Risk Service Structure Becomes a Little Less Risky for Russian Offshore Operations

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The next wave of legislative developments with respect to offshore hydrocarbon production has just reached Russia. Starting with a recent introduction of legislation elaborating on requirements for financial security of offshore operations (see the August 2013 Energy Newsletter), Russian legislators have continued development of legislative reforms with respect to offshore oil and gas production by passing new amendments in September 2013 focused on providing a tax framework necessary for the realization of offshore projects, but that also provide a legal basis for cooperation between Russian companies holding exploration and development licenses for Russian offshore acreage and other companies (including foreign companies) based on a modified risk service model.

The model for developing the country's offshore deposits that Russia has been moving towards in recent years is a modified risk service arrangement consisting of a Russian company (e.g., Gazprom or Rosneft), or its wholly-owned affiliate, that holds the respective subsoil license and a separate joint venture company that is formed between the Russian license holder and foreign oil companies to operate and manage the development. While existing projects have always been with foreign partners, it is possible for other Russian companies to participate in these joint ventures.

Recent amendments to the Russian Tax Code and the Shelf Law formally recognize the notion of a third-party joint venture company that performs as an operator for field exploration and development (a "JV Operator") (as opposed to the subsoil license holder itself), which had not been previously recognized under Russian law and thus had created a risk of invalidity of a risk sharing structure. The amendments also provide clarification that special tax treatment for offshore operations is equally available to both a JV Operator and a subsoil license holder. The amendments will come into force from 1 January 2014, with the respective tax breaks applying to offshore fields with commercial operations beginning in 2016.

JV Operator – Qualification Requirements

The amendments provide that all of the following criteria must be satisfied in order for a company to qualify as a JV Operator:

  1. Shareholding. The Russian subsoil license holder of an offshore field and/or one of its affiliated companies (the "License Holder") must directly or indirectly own shares in the JV Operator; however, the amendments do not establish any requirements with respect to the percentage of shares that must be held by the License Holder.
  2. Offshore Operations Agreement. The JV Operator must enter into an operation/service agreement with the subsoil license holder for the conduct of work related to the production of hydrocarbons from the offshore field (an "Offshore Operations Agreement").|
  3. Offshore Operations. The JV Operator must actually conduct work related to the production of hydrocarbons on the respective offshore field (in addition to exploration and production of hydrocarbons per se, such work can include the construction of facilities (including artificial islands), design or survey works).

The status of a JV Operator is officially granted by Russian tax authorities after they receive notice that the Offshore Operations Agreement has been entered into. Only one company may hold the status of JV Operator with respect to any given offshore field. The conclusion of an Offshore Operations Agreement with a new company terminates the status of any previous JV Operator with respect to relevant offshore field.

Offshore Operations Agreement

An Offshore Operations Agreement, as envisaged in the amendments, is a hybrid risk-service agreement by nature. The amendments specifically provide that remuneration payable to a JV Operator under the Offshore Operations Agreement is to be determined (fully or in part) on the basis of the amount of produced hydrocarbons, i.e., the remuneration of a JV Operator depends on the success of its operations.

The importance of the provision of the Offshore Operations Agreement and JV Operator structure in the amendments should not be underestimated. Russian civil law specifically enumerates the types of contracts available and their material terms. Prior to the amendments in question, risk service agreements occupied a "grey area" in Russian practice, particularly with respect to their tax treatment, due to the absence of relevant regulations. The introduction of these types of arrangements should create greater certainty with respect to their recognition, treatment and enforcement.

Secondment

In addition to introducing the JV Operator and risk service arrangements into Russian law, the amendments, while not formally using the term "secondment", effectively eliminate certain tax concerns related to Russian workers going on foreign secondment. In particular, the amendments provide that for a period of up to six months an employee of a License Holder can be outside of Russia for the purposes of studying or working in the sphere related to offshore field development and that such absence will not impact the person's Russian tax resident status – permitting an employee to pay taxes at the resident tax rate of 13 percent rather than the non-resident tax rate of 30 percent.

More Waves to Come

We anticipate more changes in the legislative regulations governing Russian offshore hydrocarbons production. Such amendments are likely to address, among other things, LNG export, equipment import regulations, and, potentially, the simplification of secondment of foreign specialists.

 Jennifer Josefson
 Moscow
 +7 495 228 8502
 jjosefson@kslaw.com

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 Alexandra Rotar
 Moscow
 +7 495 228 8518
 arotar@kslaw.com

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