producing light

oil products of higher quality (specically those meetingEuro-3, Euro-4 and Euro-5 standards). For more detailedinformation, please refer to the Renery subsectionof Recent and proposed development projects.

Exports and transportationThe state-owned pipeline monopoly Transneft transfers93% of all Russian-produced crude oil. The lengthof the main oil pipelines averages at 70 thousandkm, and 19.3 thousand km for pipelines carrying oilproducts. In 2010 Transneft transferred over 466 MTof oil via its trunk pipelines. The rest is transportedby oil companies themselves.

Ranked seventh in the world in terms of oil reserves,Russia is one of the largest oil exporters in the world.The majority of crude oil transported within Russiais moved by pipeline; however, more than halfof crude oil export is transported over water,particularly from the major shipping port of Primorsk.

Historically, there are three main strategic destinationsof Russian crude oil exports: Europe (Germany,Netherlands, etc.), East Asia (China and othercountries in the Asia-Pacic region) and NorthAmerica. The European market is the largest importerof Russian crude oil and oil products, with an 80%share, while crude oil deliveries to China and the USAcumulatively amount to less than 20%.

Table 1

Destination of shipments mn t %

Atlantic market

Europe 170.4 77.2

North America, Atlantic Cost 11.3 5.1

Middle East and Africa 1.0 0.5

Total 182.7 82.8

Pacic market

Asia-Pacic region 35.7 16.2

North America, Pacic coast 2.3 1.0

Total 38.0 17.2

TOTAL 220.7 100.0

Russias crude oil suppliers to the key global markets in 2010



Table 2

Russias crude oil exports in 2009-2010

Destination and way of shipments 2009 2010

mn t % mn t %

Non-CIS states 211.9 86.1 220.7 89.2

Offshore shipments 141.7 57.6 151.7 61.3

Shipments via Transnefts pipeline system 117.0 47.6 125.6 50.8Primorsk Seaport ( Baltic Sea, Gulf of Finland, Russias Leningrad Region) 70.2 28.5 70.0 28.3

Novorossiysk seaport ( Black Sea, Krasnodar Kray) 33.0 13.4 32.4 13.1

Pivdenny terminal (Black Sea, Ukraine, Odessa region) 9.5 3.9 3.1 1.3

Tuapse seaport (Black Sea, Krasnodar Kray) 4.2 1.7 4.8 1.9

Kozmino seaport ( Pacic Ocean coast. Primorski Kray, Russias Far East) 0.1 0.0 15.3 6.2

Bypassing Transnefts pipeline system 24.7 10.0 26.1 10.6

De-Kastri oil terminal ( Sakhalin Island, Russias Pacic territory) 7.4 3.0 7.1 2.9

Korsakov (Sahalin region) 5.4 2.2 6.0 2.4

Varandey oil terminal ( Russias Arctic territory, Nenets Autonomous District, Barents Sea) 7.5 3.0 7.5 3.0

Vitino sea port ( Russias White coast) 2.5 1.0 2.5 1.0Others 1.0 0.8 3.0 1.2

Druzhba pipeline 53.3 21.7 53.2 21.5

Germany 19.1 7.8 17.9 7.2

Slovakia 2.6 1.1 2.5 1.0

Czech Republic 4.9 2.0 4.7 1.9

Hungary 6.4 2.6 6.4 2.6

Poland, including shipments to Gdansk seaport 20.3 8.3 21.7 8.8

ESPO pipeline* 1.6 0.6 15.8 6.4

Shipments to Kozmino* 0.1 0.0 15.3 6.2

Other directions 1.5 0.6 0.5 0.2

Railway shipments 9.7 3.9 9.5 3.8

CPC 4.0 1.6 3.6 1.5

Other directions bypassing Transnefts pipeline system 1.8 0.7 2.2 0.9

Total Transnefts pipeline system 185.4 75.4 192.4 77.8

CIS states 34.1 13.9 26.6 10.8

Belarus 21.4 8.7 12.9 5.2

Kazakhstan 6.3 2.6 7.4 3.0

Ukraine 6.3 2.6 6.3 2.5

Total 246.0 100.0 247.3 100.0

* including combined and reversed pipeline shipments** accounted in Russias Kozmino seaport balance


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Natural gasReserves and productionWith respect to gas reserves, Russia is the worldleader with 23.9% of the worlds proven reservesas of 2010. It is the second largest producer of naturalgas, having produced 588.9 BCM in 2010, accountingfor an 18.4% share in the world total production.

Major gas reserves and exploration projectsare situated in Western Siberia, while substantialareas of Eastern Siberia, the Far East and the Arcticremain underdeveloped due to a lack of infrastructureand severe weather conditions.

Production of natural gas has been steadily increasing,having gone from 526.2 BCM in 2001 to a peakof 601.7 BCM in 2008. This increase in productionis primarily due to increasing demand and new eldshaving been brought onstream (including the Yuzhno-Russkoe and Zapolyarnoye elds and newly-discovered

deposits on the Yamburg and Urengoy sites). The 2009drop of 12.1% compared to the 2008 productionlevel was primarily caused by a decrease in demandon both foreign and domestic markets. In 2010production rose by 11.6% compared to 2009.

Exports and transportationRussia remains the worlds largest gas exporter.Most of the countrys gas exports go to customersin Western, Central and Eastern Europe, the Balticcountries and members of the Commonwealthof Independent States (CIS).

Europe is the largest market for Russian natural gassupply, and Germany, Ukraine, Italy, Belarus and Turkeyaccount for almost 60% of Russian gas exportsin 2010. Russia exports more than 90% of its naturalgas by pipeline. LNG export amounts to under 7%of Russias overall gas export volumes, with Japanand South Korea as the major customers.

Though the Russian gas pipeline system is alreadywell developed, there are currently several projectsunderway to build and develop new pipelines.This development is driven, not only by the expectationthat demand will increase, but also by past disputes

with transit countries over gas supply and transit prices,as well as concerns expressed by Western Europeancountries over the security of supply.

Several new maritime pipeline construction projectshave been announced. These are the recently-openedNord Stream and the proposed South Stream pipelines,which will enable Russia to diversify its exportroutes to Western Europe. Gazprom is also buildingits relationships with China and other Asian countriesin order to carve out opportunities in new gasmarkets. China and Russia have been negotiating

a gas supply deal for several years, with Gazpromplanning to supply 30 BCM of gas to Chinathrough a new pipeline. For further details on theseprojects, please refer to the Recent and proposeddevelopment projects section.

Russian plans for the future are not only focused onconstructing new pipelines for gas; there are also plansin place to increase transportation of LNG. The countrysrst and only LNG plant was brought into operationin 2009. For further details on the LNG projects, pleaserefer to the Recent and proposed developmentprojects section of this paper.

Today the Russian gas industryis challenged by depleting

reserves in traditional elds,with a subsequent risein gas recovery costs,and by the necessityfor signicant investmentto develop new gas provinces



Yamal The Yamal Peninsula is one of the most strategicallyimportant oil and gas regions of Russia. Its reservesamount to 10.4 trillion cubic meters of natural gas(over 20% of current Russian proven natural gasreserves), 230.7 MT of condensate and 291.8 MTof crude oil. Currently 11 gas and 15 oil,gas and condensate elds have been discoveredon the Yamal Peninsula and in its adjacentoffshore areas. The most signicant natural gasdeposit in Yamal is Bovanenkovskoye eld, with4.9 trillion cubic meters of natural gas. In March2012, pre-commissioning work was performedat the rst startup complex on Bovanenkovskoye eld.

One of the key advantages of the regionis the low transportation cost, due to the closenessof the trunk pipeline system. However, constructionand operational costs on the Yamal Peninsulaare high due to the severe weather conditions.

Gazprom holds the licenses for most of the elds,and expects gas production to increase to 75-115BCM by 2015. Therefore, the commercialdevelopment of Yamals elds, onshore and offshore,is expected to play a signicant role in the futureof the Russian natural gas industry.

Trebs and Titov eldsThe Trebs and Titov elds have over 200 MT reservesbetween them. The elds are located in ArkhangelskRegion in Nenets District, and their individual reserves

amount to 78 MT (Trebs) and 132.8 MT (Titov).The rst exploration wells were drilled in 2011. Accordingto preliminary calculations, the rst oil from the eldswill be produced in 2014, and peak production willbe reached in 2018. The maximum annual productionis estimated to be 5-10 MT. One of the key advantagesof the elds is their closeness to the pipeline system,resulting in lower transportation costs.

The holder of the license for these elds is oneof the largest Russian oil companies, Bashneft.The license is valid for a period of 25 years, includingve years of geological exploration and the requirementto process 42% of the produced crude oil in Russiaat its own renery plants and sell 15% of the producedcrude oil on the domestic market.

Key players and foreign investmentsThe Russian oil complex is represented by 8 largevertically-integrated oil companies and a numberof smaller enterprises with a very minor share of totalRussian oil production. Gazpromneft and Rosneftare state-controlled companies, and produce morethan 30% of crude oil in Russia between them.Russias other largest oil producers include Lukoil,TNK-BP, Surgutneftegaz, Tatneft, Slavneft and Bashneft.

The key player in the gas industry is state-owned Gazprom, which controls about 76%of Russian natural gas production. There are alsoseveral smaller independent companies suchas Novatek, Itera, Nortgaz and others.

The investment environment remains challengingdue to the ineffective legislation frameworkand the specics of the Russian regulatory system.

In addition, the government is reluctant to allow foreignmajority control in the energy sector, especially in projectsdeveloped at the Russian continental shelf. Signicantexceptions have included the Sakhalin offshore projects(developed based on Production Sharing Agreementsconcluded in the mid-1990s), although here toothe government has reasserted state control.

Recent and proposed development projectsUpstreamVankorskoye eld Vankorskoye oil & gas eld is the biggest

eld to have been discovered and broughtinto production in Russia in the last 25 years.It is located in the northern part of Eastern Siberia,in the Turukhansky District of Krasnoyarsky Krai.Its proven reserves are estimated at over 195 MT.

Rosneft is the license holder of the eld, and beganoperations there in August 2009 with a targetfor annual oil production amounting to 25.5 MT(about 5% of total Russian oil production). Vankorskoyeis one of the main sources of oil to be transportedthrough the Eastern SiberiaPacic Ocean pipeline.

Development of the eld is one of the largest projectsof Rosneft and in the entire Russian oil and gas industry.The total amount of oil produced in 2010 was 12.7 MT.


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Continental shelf projects ShtokmanThe development of Shtokman eld is the rst Russian

gas project on the Arctic continental shelf, which hasgreat importance, both as a signicant gas reservefor international markets, and as a means of gainingexperience for future offshore gas projects.

Shtokman is one of the 10 largest gas elds worldwide,with reserves amounting to 3.8 trillion cubic metresof gas and around 53 MT of gas condensate. The eldlies in the Barents Sea, about 600 km northeastof the city of Murmansk at local sea depths varyingfrom 320 to 340 m. The eld is expected to becomea resource base for Russian pipeline gas as well as

liqueed natural gas (LNG) exports to the AtlanticBasin markets. Originally, shareholders plannedto export all gas from the eld as LNG, but thereis now the alternative option of moving someof the gas via the Nord Stream pipeline.The Shtokman development project envisages the annualproduction of 70 BCM of natural gas and 0.6 MT of gascondensate, which is comparable to the entire annualgas output of Norway, one of the largest Europeangas suppliers. The rst stage of the project is currentlyat the planning stage, and involves the annualproduction of 23.7 BCM of natural gas and includesthe construction of Startup Facilities and an LNGplant. The Startup Facilities include the full chainfrom the upstream gas production of 23.7 BCM annuallythrough the transfer to the license holder of the pipelinegas and condensate as nal marketable products.

The start of gas production and supply via the gaspipeline is planned before the end of 2016, with LNGto follow in 2017. The stakeholders of the projectsince February 2008 are Gazprom (with 51%),Total (with 25%) and Statoil (with 24%).

Sakhalin IIIThe Sakhalin III project will become one of the mainsources of gas supply in the Russian Far East. Gazpromholds licenses for three blocks within the project(Kirinsky, Ayashsky and Vostochno-Odoptinsky)and for the Kirinskoye gas and condensate eld.

The gas resources of the Sakhalin III projectare estimated at 1.4 trillion cubic meters. The bulkof them are concentrated in the Kirinsky block.Gas production is expected to start in 2014.

PrirazlomnoyePrirazlomnoye is the rst Russian oil project to be started

on the Arctic shelf. The eld is located on the Pechora Seashelf 60 km offshore, at a water depth of 19 to 20 metres.The Prirazlomnoye eld contains 72 million tonsof oil reserves, meaning an annual production levelof 6.6 million tons is achievable.

Production operations in the Prirazlomnoye eldare scheduled to start in 2012. The license to exploreand produce hydrocarbons in the Prirazlomnoyeeld is owned by Gazprom Neft Shelf.

Oil pipelines

Caspian Pipeline Consortium (CPC)Geological exploration in the Caspian region is oneof Russias main priorities for the future developmentof its oil and gas industry. The CPC crude pipeline systemis the only pipeline in Russia carrying oil resourcesfrom the Caspian region.

Three governments and ten companies representingseven countries are participating in the project,which is operated by two joint ventures: CPC-R (Russia)and CPC-K (Kazakhstan). CPC is unique in Russia,as it is a shipper-owned pipeline. It is nancedand constructed by the group of shareholders whotransport or expect to transport crude oil by thispipeline. This is radically different from the existingRussian pipeline systems owned by Transneft,which transport third-party crude oil.



In February 2009, Russia and China signeda contract to construct a branch pipeline to China(from Skovorodino) with a capacity of 15 MT.Russia will supply China with 15 MT of oil each yearfor 20 years in exchange for a loan worth $25 billionto Russian companies Transneft and Rosneft, to be usedto develop pipelines and oil elds. The constructionwas completed on 1 November 2010, and sincethat time the pipeline has been operational.

The Eastern Siberia-Pacic Ocean oil pipeline stage 2(ESPO-2) is an extension of the rst stage (ESPO)described above.

The ESPO-2 pipeline will connect ESPO in the AmurRegion (Skovorodino) with Primorsky Krai(oil port Kozmino, near Vladivostok). Until ESPO-2is completed, crude oil is transported from Skovorodinoto Kozmino by rail. The planned capacity of thepipeline amounts to 50 MT and the capacity of ESPO

would also be increased accordingly. The commissioningof the ESPO-2 is planned for 2013-2014.

To increase the oil supply from Vankor eld to ESPO,the Purpe-Samotlor oil pipeline was put into operationin October 2011. The new pipeline transfers 25 MTof oil to the ESPO pipeline system.

ReneryThe major Russian oil producers Rosneft, Lukoil,Gazpromneft and Bashneft are introducingthe latest technologies to upgrade their reneries

in order to increase the share of light oil productsin the total production volume and to furtherincrease the processing depth.

In 2008, Rosneft devised a program to moderniseits reneries, which is now being implemented.The program envisages the construction of 30 new unitsand the reconstruction of more than 20 units at Rosneftsseven reneries. The reforming, isomerisationand alkylation units to produce the high-octanecomponents of gasoline are being installed or upgraded.The program also includes catalytic cracking unitsfor the production of high-octane gasoline componentsand to increase rening depth, and hydrocrackingunits for the production of high-quality componentsof diesel and jet fuel and to increase rening depth.

In 2001 the rst crude oil was transferred by CPC,and as of 2004 CPC is fully operational with an annualcapacity of 22 MT. The main pipeline connects oil eldsin Western Kazakhstan with a new marine terminalin Russia. CPC shipped 34.9 MT of crude oil for exportthrough its marine terminal near Novorossiysk in 2010.

CPC expansion, which is planned to result in CPCsannual capacity being increased to 67 MT, is expectedto be fully completed in 2014 or earlier, due toan expected increase in oil production in the region.

Baltic Pipeline System (BPS)The Baltic Pipeline System is a Transneft projectto increase crude oil export to the Europeanmarkets, allowing Russia to reduce its dependenceon routes through transit countries. BPS connectsthe Timan-Pechora, Eastern Siberia and Volga-Ural eldswith the port of Primorsk in the Russian Gulf of Finland.

BPS became operational in December 2001(with a capacity of 12 MT), and since 2006it operates with a total annual capacity of 75 MT(30% of the total Russian crude oil export).

Working towards diversifying crude oil pipeline routes,Transneft has started a new Baltic Pipeline Systemproject. A new line, named Baltic Pipeline System-2(BPS-2), would connect the Druzhba pipeline withthe port of Ust-Luga in the Russian Gulf of Finland.A branch pipeline would connect it to the Kirishi oilrenery. The throughput annual capacity of BPS-2

will be 50-75 MT. According to Transneft ofcials,the pipeline may be completed in 2012.

Eastern Siberia Pacic Ocean (ESPO) Pipeline,including Purpe-Samotlor pipelineThe Eastern Siberia-Pacic Ocean oil pipeline (ESPO)will transport Russian crude oil to the Asia-Pacicmarkets, especially China. The pipeline is builtand operated by Transneft, a 100% state-ownedRussian pipeline company.

The construction of the pipeline was completed in 2009.The rst stage included a pipeline from the Irkutskregion (Taishet) through Yakutia to the AmurRegion (Skovorodino), with an annual capacityof 30 MT of crude oil.


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Most of the work under the program should becompleted by the end of 2014. It is expectedthat the yield of light products will rise from 56%in 2010 to nearly 80% by 2015.

Lukoil introduced a new catalytic cracking complexto its Nizhny Novgorod renery in 2010, which isalready producing Euro-4 gasoline. An alkylation unitwas installed in 2011 which enabled the productionof automotive gasoline at Euro-5 standards.

Gazpromneft Omsk renerys development plan callsfor a transition to the production of Euro-4 gasolineand diesel fuel starting from 2012, and Euro-5 productsstarting from 2015. For this purpose, the reneryhas reconstructed its L24/9 diesel fuel plant and hasstarted the construction of a complex of diesel fuel andcatalytically cracked gasoline hydrotreatment facilities.

A light gasoline fraction isomerisation plant similar

to the one in Omsk will be also constructed at JSCSlavneft-Yaroslavnefteorgsintez (YANOS). YANOS wasone of the few Russian oil reneries that managedto start producing low-sulphur diesel fuel in the shortestpossible time. In 2008, YANOS began the productionof diesel fuel with a sulphur content of 10 mg/kgin compliance with Euro-5 requirements, accountingfor about 55% of the renerys total output.

In 2010, a large-scale modernisation program wasalso launched by Gazpromneft at the Moscow renerywith the construction of a light naphtha isomerisation

plant. The plant will produce a gasoline componentwith an octane number of up to 90.5 points.The plants capacity will be 650,000 tons per year.The commissioning of the plant is scheduled for 2012.

Russias other large oil company, Bashneft, is the leaderin terms of oil processing depth. Bashnefts reningcomplex includes a number of processing units for deepoil rening, including those for hydrocracking, catalyticcracking, thermocracking, delayed coking, alkylation,isomerisation, hydrotreatment, etc. These units allowfor the production of petroleum products meetingEuro-4 and Euro-5 standards.

In 2010, Bashneft reneries processed 21.2 milliontons of crude oil, providing an average rening depthof 86.3%, the highest level among Russias verticallyintegrated oil companies.

Gas pipelinesBlue StreamThe Blue Stream natural gas pipeline is a gas transmissionfacility which became fully operational in 2005. The BlueStream is an alternative route from Russia to Turkey(one of the largest buyers of Russian natural gas)that crosses the Black Sea, bypassing transit countries.

In 2010 the Blue Stream conveyed 8.1 BCM of gas, whileits full annual capacity amounts to 16 BCM. Implementingthis project substantially increased the reliability of gassupply to Turkey. While the current supply volume is lessthan the full capacity of the pipeline, Russia has the abilityto increase actual supply on Turkeys request.

The extension of the Blue Stream pipeline will allowgas deliveries to Central Europe, the Middle East,Israel and other countries. The Blue Stream pipeline isa complete gas transportation system that could be usedfor new projects, one of which could be Blue Stream-2.

Nord Stream PipelineThe Nord Stream gas pipeline constitutesa fundamentally new export route for Russian gasto European customers, running through the Baltic Seafrom Vyborg, Russia to Greifswald, Germany.

The pipeline began operation in November 2011.The Nord Stream is 1,224 km long and consists of twoparallel pipelines. The rst line has an annual transmissioncapacity of around 27.5 BCM, and the capacityof the second line is around 55 BCM. The target marketsfor gas supply via the Nord Stream are Germany, the UK,the Netherlands, France, Denmark and other countries.To manage the construction of the Nord Stream Pipeline,the joint venture Nord Stream AG was establishedin the end of 2005. Gazprom has a 51% share of the jointventure; other shareholders are Wintershall Holding(BASF AG subsidiary, 15.5%), E. ON Ruhrgas (15.5%),N.V. Nederlandse Gasunie (9%) and GDF Suez S.A. (9%).



LNGOne of the most successful recent oil and gas projectsin Russia was the opening of Russias rst LNG planton Sakhalin Island in February 2009. It was builtas part of Sakhalin-2, a large integrated projecton the development of two offshore oil & gas eldsto the north-east of Sakhalin for the productionand export of crude oil and liqueed natural gas.Sakhalins LNG plant features two production trains,each with an annual capacity of 4.8 MT, and is the sixth

largest LNG plant in the world. Future producedvolumes of gas have already been purchasedunder long-term sales contracts with Japan,South Korea, India, Kuwait, China and Taiwan(some of the contracts are for over 20 years).

Russia plans to set up two more LNG plants for its twolargest gas elds, Bovanenkovskoye and Shtokman.

The main advantage of this pipeline is the absenceof transit countries on the way to Germany, meaningthat Russia will no longer have to negotiate transit feeswith them or pay in natural gas. A possible branchconnection to Sweden has also been considered.

South Stream PipelineThe South Stream is another transnational gaspipeline project to diversify the routes of natural gassupplies to European consumers. An offshore sectionof the South Stream pipeline will run across the BlackSea from the Russian coast to the Bulgarian coast.The total length of the section will be around 900 km.This pipeline is expected to compete with the Nabuccopipeline, although according to estimations madeby Gazprom both pipelines will not be sufcientto satisfy future European gas demand.

A further pipeline route will run through Bulgarianterritory, where it would divide into two directions:

the rst link would go from Bulgaria through Greeceto Italy, and the second link would go from Bulgariato Austria with transit through Slovenia, Serbiaand Hungary, and with transit through Romaniaunder consideration. The maximum throughput capacityof the South Stream will amount to 63 BCM per annum.

In January 2008 Gazprom and Italian company ENIset up South Stream AG to carry out marketingresearch, compile a feasibility study and constructthe maritime part of the South Stream project.In 2010 intergovernmental cooperation agreements

were signed with Bulgaria, Hungary, Greece, Serbia,Slovenia, Croatia and Austria in order to constructthe onshore sections of the pipeline.

The project is currently at the stage of feasibilitystudy acceptance; therefore, actual constructionof the pipeline has yet to begin. The projectis planned to become operational in 2015.


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General requirements with respectto the use of subsoil resourcesThe legal framework with respect to the use of subsoilresources in Russia is established by the FederalLaw On Subsoil Resources of 21 February 1992(hereinafter Subsoil Law).

According to the Subsoil Law, geological surveys,exploration and extraction of minerals (including oiland gas) are performed under a license for subsoiluse. This license certies the right of a subsoil userto perform certain activities on a certain part of subsoilwithin a limited period of time subject to compliancewith the licensing conditions (usually established bya license agreement, an integral part of the license).

As a general rule, a license for subsoil use is grantedbased on the results of an auction or tender.

The Subsoil Law provides for signicant limitations

with respect to granting licenses for subsoil usewith respect to areas of subsoil considered to beof federal signicance, including areas of subsoil:

containing extractable oil reserves of 70 MT or more; containing natural gas reserves of 50 BCM or more; located in internal waters, territorial sea or

on the continental shelf of the Russian Federation.

For areas of subsoil considered to be of federalsignicance a license may be granted onlyto a Russian legal entity. Upon holding an auction/ tender for the right to use such an area of subsoil,

the Russian Government may also place restrictionson the participation of Russian legal entities whichare owned by foreign investors in whole or in part.

For areas of subsoil located entirely or partlyon the continental shelf, a license may be grantedonly to a Russian legal entity with no less than veyears experience in working on the continental shelfand in which the Russian Federation directly or indirectlyholds more than 50% of shares. In practice, this meansthat these licenses are granted only to state-owned oil& gas companies (such as Gazprom and Rosneft) or,in some cases, to joint ventures with these companies(provided that the Russian Federation retains morethan 50% of shares in the venture).

In most cases, foreign investors choose to obtaina license for subsoil use in the name of a Russiansubsidiary company. Still, for areas of subsoil that donot fall within the category of federal signicance,a license may usually be obtained through a dulyregistered branch ofce of a foreign legal entity.

The above regulations are applicable only to companieswhich are directly engaged in geological surveys,exploration and extraction of minerals. Servicecompanies do not need to obtain a license for subsoiluse, although they may still need to obtain otherlicenses to perform certain types of activities.

Payments for subsurface useCompanies holding licenses for exploration andproduction are subject to the payments described below.

Regular payments for the right to prospect and appraiseoil and gas deposits. The rate of these payments is set

within a range of RUB 120/sq km to RUB 360/sq km(approximately USD 4-12/sq km) of the area beingprospected and appraised. For the continental shelf andexclusive economic zone, the rates vary from RUB 50/sqkm to RUB 150/sq km (approximately USD 1.5-5/sq km).

Regular payments for the right to explore deposits(i.e. the stage following prospecting and appraisal).The payment rate is set within a range of RUB 5,000/ sq km to RUB 20,000/sq km (approximately USD170-670/sq km) of the area under exploration.Rates of RUB 4,000/sq km to RUB 16,000/ sq km

(approximately USD 130-530/sq km) of the area underexploration are prescribed for the continental shelfand Russias exclusive economic zone.

One-time payments for the use of subsurfaceresources. The terms of these payments are establishedby the relevant licenses, but should not be lower than 10%of the estimated annual amount of Mineral extraction tax.This may potentially be one of the most signicant costsrelated to obtaining and developing a license area.

Fee for participation in a competitive tender/auction.The amount of the fee is determined based on the costsof preparing for, holding and evaluating the tender/ auction, together with experts fees.

Legislative frameworkin the Oil & Gas industry



Expenses associated with obtaining a licensefor subsurface use, including expenses for the appraisalof natural resource deposits, feasibility studies,obtaining geological information etc., should beincluded in the cost of the relevant license, treatedas an intangible asset and amortised on a straight-linebasis over its lifespan. Expenses relating to participationin a license tender may alternatively be treatedas a production and sale expense which is amortisedover a period of two years at the taxpayers request.If no license is obtained, the expenses are amortisedover a period of two years following the monthof the relevant tender.

Types of business presenceOne of the initial stages of planning operations in Russia ischoosing the most appropriate form of business presence.

The possible options include creating a Russian legalentity (either solely or as a joint venture with a Russian

partner), opening a branch or representative ofce,registering a separate subdivision for tax purposesor performing activities through a joint activityagreement (simple partnership) with local partners.

In most cases, foreign companies choose to operatethrough a branch ofce or a Russian legal entity.The most important differences between these twoforms of business presence are indicated in Table 3.

In general, operations carried out through a branchofce of an FLE could be more benecial from a nancialperspective since the repatriation of prots after taxationwould not be subject to any further taxation in Russia.

Foreign companies may also choose to operate in Russiadirectly without opening a branch ofce. In thiscase, the foreign company should register a separatesubdivision with the Russian tax authorities. Operationscarried out through this subdivision will not allowa foreign company to obtain any licenses and permitsfor activities in Russia, including documentation requiredto authorise foreign personnel to work in Russia in mostcases. Still, this option could be workable in certainsituations, especially for short-term offshore projectsperformed by service providers.

Regarding operations carried out through representativeofces or joint activity agreements (JAA), these optionsare less popular and apply only to certain specic cases.

Formally, representative ofces should not be d irectlyengaged in business operations and their activityshould be of a non-commercial nature (such asmarketing and information gathering). A JAA is nota legal entity in and of itself, but represents the poolingof assets for the common conduct of business.One of the partners is usually appointed as the partyresponsible for bookkeeping and statutory reporting.

Table 3

Issue Branch of foreign legal entity (FLE) Russian legal entity (RLE)

Repatriation of prots Not subject to taxation Taxed as dividendsConsolidation of nancialresults of several businessunits for prots tax purposes

Impossible (each branch creating a permanentestablishment for tax purposes is a separate taxpayer).

Possible (nancial results of all business unitswithin one company, including the RLE itselfand its branches, may be consolidated).

Liabilities FLE is responsible for all liabilities of its Russian branch. As a general rule, shareholders of an RLEare not responsible for its liabilities.

Period of establishment The maximum period is 5 years, after which the branchshould be reregistered with the Russian authorities

Unlimited.

Obtaining licensesand permits

Although a branch is formally entitled to obtainmost licenses and permits for operations in Russia(with a few exceptions), from a practical standpoint

the process is more complicated than for an RLE.

In practice, the process could be easier comparedto a branch of an FLE.

Closure Compared to the procedure of closing an RLE,the process is simpler.

The process is quite formal and complicatedand includes various stages and registrationactions with the Russian authorities.


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Acquisition of an existing oil & gas businessA foreign investor may choose to enter Russian oil & gasindustry by acquiring an existing oil & gas business.

Acquisition may be carried out through the purchaseof shares in an operating Russian company,or by purchasing a property complex requiredfor the planned operations.

Purchase of shares in a Russian company Such a purchase may be complicated by the Russianantimonopoly and strategic investments regulations.

First of all, the purchase of shares may be subjectto preliminary approval by Russian antimonopolyauthorities if the total assets of the investor (and its groupof entities) and of the acquired company (and its groupof entities) exceed RUB 7 billion (approx. USD 230million). Approval is also required in certain other cases.

The denition of the group of entities provided byRussian antimonopoly regulations is rather complicatedand generally includes companies and individualsafliated with the investor and the acquired company.With respect to the purchase of oil & gas companies,Russian antimonopoly requirements apply in most casesdue to the amount of total assets of the companiesbelonging to the group of investors and/or the target.

If the target company holds a license for subsoiluse with respect to an area of subsoil of federalsignicance, the Federal Law On the procedure

for foreign investments to commercial legal entitiesof strategic importance for national defense and statesecurity of 29 April 2008 (hereinafter StrategicInvestments Law) may apply.

In this case, the purchase of 25% (in some cases 5%)or more shares in such a company by a foreign investor(or a company forming a group of entities with a foreigninvestor) may be subject to separate approvalby the Russian Government Commission, headedby the Russian Prime Minister.

The procedure of obtaining approval is rathercomplicated and time-consuming. In addition,the Strategic Investments Law does not specify

cases when the Government Commission may rejectgranting its approval. In this regard, the decisionsof the Commission could potentially be rather subjective.

In spite of the complicated procedure of obtainingapproval, in practice the Government Commissionapproves most applications. As of January 2012,out of 137 applications received by the Commission(starting from 5 May 2008, the date on whichthe Strategic Investments Law entered into force),only eight were rejected.

Purchase of a property complexWhen property is purchased, Russian antimonopolyrequirements may also apply.

The purchase may be subject to preliminary approvalof the Russian antimonopoly authorities if the totalassets of the investor (and its group of entities)and of the seller of property (and its group of entities)

exceed RUB 7 billion (approx. USD 230 million)and as a result of purchase the investor obtains propertywith a balance value exceeding 20% of the totalbalance value of the sellers xed and intangible assets.This requirement may also apply in some other cases.

Licensing and regulatory mattersTo perform certain types of activities in Russiaa company may need a special license or permitin accordance with Russian legislation. In most cases,these licenses (permits) are issued by state authorities.

The list of licenses (permits) which could be applicableto a company engaged in the oil & gas business mayvary greatly depending on the details of a particularproject. However, in practice the following licenses(permits) could potentially be required:

License to operate re-hazardous and highly explosiveindustrial objects;

License to operate chemically hazardous industrialobjects;

License to collect, use, neutralise, transport and placehazardous waste;

License to work with state secrets (in certain casesinformation gathered during geological surveysand exploration of mineral deposits could containinformation carrying the status of state secrets);



and loss, changes in equity, cash ows (with one yearscomparatives) and supplementary notes.

Branches and representative ofces of foreign legalentities may elect not to maintain accounting recordsand not to prepare nancial statements in accordancewith RAS, provided they maintain tax records compliantwith Russian tax legislation.

RAS nancial statements must be led with thetax authorities within three months after the endof the calendar year. Certain entities, including open

joint stock companies, banks and other lendingagencies, insurance companies, stock exchangesand investment funds are required to publish theirRAS nancial statements. Such companies may haveadditional reporting and disclosure requirements(see the section "Adoption of IFRS in Russia" for details).

RAS audit requirements

The audit of annual RAS nancial statementsis mandatory for:

Open joint stock companies; Companies with securities traded on stock exchanges; Banks and other lending agencies, insurance companies,

credit bureaus, pension and investment funds, securitiesmarkets participants and stock exchanges;

Companies with annual revenue for the precedingnancial year exceeding RUB 400 million(approximately USD 13 million).

Companies with total assets as at the preceding

31 December exceeding RUB 60 million (approximatelyUSD 2 million), publicly traded companies, banks,insurance companies, non-governmental pension funds,and companies owned more than 25% by the statemust be audited by an audit rm, rather thanby an individual auditor.

Harmonisation of RAS with IFRSSignicant progress is being made towards convergingRAS with IFRS. During 2011, this trend saw new Russianstandards on provisions, contingent assets and liabilities,segment reporting and cash ow statements cominginto force, with new standards on inventory, xed assets,employee benets and leases expected in 20122013.

Permit to perform construction work (issuedby Self-Regulated Organisations; in order to obtainit a company needs to join such an organisation);

Documentation required according to Russian regulationson the industrial safety of dangerous objects, such ascertication of the equipment used at such objects,attestation of employees, expertise of industrial safety.

The licenses to perform certain types of activitiesmay be required for both the users of the subsoil(holding the appropriate license to use the subsoiland directly engaged in geological surveys, explorationand extraction of minerals) and service companies.

In some cases, the operations of a company engagedin the oil & gas business may be structured in sucha way where activities requiring a license may besubcontracted to third parties holding the requiredlicenses. In this case, the company may not needto obtain these licenses itself.

Accounting environmentOverview For historical reasons, the Russian nancial reportingframework has been determined and regulatedby the state, rather than being developed by professionalbodies. Indeed, the primary users of Russian statutorynancial statements based on Russian AccountingStandards (RAS) are the tax and other state authorities,rather than management or third parties. Currently,International Financial Reporting Standards (IFRS)are becoming increasingly important, both in terms

of inuencing the development of RAS and as thecompulsory standards for certain types of Russian entities.

Preparation of RAS nancial statementsEvery legal entity registered in Russia must preparestandalone RAS nancial statements for each nancialreporting (calendar) year ending 31 December.The format and content of the nancial statementsare set by the Ministry of Finance, including the chartof accounts and recommended accounting entriesfor typical transactions.

The nancial statements must include a balance sheet(with two years comparatives), statements of prot


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New procedures for revising and adopting Russianstandards apply from 2013, including a requirementthat they are based on the IFRS equivalent.

There nevertheless remain signicant differencesbetween RAS and IFRS, including:

The fair value concept is not applied; Most nancial instruments are accounted for at cost

or amortized cost (less impairment provision); Finance leases may be capitalized or expensed

by agreement of the parties to the lease contract; Property, plant and equipment are not impaired,

but revaluation to current replacement cost is allowed; The useful lives of xed assets tend to be in line with

the useful lives specied for tax purposes;

Deferred tax is calculated using the income statementmethod, although the methodology differs; Revenue and expenditure are generally recognized

after primary documentation supporting the transactionhas been received in accordance with the tax rules.

In 2004, the Ministry of Finance of the RussianFederation issued its Medium-term conceptfor the development of accounting and nancialstatements, which set a target for the convergenceof RAS with IFRS. Over the last two years, signicantprogress towards IFRS has been made, e.g.,

new standards on accounting for construction contractsand the correction of fundamental errors, and the newconsolidation law. Already, companies in the bankingsector submit nancial statements to the Central Bankof Russia which are much closer to IFRS, as well as IFRSconsolidated nancial statements.

Adoption of IFRS in RussiaFollowing the formal adoption of IFRS in Russia during2011, public interest entities (PIEs) are now requiredto prepare consolidated nancial statements under IFRS(previously, only Russian banks were required to prepareIFRS statements). This requirement is in additionto standalone statements prepared under RAS. PIEsinclude companies with securities traded on a stockexchange, banks, and insurance companies. Otherentities that have issued securities by way of publicoffering, or by means of private placements to a widegroup of shareholders, are also required to prepareconsolidated nancial statements under IFRS.

Most PIEs must prepare their rst full set of IFRS nancialstatements for the 2012 calendar year (with 2011comparatives), deferred for three years in the caseof issuers of traded securities which already prepare USGAAP nancial statements, or which only issue bonds.

Annual consolidated IFRS nancial statements mustbe audited, presented to the shareholders and ledwith the Federal Committee on Securities Markets(or the Central Bank for banks) within 120 days afterthe year end. The nancial statements must also be

published, for example, on the internet.

Accounting systemsMost companies in Russia maintain their accountingrecords using IT systems tailored to the prescribedRAS chart of accounts and reporting formats.Management reporting is also often based on RAS,with quarterly or annual transformation to IFRS. Onlylarger companies have in-house capabilities to performthe transformation to IFRS and therefore this processis often outsourced to consulting rms, or at leastperformed with their assistance.



Production Sharing AgreementsRussian legislation provides for the possibility to enterinto a Production Sharing Agreement (hereinafter PSA) between the Russian Federation and an investor(including foreign legal entities).

Under a PSA, the state grants an investor exclusive rightsto explore and extract subsoil resources on the speciedsubsoil area. The investor should perform work relatedto exploration and extraction of subsoil resourcesat its own expense and risk, either itself or througha third-party contractor (operator of the PSA).

The PSA provides for sharing production betweenthe investor and the state. There are two basicapproaches to sharing production:

Establishing different procedures for sharing productionduring the period until the costs borne by the investorare repaid (sharing of compensatory production)and during the period after such costs are repaid

(sharing of protable production); Establishing a single procedure for sharing production

over the entire lifespan of the project.

The PSA regime does not release the investorand operator from the general Russian licensingand regulatory requirements. The right of the investorto work on a certain area of subsoil under a PSAshould be conrmed by the license for subsoil use.The PSA regime may be only applied with respectto a limited number of subsoil areas. If there is an auctionto grant an area of subsoil for development under

the general regime under the Subsoil Law and the auctionfails (e.g. if the auction has only one participant), thenthe related area of subsoil is included on the list whichmay be developed under the PSA regime.

To conclude a PSA, another auction should be held.The SA is concluded with the winner of that auction.

The PSA model is not widely used in Russia. There are only3 active PSAs (Sakhalin-1, Sakhalin-2 and the Kharyaginskyproject), which were concluded before the current FederalLaw On PSAs entered into force in 1996, and as such aregrandfathered. Top ofcials of the Russian Governmenthave made several public announcements, stating thatthe Russian Federation would not enter into new PSAs.

Continental shelf projectsRussian legislation provides for specic regulationswith respect to the development of oil & gas depositslocated offshore, on the Russian continental shelf.

The continental shelf is a seabed and subsoilof the underwater areas located outside the RussianFederation territorial sea (the external borderof the territorial sea is 12 nautical miles fromthe seashore). The external border of the continentalshelf is 200 nautical miles from the external borderof the territorial sea. If the underwater continentalmargin extends beyond 200 nautical miles, the externalborder of the continental shelf coincides with the outerboundary of the underwater continental margin.

As noted above, the license for subsoil use with respectto areas of subsoil either fully or partially locatedon the continental shelf may currently be grantedonly to state-owned companies where Russia holds

more than 50% of shares or, in some cases, to jointventures involving companies matching that description.Unless a foreign investor forms such a joint venture,its operations on the Russian continental shelf may belimited to providing services to state-owned companiesor joint ventures with these companies.

The continental shelf is not considered partof the territory of the Russian Federation. In this regard,work on the continental shelf entails certain tax, customs,state frontier, immigration and other complications.Related operations should be planned accordingly.

Drilling work, the establishment and use of articialislands, installations and structures on the continentalshelf must be approved by the competent Russianauthorities. Such approvals should generally be obtainedby the operator of the project, not by service providers.If the license for subsoil use issued to the operatoralready provides for the right to perform such work,the operator is not required to obtain separate approval.


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Prot taxTaxpayersProt tax applies to Russian legal entities and foreignlegal entities carrying out activities in Russiathrough a permanent establishment or receivingincome from Russian sources.

A Russian legal entity must be registered with the ofceof the tax inspectorate corresponding to the locationof the companys registered address, as well asat the ofces corresponding to any branchor subdivision of the entity. The company is liableto pay prot tax in respect of each of these locations.

As of 2012, the Tax Code introduced consolidationfor prot tax purposes for taxpayer groups if all qualifyingparticipants combined meet the following minimumrequirements in relation to the preceding calendar year:

total taxes paid of RUB 10 billion (approx. USD 330 million); total revenue of RUB 100 billion (approx. USD 3.3 billion); total value of assets (at year end) of RUB 300 billion

(approx. USD 10 billion).

Please refer to the chapters entitled Taxationof foreign presences and Russian-sourced incomeof foreign companies for details about the taxationof FLEs and to the chapter entitled Tax incentivesfor information on prot tax reductions and exemptions.

RatesThe maximum prot tax rate is 20%, comprising:

2% payable to the Federal budget;

18% payable to the Regional budget.

Regional governments have the right to reducetheir portion of prot tax by up to 4.5%.Please refer to the chapter entitled Tax incentivesfor further details.

Tax baseThe tax base is dened as the total income received bya taxpayer less related expenses and allowable deductions.

Income includes sales income, i.e. total proceeds fromthe sale of goods, work, services and property rights,and non-sales income. Income received in a foreigncurrency must be converted into rubles using the ofcialexchange rate set by the Central Bank of Russia (CBR)as of the date on which income is recognised.

Non-sales income includes goods, work, servicesand property rights received free-of-charge, basedon market value, except in the case of propertyreceived by a Russian company from its parent

or subsidiary where the parent owns more than 50%of the subsidiary. This exemption is lost if the property(other than cash) is transferred to a third partywithin one year. Non-taxable income, of whichthe legislation provides an exhaustive list, also includesproperty and property rights received as a contributionto a companys charter capital, leasehold improvementsmade by a lessee to the lessors property, and interestreceived on overpaid tax.

Deductible expenses are subdivided into sales expensesrelated to the core business activity of a taxpayer,

and non-sales expenses.

Taxation of Oil & GasCompanies

Income from the sale of unquoted sharesand participation in Russian companies,and of quoted shares in high-technologyRussian companies, acquired

after 1 January 2011 and held for at least5 years, are exempt from prot tax



Assets and liabilities denominated in foreign currencymust be converted into rubles. The revaluation protor loss is included in non-sales income/expenseon the last day of the reporting (tax) period or the dateof disposal/settlement (whichever is earliest).

ExpensesGeneral criteria for deducting expensesExpenses are considered deductible for prot taxpurposes if they meet three general criteria:

the expenses must be incurred in the courseof a taxpayers income generating activity;

they must be economically justiable and supportedby relevant documentation;

they must not be listed as one of the specicallynon-deductible expenses provided in the law.

Additional deductibility criteria applying to certain typesof expenses are noted below.

Expenditure which indirectly benets or promotesthe growth of the business may not be consideredeconomically justied. Documentary requirementsare also exacting, and include both documents speciedby legislation (agreement, act, invoice and VAT invoice)and other supporting materials.

For overseas expenses, the documentation must beprepared in accordance with the common businesspractices of the country where the expenses wereincurred, although this does not guarantee deductibility.

DepreciationA depreciation charge can be deducted in calculatingthe prot tax liability, starting from the rst dayof the month following the month when an assetis put into operation. Examples of the useful livesof xed assets typically used in the oil and gas industryare shown in Table 4.

Table 4

DepreciationGroup

Useful life(years)*

Examples of types of xed assets Depreciationmethod

1 1-2 Metal-working and woodworking tools/machines; oil and gas production equipment;construction hand tools

Straight-linemethodor decliningbalancemethod

2 2-3 Drilling machines; construction power tools; equipment for underground tunneling workand sampling

3 3-5 Elevators; forestry tractors; automobiles; tank trucks; computers and peripheral equipment;ofce machinery

4 5-7 Ofce furniture; television equipment; clocks; light trucks (with less than 0.5 ton capacity)

5 7-10 Oil/gas collecting systems; gas pipelines; ber-optic communication systems; heavy trucks(5 15 ton capacity)

6 10-15 Oil wells; railway transport infrastructure; heavy trucks (over 15 ton capacity)

7 15-20 Bridges; ductwork; refrigerators; drilling ships

8 20-25 Blast furnaces; wharves; river and lake passenger vesselsStraight-linemethod

9 25-30 Runways; nuclear reactors; oil/gas tanks

10 >30 Escalators; forest shelter belts

* The exact useful life of xed assets is determined based on their classication as prescribed by the Russian Classication for Fixed Assets.

In practice, the tax authorities apply the general criteriavery strictly, and may challenge any expensewhich is not directly related to the generation of income


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rates shown in Table 4 are, in certain cases, adjustedby coefcients, for example:

for xed assets which are used in a demandingenvironment, belong to residents in Special EconomicZones, or are designated as energy-efcient, up to twotimes the normal rate is applied;

for leased property and xed assets which are used onlyfor scientic and technical purposes, up to three timesthe normal rate is applied.

Taxpayers are entitled to deduct a one-time depreciationallowance of 10% (30% for asset groups 3-7)of the historic cost of xed assets purchased or capitalimprovements made. The regular depreciation expenseis then computed on the reduced tax base.

Treatment of exploration cost Expenses relating to the exploration and appraisal

of natural resource deposits (whether or not successful)should be deducted on a straight-line basis over

the 12 month period following completion of the work.Separate tax accounting is required for eachexploration project.

Expenses relating to the preparation of land plotsfor the extraction of natural resources and restitutionwork for cleaning up environmental damage causedduring the construction and operation of extractionplant are deductible evenly over the two yearperiod following completion of the work (althoughthe expenses may no longer be deductible if the plantis decommissioned during that period).

Expenses relating to dry wells should be deducted

evenly over a 12-month period starting from the rstday of the month following the wells abandonment.No provisions for future abandonment costs are allowed,and thus these costs are deductible only when incurred.

GoodwillGoodwill arising on the acquisition of a propertycomplex essentially, a bundle of assets whichhas a collective purpose, such as a production plant may be recorded as an asset and written off on a straight-line basis over the course of ve years. The amountof goodwill recognised is the excess of the price paid overthe net asset value of the company. If the price paidis lower than the net asset value, the buyer recognisesthe difference as income at the moment the propertyright is registered.

Depreciable property is property, both tangibleand intangible, which has the following characteristics:

a useful life of at least 12 months; a value of no less than RUB 40,000

(approximately USD 1,300).

If the property does not meet these criteria, it is treatedas an expense and should be included in the costof sales. Land cannot be depreciated.

All depreciable xed assets fall within one of tengroups described in Table 4, and the taxpayershould determine the useful life of its xed assetsbased on this classication.

The useful life of an intangible asset is basedon the utilisation period stated in any agreementor the validity period in the case of a patent.In any other cases, it is 10 years.

Leasehold improvements undertakenat the expense of a lessee, and with the lessorsapproval, can be depreciated by the lessee overthe useful life of the relevant assets for the periodof the lease agreement.

Two methods of calculating the depreciationexpense are available the straight-line methodor the reducing balance method. The straight-linemethod must be used for buildings, other constructionsand transmission devices that fall within depreciationgroups 8-10, while either method may be used for other

xed assets. The method chosen should be statedin the taxpayers tax accounting policy and can bechanged from the straight-line method to the reducingbalance method from 1 January of the next tax year,and once every ve years in the reverse case.

Under the straight-line method, the monthlydepreciation is calculated as:

1/ useful life in months x historic cost of the asset

Under the reducing balance method, the monthlydepreciation is calculated as:

Net book value of asset group x depreciation rate (%)The net book value, on which the monthly depreciationis based, thus reduces every month. The depreciation



Expenses subject to limitationThe following types of expense may be deducted forprot tax purposes within certain limits:

AdvertisingExpenses on advertising, including in the press, on radioand television, outdoor advertising, printing brochuresand catalogues and participating in exhibitions are notsubject to any limitation. Other categories of advertisingexpenditure may be deducted for prot tax purposesup to an amount equivalent to 1% of a taxpayers salesrevenue (net of VAT).

Entertainment Expenses incurred on hosting clients duringnegotiations and those attending board meetingsare deductible up to 4% of a taxpayers total payrollcost in the reporting period.

Insurance

Obligatory property insurance premiums are deductiblewithin certain limits. Voluntary insurance premiumsare only deductible if specically providedby the tax legislation.

R&DThe Tax Code contains a complete list of R&D expenseswhich are deductible. Costs for certain types of R&Dare fully deductible in the period the R&D activity(or its separate stages) has been completed and (or)the act of acceptance has been signed, irrespectiveof the result. For some types of expenditure,

the deduction is 150% in the period the cost is incurred.

Interest The general rule is that interest charged at a ratemore than 20% above the average rate chargedon comparable loans made in the same quarteris non-deductible.

In the absence of comparable data, or at the taxpayersrequest, the maximum rates are as follows:

For ruble-denominated loans, the Central Bank of Russia(CBR) renancing rate at the date when the loanis advanced, multiplied by 1.8

For foreign currency-denominated loans, the CBRrenancing rate on the date the loan is advanced,multiplied by 0.8

Interest on foreign controlled debt is further restricted.

Thin capitalisationThe thin capitalisation rules restrict the deducibilityof interest charged on foreign controlled debt.

The rules apply to loans (and other debts): to a Russian company from a foreign entity which owns,

directly or indirectly, more than 20% of the Russiancompanys share capital;

from a Russian company, which is an afliateof a foreign entity, to another Russian companywhere the foreign entity owns, directly or indirectly,more than 20% of the recipients share capital;

guaranteed or otherwise secured by a foreign entity thatowns, directly or indirectly, more than 20% of the Russiancompany that received the loan, or loans guaranteedor secured by a Russian afliate of the foreign entity.

The deductibility of interest is restricted to the extent

that the controlled debt exceeds net assets by morethan three times, or 12.5 times in the case of banksand leasing companies. Interest on excess debtis non-deductible and treated as a dividend subjectto withholding tax. In the event that the taxpayer hasnegative net assets, the whole amount of interestaccrued on the controlled debt will be non-deductibleand treated as a dividend.

ReservesA taxpayer may create certain types of reserves,including reserves for warranty repairs, repairs of xed

assets, R&D and for doubtful debts, subject to certainrules. In principle, a taxpayer may transfer the followingtax-deductible amounts to a doubtful debt reserve:

50% of the invoice value for debts outstandingfor between 45 and 90 days;

100% of the invoice value when that period is exceeded.

The total reserve for doubtful debts as at the endof the reporting (tax) period may not exceed 10%of revenue for the period. Special rules apply to banksand licensed dealers in securities.

Loss carry forwardLosses incurred by a taxpayer may be carried forwardfor up to ten years following the period in whichthe loss was incurred. Losses on certain types of activity


22/5622

to foreign companies must withhold tax each timeincome is paid. The tax must be remitted to the budgetwithin one day of the payment date.

Interest applies to late paid tax.

Taxation of foreign presencesA foreign legal entity (FLE) which conducts activityin Russia through a separate division, a term whichincludes representative ofces, branches, constructionsites and other places of business, for a period exceeding30 days in a calendar year, is required to registerwith the Russian tax authorities within 30 daysof commencing activity. This is regardless of whetherthe activity is taxable or not. If the FLE operates in morethan one location, it must register separately in eachlocation in which it is present. Each real estate projector construction site must also be separately registered.Although the taxation of a separate division of an FLEis similar to that of a Russian legal entity, there are

a number of differences that can make this an attractiveform of doing business in Russia.

Prot tax FLEs are liable for prot tax on their business incomeonly if their business activity creates a permanentestablishment (PE). If no PE exists, foreign entitiesare exempt from Russian prot tax. An FLE receivingincome from a source in Russia not connectedwith the activity of a PE is subject to withholding taxas described in the chapter entitled Russian-sourcedincome of foreign companies. Passive income,

such as dividends, interest and royalties are the mostcommon types of Russian-sourced non-business income.

The Tax Code denes the term permanentestablishment as a branch (lial), representative ofce,division, bureau, ofce, agency or any other separatexed place of activity, through which a foreign companyregularly engages in business activity in Russia. The termis used exclusively for tax purposes and does not affectthe legal status of an entity. The following areas of activityare expressly listed as giving rise to the creation of a PE:

exploration for or extraction of natural resources; construction, installation, assembly, adjustment,

maintenance and operation of machineryand equipment, including gambling equipment;

(e.g. securities, nancial instruments) are determinedand carried forward separately and may in future beoffset only against prot from the same activity.

Taxation of dividendsDividends are taxed as follows:

9% at source for dividends paid by one Russiancompany to another (unless the 0% rate below applies).In determining the tax base, the paying companyshould deduct the amount of dividends receivedin the same and preceding tax periods.

15% at source for dividends paid by Russiancompanies to foreign companies.

9% for dividends paid by foreign companies to Russiancompanies (unless the 0% rate below applies).Wherea double tax treaty applies, a credit for any withholdingtax suffered can be claimed against this liability.

0% for dividends paid by either a Russian or foreigncompany to a Russian company, provided thatthe Russian company has owned no less than 50%

of the company for at least 365 consecutive days.Dividends from foreign companies registered in certainlow tax jurisdictions are excluded from this rule.

AdministrationThe tax period for prot tax is the calendar year.The annual prot tax return is due by 28 Marchof the following year.

Taxpayers may choose to pay tax either on a monthlyor a quarterly basis, provided it is applied consistentlythroughout the tax year. If the monthly basis

applies, the tax return must be led and the tax paidby the 28th day of the following month. If the quarterlybasis applies, monthly payments are made based onone third of the previous quarters liability, while a taxreturn must be led, and the balance of taxes should bepaid by the 28th day of the calendar month followingthe reporting quarter. In each case, the cumulativeprots and payments to date are taken into accountwhen ling each monthly or quarterly return and makingthe appropriate tax payment.

Certain types of taxpayer, including foreigncompanies using the quarterly basis, are exemptedfrom the obligation to make monthly payments.Tax agents paying income, including dividends,



sales from warehouses owned or rented by a foreignlegal entity in Russia;

provision of services or performance of any otheractivity, apart from preparatory and auxiliary activitiesor activities explicitly dened as not creating a PE.

A foreign legal entity may also be considered as havinga PE if it conducts the activities listed above througha dependent agent. A dependent agent representsan FLE in Russia under a contract, acts on its behalf,and has and regularly exercises the right to sign contractson behalf of the FLE, or negotiates their signicant terms.

Russian tax law specically states that the gatheringand distribution of information, marketing, advertising,market research and the import and export of goodsby a foreign company should not by themselves leadto the creation of a PE. Russias double tax treaties,which prevail over Russian domestic law, also includea denition of a PE. Thus, if an FLE qualies as a resident

of a country with which Russia has a tax treaty in force,then the denition of a PE in that treaty will prevail.A list of countries with which Russia has a double taxtreaty is provided in the Appendix.

Prot tax base calculationPEs and Russian legal entities use similar rulesfor determining taxable prots and the calculationof taxes due. The rules on tax return lingand the maintenance of tax registers are also similar.The only major difference between a foreign entitywith a PE and a Russian legal entity is the monthly

advance payment of prot tax. PEs are exemptfrom this requirement and are thus not obligedto remit prot tax on a monthly basis.

Generally, PEs should calculate their prot tax usingthe direct method (i.e. gross income net of allowabledeductions) to arrive at taxable income. However,when a foreign entity has a PE because it conductspreparatory and auxiliary activities in Russia in favourof third parties on a free-of-charge basis, the PEwill be deemed to have taxable income equal to 20%of the expenses of the PE. In addition, Russian taxlaw allows an FLE to allocate income and expensesto its Russian PE. In particular, where all incomefrom activity in Russia earned through a PE is received

by the head ofce of the FLE, the income of the RussianPE is determined by reference to the FLEs accountingpolicy. Moreover, in cases provided by a double tax

treaty, Russian tax law also allows a deduction by the PEof overhead expenses incurred by the head ofce butrelating to the PE, e.g. management and administrativecosts. The tax authorities may require documentarysupport and justication of any amounts allocated.

Nevertheless, the allocation of income and expensesbetween an FLE and its Russian PE should takeinto account the functions carried out in Russia, assetsused and commercial risks borne. Russia does notimpose a branch prot tax on prot repatriatedby a PE to its head ofce.

Property tax The Tax Code establishes certain conditions regardingthe application of property tax to FLEs whichare summarised below:

An FLE which carries out activity in Russia through a PEis liable to corporate property tax on both movableand immovable property of the PE in accordancewith the corporate property tax rules applicable to Russianlegal entities (refer to the chapter entitled Property tax).

An FLE whose activities do not constitute a PE paysproperty tax only on its immovable property locatedin Russia. Thus, an FLE owning movable property located


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income from international freight, including demurrageand other payments relating to freight;

nes and penalties due by Russian parties for breakingcontractual obligations;

other similar types of income.

Income generated from the sale of goods,the performance of work and the provision of servicesin Russia are not subject to Russian withholding tax,provided that the activity does not lead to the creationof a Russian PE. Withholding tax is applicable regardlessof the form of payment and includes payments in kindor by means of a mutual offset of liabilities betweenthe seller and the buyer.

With respect to income from the sale of sharesor immovable property, related expenses may be deductedwhen determining the tax obligations of the FLE, providedthat the tax agent receives documents supportingthe expenses before payment is made. The withholding

tax rate varies according to the type of income, as shownin Table 5. The issuer of securities must act as the taxagent regarding the payment of interest and dividendsto a FLE, and if the issuer fails to withhold the relevant tax,responsibility lies with the broker, asset manager, nominalholder or other agent to the transaction. The broker,asset manager, etc., is also the responsible tax agent withrespect to withholding tax on a capital gain derived byan FLE from the disposal of securities. The tax agent is notobliged to withhold tax in the following circumstances:

the tax agent has received notication from the taxpayerthat the income relates to a PE of the taxpayer in Russia,

and the taxpayer has provided a notarised copy of itstax registration certicate, issued no earlier than theprevious tax period;

the income is exempt from tax under a productionsharing agreement;

the relevant double tax treaty provides for an exemptionfrom withholding income tax.

To claim the benet of a double tax treaty at the timeof paying Russian-sourced income, the foreign legal entitymust provide written conrmation to the payer thatit is a tax resident of that foreign country. The writtenconrmation must be provided prior to the payment date.

in Russia which is not attributable to a PE of the FLEin Russia is not liable to corporate property tax on thatmovable property.

There are some differences in the taxation of immovableproperty depending on whether it is owned by a foreignlegal entity or a Russian legal entity.

The immovable property tax base of an FLE without a PEin Russia, or which does not relate to a PE of the FLEin Russia, is determined based on the inventory valueof the property (as determined by the relevant statebody) rather than the average annual value. The taxbase for the year is the inventory value as of 1 January,with the quarterly advance tax payments basedon one quarter of the inventory value multipliedby the applicable tax rate.

Russian-sourced income of foreign companiesAs with other jurisdictions, the Russian-sourced

income of a foreign entity which is not attributableto a PE may be subject to withholding tax at source.The responsibility for withholding the tax lieswith the tax agent the Russian entity or FLEwith a registered PE making the payment to an FLEthat does not have a Russian PE. Failure to withhold taxmay lead to nes of up to 20% of the tax, while delayin payment may lead to late payment interest.

Withholding tax is applied to the following typesof Russian-sourced income:

dividends;

income relating to the distribution of prot or property,including distributions due to liquidation; interest on debt instruments, including prot-sharing

debt and convertible bonds; royalties; income from the sale of shares of a Russian legal entity

if more than 50% of its assets consist of immovableproperty located in Russia, or from sales of nancialinstruments which are derived from such shares(excluding most sales on a foreign stock exchange);

income from sales of immovable property located in Russia; income from leases and sub-leases of property used

in Russia (including sea and aircraft);



It must also be certied by the competent foreign bodyand apostilled. Lastly, the Russian tax authorities may alsorequire a legalised Russian translation of the conrmation.If conrmation is not provided prior to payment,and the foreign company suffers a withholding rategreater than that provided by the treaty, it is possibleto claim a refund within the three year period followingthe end of the tax period in which the payment was made.

In principle, after receiving the proper documentation,the Russian tax authorities should refund any excess taxwithin one month of the date of the application.

However, in practice this process is usuallysignicantly delayed.

Special provisions allow banks to bypass the residenceconrmation requirement for inter-bank transactions,provided that the residence of the foreign bankin a treaty jurisdiction can be conrmed by referenceto a public information source.

Withholding tax rates for treaty countriesThe main treaty tax rates for Russian-sourced incomeare shown in the Appendix.

Table 5

% Type of income

10 Income from international freight and rental of property involved in international shippingand income from leasing and sub-leasing sea and aircraft

15 Dividends received by foreign companies from Russian legal entities, as well as interest on stateand municipal bonds

20 Royalties, interest (other than that received from state and municipal bonds), income from leasingand sub-leasing of property used in Russia, distribution of prot or property to foreign companies,including liquidation proceeds and other similar income of an FLE without a PE in Russia

20 Prot from the sale of shares (or share derivatives) in a Russian entity, where more than 50%of the companys assets consist of immovable property located in Russia, or from the saleof immovable property located in Russia, provided that the income recipient submitsdocuments supporting the deductibility of the expenses to the tax agent prior to his paymentof the proceeds. In the absence of documentation, etc., it is 20% of the sale proceeds


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RUB 1 billion, and is then taxable at a 0% rate untilthe start of the year in which prot of RUB 300 million(approximately USD 10 million) accrues. A propertytax exemption applies up to the same point, while VATstarts from the quarter in which the RUB 300 millionthreshold is reached. The prot tax and VAT exemptionsexpire 10 years after becoming a participant. Socialsecurity contributions are also reduced.

Social insurance concessionsReduced rates of social insurance contribution rangingfrom 14-26% (compared to the 30% standardrate), and the exemption of earnings exceedingthe cap, may apply to Russian companies/individualentrepreneurs (IEs) working in the following areas:

software development (more than 30 employees); engineering (more than 100 employees); where the taxpayer is resident in an Innovation

or Tourism SEZ; production and publication of mass media; agricultural production where the taxpayer qualies

for the unied agricultural tax regime; taxpayers engaged in the production and social spheres

applying the simplied taxation regime.

Imported equipmentThere is an import VAT exemption for technologicalequipment which has no equivalent produced in Russia,according to a government-approved list.

The equipment listed generally also qualies for a 0%rate of customs import duty. The customs import duty

exemption for certain equipment imported as in-kindcharter capital contribution remains in effect.

Other incentives Certain types of research and development expenditure

qualify for a 150% prot tax deduction. Export oriented software developers may apply

an immediate prot tax deduction for computerequipment.

Accelerated depreciation is available for certain leasedassets, and those used for research and developmentor with a high energy efciency rating.

The prot tax rate for priority medical and educationalactivity meeting certain criteria is 0%. The same appliesto certain agricultural producers until the end of 2012

Other forms of federal and regional support, includinginterest subsidies, investment tax credits and grants,may be available for certain investment projects.

Tax incentivesIn recent years, few tax incentives have beenavailable in Russia, but that picture is now changing,partly due to the Russian governments currentmodernisation agenda.

Regional incentivesRegional authorities have the right to reduce theirregional allocation of prot tax of 18% to 13.5%,resulting in a minimum overall tax rate of 15.5%including the 2% Federal portion. They may alsoprovide exemptions from property and land tax,chargeable at maximum rates of 2.2% and 1.5%,respectively. Such exemptions are normally conditionalon meeting specic investment criteria in the region.The St. Petersburg, Leningrad and Kaluga regions, amongmany others, offer incentives of this kind, but neitherMoscow nor Moscow region have followed this lead.

Special Economic Zones

The legal framework for Special Economic Zones (SEZs)provides for broader tax and other concessions.

The 24 existing zones have geographical boundaries andfall into four categories: Industrial, Innovation, Tourismand Port & Logistic. All are created for a period of 49 years.Although originally slow to take off, the infrastructureof many of the Industrial and Innovation SEZs is welladvanced and approximately 250 investors, including morethan 25 foreign investors, are now in place.

The potential benets include a customs free zone,

accelerated depreciation, reduced social contributionsand a guarantee against unfavourable changes in taxlaw. Reduced rates of prot tax also apply, dependingon the regional authority and type of zone, but until2012 the overall rate could not be less than 15.5%.As of 2012, the minimum rate is 2% (the Federal portion ofthe tax), and 0% in the case of Innovation and Tourist SEZs.

Kaliningrad and Magadan have separate SEZ regimeswhere different concessions apply. The Kaliningradregion provides for 0% prot and property tax ratesfor SEZ residents for the rst six years.

SkolkovoThe Skolkovo Innovation Centre is a site close to Moscowwhich aims to attract R&D activity in a number of specictechnical elds. A participant is exempt from prot taxreporting until the year in which annual turnover exceeds



Work and services are generally deemed to be suppliedat the place of business of the supplier unless anotherspecial treatment is applicable. In particular, specialtreatment applies to the following:

Services relating to immovable property and movableproperty which are deemed to be supplied wherethe property is located

Cultural, sports, arts, educational or tourism serviceswhich are deemed to be supplied at the locationwhere these services are performed

Transportation, freight and associated services which aredeemed to be supplied in Russia if the point of departureor destination is located

Guide to the Russian Oil Gas Sector Deloitte

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