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The Curious Attraction of Israel to Foreign Law Firms

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For a foreign law firm, Israel is no easy market to crack.

Israel is the ‘Lawyers’ Nation’, a country which boasts 126 lawyers per capita, with no signs of a slowdown.

Imagine: for every couple of public buses that goes past, there’s one lawyer. Attend a ball game? Probably three dozen lawyers in the stands. Someone hit your car when sitting in traffic? Put your head out the window and call for a lawyer – you’ll get a couple of quotes before the lights change. We’re being facetious; still, competition for a slice of the Israeli legal pie is cutthroat.

Add to that: Israeli legal fees are extremely low by international standards.

In Israel, a lawyer works the same long hours as their EU or US cousins, and earns a third or even a quarter of the fees. A legal intern might bill $75 per hour, and at higher rungs of the ladder, $250 per hour is considered not-too-bad of a deal for associates and partners.

In some sectors of Law, dog-eat-dog competition has lawyers scrapping for minuscule margins. In real estate, some firms charge a trifling 0.5% of transaction values. Great for buyers, virtual suicide for lawyers.

No Accounting for Taste

You’d think heavy competition and low fees would chase away foreign law firms.

Think again.

Actually, more than 85 foreign law firms operate inside Israel. In 2012 new legislation opened the door to non-Israeli firms, allowing them to practice laws of their country of origin without needing to join the Israel Bar Association.

Early arrivals were Greenberg Traurig from the US and London’s BLP (Berwin Leighton Paisner), both in 2012. It’s almost as if they were bursting for the chance to get into the Start-Up nation.

There’s been an explosion of foreign activity; large firms such as Skadden Arps Slate, Freshfields Bruckhaus Deringer, Linklaters, White & Case, and DLA Piper recently entered the Israeli market.

Mid-size firms are following suit, sometimes from unexpected countries: Ireland, Poland, Belgium, Cyprus, and Greece have turned their eyes to Israel. For some firms, presence is simply a desk occupied by a visiting partner, perhaps half a week in the month. For other, braver firms, a presence inside Israel means serious investment of money and human resources.

Yingke, China’s second-largest law firm, has made heavy inroads into Israel. Through a merger, they assembled Yingke Israel in 2013, partnering with local Israeli firm Eyal Khayat Zolty Neiger & Co (who specialize in high-tech, venture capital and corporate legislation).

It’s no accident a Chinese firm has become so prominent – here’s a clear reflection of Israeli government encouragement of stronger ties with China and Southeast Asia.

There’s something in the water

Look hard enough and you’ll find plenty of opportunities for foreign law firms.

Famously fueled by high-tech and biotech, there’s more to the Israeli market than meets the eye. Foreign investors take active interest in local industries such as food, insurance, defense and, most recently, natural gas.

As mentioned, in the Holy Land, fee rates tend to favour the client; there’s nothing too special about servicing average deals in these industries. However, from time to time a treasure chest drops, for example, in the form of massive outbound and inbound international M&A deals.

Hot sectors of the Israeli Economy

Tech

As far as High Tech is concerned, Israel remains a world leader. In 2013 a total of $380 million (USD) was raised by Israeli start-ups, of which 25% went to internet companies.

Historically, Israel has played a major role in global technological developments, with Intel’s Israel Development Centre in Haifa developing the 8088 chip used for the IBM PC, plus the game-changing Pentium and Centrino chips.

There’s big money in Israel’s App niche. The $1.1bn takeover of navigation technology-maker Waze Mobile by Google is a prime example. Waze Mobile’ 100 employees received a reported $120m. And the lawyers didn’t do too badly, either. Any firm taking a percentage on such a deal stood to earn handsomely.

Another Israeli navigation app, Moovit, transformed the way people use public transport, providing real-time travel information about buses and trains. The funding round was closed in 2013, at $28 million (USD). Not bad returns on a few blips on a moving screen!

Cyber

Surrounded by hostile neighbors for 60-odd years, it’s no surprise that Israel makes considerable military and security investments. Lately, much has been made of Cyber security, the front line in the military-industrial merry-go round.

Cyber-Security is another profitable area for Israeli business, where canny lawyers can take a lion’s share of upside. The country boasts a newly-established National Cyber Defense Authority, described by Prime Minister Binyamin Netanyahu as an ‘air force’ to protect facilities, security agencies and civilians against cyber attacks.

This compliments the existing Israel National Cyber Bureau, created in 2011, which defends business and infrastructure. The Authority and Bureau now operate in close tandem, and wield real financial and political clout.

The sector has had significant benefits for Israel, with a recent spike in commercial activity. In November 2014 Aorato – an Israeli hybrid cloud security startup – was purchased by Microsoft for an estimated $200m (USD). In September 2014 CyberArk, Israel’s largest privately-held cyber company went public on NASDAQ, reflecting a valuation just shy of $0.5 billion (USD).

Energy

Elsewhere in the economy, the energy sector is also booming. This is largely down to discovery of two major natural gas reserves off the Mediterranean coast: Tamar (2009), the larger Leviathan (2010), the latter being the largest gas field in the Mediterranean Sea. At 622 billion cubic metres, Leviathan reserves are too large for Israeli domestic use alone. Supplying this gas abroad will create an entirely new revenue stream for Israel. Naturally there are disputes between private sector and government-backed, concerning how best to divide the cake.

Real Estate

In Tel Aviv property prices are rocketing. The city’s prime residential property market grew 75.4 % in the five years to the first quarter of 2014, according to a report by Knight Frank. Having said that, the International Monetary Fund warns: this bubble ready to burst.

Despite the huge volume of work, legal fees on real estate deals have hit rock-bottom – sometimes less than 0.5 per cent of the transaction value. The Israel Bar Association pushed for a minimum legal fee on property transactions to prevent ridiculously low undercutting. As yet, this hasn’t budged an inch.

Foreign Takeovers

On the horizon is the serious prospect of lucrative foreign takeovers of Israeli firms. In 2015 a law was passed, forcing conglomerates to sell assets, part of a broader Israeli domestic war on monopolies.

One headline-making deal was Chinese state-owned Bright Food buying a 56% stake in major Israeli food maker Tnuva in May 2015 for $960m (USD) from UK private equity group Apax Partners.

Conclusion

Business in Israeli is never a walk in the park, especially for lawyers. A small competitive market with low fees never sounds as the best business plan for a law firm.

Having said that, Israel still manage to become an incredibly attractive piece of land, with industries that are in constant growth and development, offering a dynamic technological world that has much to offer to the world.

The uniqueness of Israel lies mainly on its people’s spirit of enterprise; the desire to create new and profitable ventures, tenacity in driving ideas through to delivery, sheer will power, and the relentless wish to cut inefficiencies. There’s an energy and optimism in this little country that’s hard to beat.

Israelis drive a hard, bargain and are deeply skeptical. There are many cultural barriers to overcome, not least of which a fierce independence, and lack of trust in outsiders. Israelis exude the sense ‘we know best’, even when the facts scream loudly to the contrary.

Crack past the hard ‘sabra’ shell, through to the warm, soft fruit, and you’ll find fertile soil in Israel for a patient, perhaps slightly adventurous, legal mind.

About Robus:

  • As Israel’s leading legal marketing consultants, Robus see its outbound services to foreign law firms as part of the company’s DNA.
  • Representing a full spectrum of Israeli law firms, from boutique to Israel’s largest law firms, Robus is a valuable strategic partner for foreign law firms asking to obtain a foothold in Israel.
  • Robus consult many foreign law firms, among others – US law firms, European law firms from the UK, Germany, France and east Europe, all asking to provide legal services in Israel.
  • With a team of native English speaking jurists and lawyers, rich business experience and in-depth acquaintance with the Israeli legal market, Robus is the perfect starting point from which your law firm can set sail for new opportunities in Israel.
  • Founder of Robus, Adv. Zohar Fisher is a vastly experienced strategic and business advisor, and a commercial lawyer who has been practicing Legal Marketing for many years, inter alia, as the business development manager of one of the leading and largest Israeli law firms.

Policy Review: Mexico’s Law Initiative for the Energetic Transition

Energy and Natural Resources, Latest News

Currently, the legal framework on matters of renewable energies in Mexico is circumscribed to the Law for the Use of Renewable Energy and the Financing of the Energetic Transition (“LUREFET”). This law defines what has to be understood as renewable energies (including biofuels and efficient cogeneration of energy while excluding the hydroelectric projects that produce more than 30 MW). In the light of the limitations of the current legal framework regarding the use of renewable energies, the aspirational target of reducing the dependence on fossil fuels use in the electric industry is highlighted[1]. These percentages are intertwined with the ones established in the General Law for Climate Change (“GLCC”) that imply a reduction of up to 50% of the greenhouse gases emissions on 2050 with respect to the total of emissions generated on the year 2000.

Mexico´s Energy Reform represents a dilemma between the use of renewable energies and the opening of fossil fuels exploitation to private investment. In effect, the opening for the exploitation of new oil and gas fields appears to contradict the targets set forth within the National Policy on Climate Change and the reduction of greenhouse emissions targets provided by the LUREFET.

I. The Law for the Energetic Transition(“LET”).

This initiative forms part of the secondary legislation product of the Constitutional reform on energy matters, contained in the Decree by means of which several dispositions of the Political Constitution of the United Mexican States were added and reformed, which was passed by the Mexican Congress and published in the Official Gazette of the Federation on December 20, 2013. The LET is currently being discussed at the Senate and will abrogate the LUREFET.

Apart from the fact that the LUREFET appears to fall short in terms of the Energy Reform recently passed, its coordination with the GLCC apparently would eliminate the instruments that would eventually allow to achieve the aspirational targets for the reduction of pollutant emissions.

In effect, the LET will allow all of the components of the national electric sector to meet the reduction targets through an economical efficient scheme. In other words, this will mean: “less cost with the highest possible social welfare (…), and the reduction of the impact of the electric sector on the environment and the increase of the energetic efficiency”.[2]

II. Main Aspects of the LET.

The LET compels the Mexican government to implement the necessary policy instruments and programs to enhance the use of renewable energy resources that will eventually substitute the use of fossil fuels, guarantying that the legal, regulatory and fiscal instruments that will ease the achievement of clean energy goals and the consequent reduction of greenhouse emissions will exist. One of the primary goals is that the Ministry of Energy will aim towards a minimum participation of clean energies on the generation of electric power of 25% on 2018; 30% on 2021; 35% on 2024; 45% on 2036 and 60% on 2050. In aspects of energy efficiency, the LET pursues to ease the accomplishment of indicative targets that are established in the National Program for the Sustainable Use of Energy, as determined by the Ministry of Energy and the National Commission for the Efficient Use of Energy through a Route Map that has to be published within 260 days following the entry into force of the LET. It is also important to note that this law foresees the creation of a voluntary procedure of certification on energetic efficiency.

The LET takes into account limits of heat power in no less than 70% and of pollutant emissions in no more than 100 kg/MWh, in order to determine what other technologies could be considered as clean energies by the Ministry of Energy and the Ministry of Environment and Natural Resources in terms of the Law of the Electric Industry.

  • Planning Instruments.

The LET establishes three planning instruments seeking to develop a public policy in regards to: (i) the regulation of the sustainable use of the energy; (ii) requirements of clean energies, and (iii) obligations of pollutant emissions reductions of the electrical industry.

The first planning instrument is the National Strategy for the Energetic Transition and the Sustainable Use of Energy (“Strategy”). This policy instrument shall indicate the goals of clean energies and energetic efficiency. The Strategy will establish the policy and actions that should be executed in order to achieve the referred goals, including the reduction of pollutant emissions generated by the Electric Industry under economical criterion, including the dependence on fossil fuels as a primary source of energy.

The LET also includes a Special Program for the Energetic Transition, which establishes the activities and projects derived from the Strategy that have to be executed throughout each term of the Federal Public Administration, indicating the required infrastructure works and activities in order to accomplish the targets on clean energies matters. The third planning instrument is established in the LET as the National Program for the Sustainable Use of Energy (“PRONASE” for its acronym in Spanish), which has as its primary objective to set forth the actions, projects and activities derived from the Strategy that will allow to meet the targets on matters of Energetic Efficiency contained in the LET.

  • Smart Grids Program (“SGP”).

The SGP intends to support the modernization of the National Grid of Transmissions and of the General Distribution Grids, in order to keep a reliable and safe infrastructure that will assure the electric energy demand in an economical efficient and sustainable way. The conformation of these programs pursue the democratization of power distribution, as well as to opening the possibility of users to generate their own electricity and eventually obtaining a payment for its generation.

  • Clean Energy Certificates

The energy reform has brought new investment opportunities, specifically the LEI foresees Clean Energy Certificates (“CELs”, for its acronym in Spanish), same which are aimed to promote investment in clean energy. Likewise, CELs have been design to achieve the targets on matters of reduction of pollutant emissions (primarily greenhouse gases). In terms of the applicable instruments, the Ministry of Energy will establish the requirements for the acquisition of CEL’s during the first trimester of every year and must be complied with during three years after their emission.

Obligated participants[3] must demonstrate that they have certain number of CEL’s to cover the total proportion of electric energy consumed during the period of 1 of January and 31 of December of each year. CEL’s can be purchased; therefore, clean energy generators will be able to transfer these, to those participants that have not complied with the corresponding requirements. This will create a new market that will have the purpose to incorporate clean energies in the generation of electric energy. At the same time, this cap and trade market will help the implementation of the economic incentives described by the GLCC, as well as to reduce the emissions of greenhouse gases.

III. Miscellaneous Matters.

The LET also creates the National Institute of Electricity and Clean Energies and the Advisory Council for the Energetic Transition. It also creates the Fund for the Energetic Transition and Sustainable Use of Energy, in order to capture and channel financial resources to implement actions for the achievement of the Energetic Efficiency and Clean Energies targets.

IV. Conclusions

  • The LET establishes new schemes of energy generation from renewable sources that are aimed to achieve a reduction of up to 60% of greenhouse emissions on 2050.
  • Three main planning instruments are set forth in the LET: The Strategy, the Special Program for the Energetic Transition and the National Program for the Sustainable Use of Energy.
  • Under the SGP, users will now be able to generate their own electricity, opening the opportunity for them to become self-sustainable in terms of generation of energy.
  • The creation of CELs will bring a new cap and trade market that will promote the investment on clean energies by establishing the economic incentives set forth by the GLCC.

[1] The percentages of reduction of pollutant emissions set forth by this law are related to a reduction on the dependence on fossil fuels for the generation of electric energy with respect to the years 2024, 2035 and 2050. For the year 2050, the aspirational target will be the use of up to 50% of renewable energies within the electric industry.

[2] CFR. Exposition of motives of the proposal of decree that issues the Law for the Energetic Transition, No. 4176-III, dated December 15, 2014. Page 2.

[3] Suppliers, qualified users participants of the market and the final users of self-generated electric energy, as well as the holders of Interconnection Legacy Contracts of Charging Points or Centers.

 

Doing Business in Trinidad and Tobago

Articles, Corporate/Commercial Law, Energy and Natural Resources, Latest News, Tax

Introduction

Trinidad and Tobago (T&T) is a twin-island Republic located in the southern Caribbean with a population of approximately 1.3 million. Unlike most of the tourism-based economies in the Caribbean, T&T’s economy is heavily dependent on the energy sector. T&T has transitioned from a primarily oil-based economy to a natural gas-based one with major investments in petrochemicals. In this regard, T&T is currently the world’s largest exporter of methanol and is a leading exporter of liquefied natural gas (LNG). As a result, T&T is one of the wealthiest countries in the Caribbean and Latin America as measured by per capita GDP.[1]

Over the past quarter century, the T&T government has undertaken a number of reforms to liberalize the economy so as to facilitate foreign investment in the country. These reforms include the removal of most restrictions on the ownership of property by non-nationals[2] and the virtual abolition of foreign exchange controls.[3]

In addition, T&T has several advantages when compared to other countries in the region, including:

  • Availability of skilled manpower;
  • Availability of relatively good telecommunications and other infrastructure;
  • Relatively low energy costs; and
  • Strategic location at the crossroads of the Americas.

In the circumstances, T&T is well-placed to attract foreign investments.

Establishing a Business in T&T

Generally, foreign investors may carry on business in T&T through a locally incorporated company or by registering an External Company (Branch) in T&T. The process of incorporating a subsidiary company or registering a branch is relatively straightforward and inexpensive. On average, incorporating a T&T subsidiary company would take approximately one week while the process of registering a T&T branch of a foreign company may be accomplished in about two week time.

Generally, companies are required to be registered for corporation tax, employee tax (“PAYE”) and national insurance (“NIS”). Depending on the level of their business activity, they may also have to register for value added tax (“VAT”). These registrations are fairly uncomplicated and can be accomplished within a reasonable period of time. Generally, one can obtain registration in respect of corporation tax, PAYE and NIS within one day while registration for the purposes of VAT can usually be completed within one week.

Taxation Overview

The current rate of corporation tax for most companies operating in T&T is 25%. Companies in the petrochemical sector[4] are taxed at the rate of 35% while companies engaged in the petroleum production business and refining businessare subject to tax under a separate regime altogether.[5]

Payments of dividends to non-residents are subject to a 10% withholding tax. Where dividends are paid to a non-resident parent company, a reduced rate of 5% is applicable. Other payments to non-residents (interest, rentals, royalties, management charges) are subject to tax at a rate of 15%. It should also be noted that T&T has entered into Double Taxation Treaties with various countries[6] and such treaties may provide for reduced rates of withholding tax.

Capital gains are not generally subject to tax in T&T. There is, however, a regime for the taxation of short-term capital gains which are defined as the gains accruing on the disposal of an asset within 12 months of its acquisition. Such short-term capital gains are subject to tax at the rate of 25%.

The other principal taxes impacting on businesses in T&T include the following:

  • A business levy of 0.2% on the gross sales or receipts of a company. However, companies are only liable to pay the higher of its business levy or corporation tax liability. Further, companies are exempt from business levy for the first 36 months following registration.
  • A green fund levy amounting to 0.1% of a company’s gross sales or receipts is payable by all companies.
  • VAT, at a rate of 15%, is due on the supply of goods and certain prescribed services. Where a company is registered for VAT, however, it would be entitled to recover all of the VAT it has incurred in the course of its operations.
  • An ad valorem stamp duty is imposed, at varying rates, on certain transactions including the sale or transfer of property or shares.

Free Zone

The T&T Free Zones regime was designed to encourage local and foreign investment in export-driven projects that create jobs, develop skills and create external markets for products and services. Such investors benefit from various fiscal incentives provided for in the relevant legislation. It should be noted that companies engaged in the exploration and production of petroleum and natural gas and the manufacture of petrochemicals do not qualify for free zone status in T&T.

Approved free zone companies are exempt from corporation tax, business levy and green fund levy on the sale of goods and the export of services. Distributions and certain payments also qualify for relief from withholding taxes. Approved companies are also exempted from Customs Duties on imported goods and materials. Approved companies also benefit from an exemption from property taxes.

The T&T Government recently signaled its intention to encourage the building of centralized service hubs to support the financial services sector. This involves the consolidation by financial institutions of national and regional back-office operations in T&T. In the circumstances, such enterprises will provide services to customers in T&T as well as the wider region. These operations may include data base management, accounting, legal, HR support and credit card processing, among others. The intention is to utilize the existing free zone regime in order to incentivize these activities.

Manufacturing

Companies engaged in manufacturing may qualify for approval under the free zone regime. Additionally, manufacturers are entitled to accelerated capital allowances in the form of a 90% initial allowance on the capital expenditure incurred in acquiring plant and machinery. Companies engaged in manufacturing may also seek approval under the Fiscal Incentives Act. Benefits available to such companies under this legislation include relief from customs duties and VAT on the importation of plant and machinery as well as total or partial relief from withholding tax on distributions.

Tourism Projects

Companies in the tourism sector may access benefits under the Tourism Development Act for approved tourism projects (which are not limited to hotels but include ancillary facilities such as marinas, theme parks, golf courses). Approved companies may be granted corporation tax holidays of up to seven years as well as relief from customs duties on imports. A tax exemption on interest received in respect of loans used for approved projects is also available.

Immigration Issues

Non-residents can generally freely enter T&T for business meetings. A work permit will, however, be required where a non-resident person intends to work in T&T for a period exceeding 30 days in any 12 month period. In addition to work permits, nationals of certain countries are required to obtain an entry visa to visit T&T. Work permit applications are made to the Ministry of National Security and normally take between 4-6 weeks to be issued.

General Environment

T&T is a parliamentary democracy and has a stable political climate. The legal system is based on the English common law system. The final Court of Appeal is the Judicial Committee of the Privy Council in the United Kingdom. The Courts in T&T are independent though the judicial process tends to be lengthy.

In recent years, the T&T economy has been characterized by moderate inflation and relatively low rates of unemployment.[7] The defining feature of the financial system in the past few years has been a low interest rate environment combined with high liquidity in the system. Total public sector debt currently amounts to 39.9% of GDP. The country’s investment grade status is currently rated “A” (Standards & Poor) and “Baa2” (Moody’s).

The country is heavily dependent on the energy sector (40% of GDP, 50% of Government revenues, 80% of exports), however, and its overall economic performance is closely linked to energy prices. As a result, the Government is keen to promote investments in the non-energy sector as a means to diversify the economy.

T&T has an established, well regulated financial sector that includes commercial banks (including the local operations of international banks), insurance companies and a stock exchange. Further, there are no foreign exchange controls in T&T and profits may be freely repatriated.

Investors have access to a well-educated labour force. Tertiary education is free in T&T and this has resulted in ever increasing numbers of university and technical graduates entering the work force. There is a minimum wage in T&T that is currently set at TT$15 per hour.

T&T has two international airports with a number of airlines offering direct and connecting flights to all major international destinations. T&T also has two strategically located international ports (Port of Spain and Point Lisas). T&T also has a modern communications network with ready access to land-line telephones, mobile telephones as well as the internet.

In conclusion, T&T has made significant strides in recent times to transform the business environment of the country so as to attract foreign investment.

[1] In 2014, according to information from the International Monetary Fund, T&T had a GDP (nominal) per capita of US$21,311.

[2] Non-nationals of T&T may purchase up to five acres of land for commercial purposes without having to obtain a licence.

[3] The T&T dollar is the subject of a managed float and the current rate of exchange is approximately TT$6.35 to US$1.

[4] The 35% Corporation Tax rate is applicable to companies engaged in (a) the liquefaction of natural gas; (b) manufacture of petrochemicals; (c) physical separation of liquids from a natural gas stream and natural gas processing from a natural gas stream; (d) transmission and distribution of natural gas; and (e) wholesale marketing and distribution of petroleum products.

[5] Petroleum production companies are subject to petroleum profits tax at the rate of 50% of chargeable profits, unemployment levy at the rate of 5% of chargeable profits and supplemental petroleum tax with rates based on weighted crude oil prices.

[6] Currently T&T has entered into Double Taxation Treaties with Brazil, Canada, CARICOM, China, Denmark, France, Germany, India, Italy, Luxembourg, Norway, Spain, Sweden, Switzerland, the United Kingdom, the United States and Venezuela.

[7] The inflation rate is currently at 5.6% while the unemployment rate is 3.7% (Central Bank of Trinidad and Tobago Economic Bulletin: July 2015).

Refunds of Excess VAT Accumulated During Mineral Exploration

Articles, Energy and Natural Resources, Latest News, Tax

Refunds of value added tax (VAT) incurred in connection with the export of goods[1] has lately become a pressing issue. Despite the fact that tax legislation clearly sets out the procedure for refunding excess VAT, in reality taxpayers encounter a number of obstacles. This article focuses on excess VAT accumulated during exploration prior to the export of minerals.

The Rationale for Applying VAT to Exported Goods

Two opposing principles underpin indirect taxation[2] of cross-border trade: country of origin and country of destination. The vast majority of countries, including Kazakhstan, the CIS countries, and the European Union, charge VAT on the basis of country of destination. This system has well-recognised benefits in terms of customs control and customs valuation.

According to the country of destination method, exporting goods and the capital expenditure incurred during production of these goods are not subject to VAT in the country of origin. These goods are only subject to VAT in the country into which they are imported and where they are used.

When trade occurs between two countries, it gives rise to a potential double taxation scenario. The country of destination method is intended to avoid this. Furthermore, it places domestic producers on a level playing field with foreign producers, thus ensuring the competitiveness of exporting goods in the international market.

The Country of Destination Principle in the Tax Code[3]

The country of destination principle is formalised in Articles 242 and 272 of the Tax Code and implemented in the following way.

During production of exported goods

Materials, equipment, work and services used in producing exported goods, including construction of facilities for production of exported goods, once they are purchased by the exporter, become subject to VAT at the current rate (12%). In other word, when materials, equipment, work and services are acquired, the exporter has to pay suppliers the price together with VAT, according to tax invoices. VAT is then offset and accumulated by the exporter prior to export. These obligations are contained in Articles 229, 231, 268 and 256 of the Tax Code.

For the export of produced goods

Export sales are subject to VAT at the rate of “0”%, i.e. export goods are not subject to VAT, as stated in Article 242 of the Tax Code. This gives rise to excess VAT that can be offset against the assessed VAT.

Paragraph 2 of Article 272 states that the exporter has the right, at the start of the export process, to claim a VAT refund from the tax authorities of the amount paid during preparation for production and the actual production of the exported goods.

Thus, it is a mistake to regard the zero rate VAT on exports and the VAT refund as tax privileges or exemptions from the government to taxpayers. In fact, it is a means of enshrining the ‘country of destination’ principle for applying VAT. The tax authorities, in essence, are returning tax previously paid by the exporter.

Article 272 of the Tax Code:

The application of Article 272 is disputes between the tax authorities and taxpayers. A detailed analysis of this Article is provided below.

Paragraph 2 of Article 272 states:

“Excess value-added tax specified in the first part of subparagraph 1) of paragraph 1 of this Article, relating to goods, work and services purchased prior to January1, 2009, except for excess related to the purchase of goods, work and services that are or will be used for the purposes of turnovers taxable at a zero rate, shall not be refunded ….”

This rule gives taxpayers the right to claim a refund of excess VAT related to turnover from export goods, including excess amounts incurred before 1 January 2009. The phrase “… will be used …” indicates that the exporter has the right to claim a VAT refund paid by the exporter during production of goods for export from Kazakhstan. For example, during mineral exploration the VAT paid by a subsoil user at the moment of purchasing materials, equipment, goods, work and services, can be refunded when the export of mineral resources begins.

Thus, according to Paragraph 2, the exporter may exercise his/her right to a refund of excess VAT if the following conditions are met:

     once the sale of export goods has occurred i.e. once the process has begun, the exporter has the right to submit a declaration to the tax authorities claiming a refund of excess VAT accumulated during production of the exported goods;

     if the excess VAT for refund is related to export turnovers – in other words, goods, materials, equipment, work and services used to produce exported goods and for which the exporter paid VAT (thereby giving rise to the excess VAT payment).

Paragraph 3 of Article 272 states:

“With regard to turnovers taxable at a zero rate, excess amounts of value-added tax to be offset against the assessed tax as stated in a declaration as a progressive total at the end of the reporting tax period shall be subject to refund, provided the following conditions are simultaneously met:

1)     a payer of value-added tax permanently carries out sales of goods, work, services taxable at a zero rate;

2)     if turnover from sales taxable at a zero rate, for a tax period in which turnovers taxable at a zero rate were received and in relation to which a claim for refund of excess value-added tax is made, was not less than 70 per cent of total taxable sales turnover”.

The provisions of Article 272 cited above set out the extent to which excess VAT is refundable to the exporter, namely whether it may be refunded in its entirety or only in part. The amount of excess VAT for refund depends on whether export of goods is a consistent activity for the exporter. If the exporter constantly exports goods and the export turnover share exceeds 70% of the exporter’s total sales turnover, then the entire amount of the excess VAT is refundable. If, on the date when the refund claim is made, the exporter does not meet the criteria in paragraph 3 of Article 272, then only part of the excess VAT will be refunded. In this case, the amount of excess VAT is determined according to Paragraph 4 of Article 272.

Paragraph 4 of Article 272:

“The Government of Kazakhstan shall establish criteria for classifying the sale of goods, work, and services taxed at a zero rate as permanent sales as specified in sub-paragraph 1) of paragraph 3 of this Article, and the procedure for calculating excess value-added tax to be refunded in the following circumstances:

1)     in relation to turnovers taxable at a zero rate, in the case of non-observance of provisions established by paragraph 3 of this Article;

2)     in relation to VAT specified in the second part of subparagraph 1) of paragraph 1 of this Article”.

Paragraph 4 of Article 272 is a reference rule that applies when the exporter does not meet the criteria specified in Paragraph 3 on the date a VAT declaration is submitted. If the exporter does not meet at least one of the conditions, the amount (share) of the refundable excess VAT is determined according to the “Rules for Determining Refundable Excess Value Added Tax, and Criteria for Classifying the Sale of Goods, Work, and Services Subject to Zero Rate VAT as Permanent Sales’’, approved by the Government of Kazakhstan, No.373 of 20 March 2009.

Thus, if we apply Article 272 to a situation when a subsoil user has begun production and export of mineral resources from Kazakhstan, this Article allows the subsoil user to claim a refund of excess VAT accumulated during exploration, that is, before mineral export sales. Goods, materials, work, and services, as capital costs incurred during exploration, are used for field development in preparation for production and export.

Once the subsoil user starts exporting minerals, he is entitled to claim a refund of VAT incurred during exploration (in preparation for producing exports). Hence, in confirming the refundable excess VAT, it does not matter whether the excess VAT was amassed before or after the mineral exports began. An important condition, as noted above, is that the excess VAT claimed for refund relates to export turnovers. In other words, goods, materials, equipment, work, and services in connection with which VAT was paid by the subsoil user (leading to excess VAT) should be used for field development and extraction of raw minerals for export.

The Tax Authorities’ Perspective

The tax authorities believe that only excess VAT accumulated once goods have been exported is subject to refund. In other words, the tax authorities deny the exporter’s right to a refund of VAT paid during the production of goods (during exploration) that were subsequently exported. Thus the tax authorities, referring to Paragraph 3 of Article 272, mistakenly believe that only this rule establishes the exporter’s right to a refund of excess VAT, not taking into account the other paragraphs in Article 272 that classify VAT paid during production as refundable,

We believe this view is misguided since it fails to take into account Article 272.

It should be noted that this reflects recent practice. Under the previous Tax Code, VAT refunds were made for VAT accumulated during exploration. Thus Article 251 of the previous Tax Code[4] and Article 272 of the current Tax Code, which both contain the exporter’s right to VAT refunds, do not significantly differ in their content.

We therefore believe VAT refund problems relate more to enforcement practices than to the legislation itself.

Opinion of the Advisory Council

The Advisory Council on Taxation works under the Government of Kazakhstan and its primary goal is to resolve ambiguities and inaccuracies in Kazakhstan tax law. During 2013 the Advisory Council issued two decisions regarding the interpretation of Article 272 of the Tax Code, which, in our opinion, are contradictory.

According to the decision of 31 January 2013, the Advisory Council confirmed the taxpayer’s right to refund excess VAT accumulated prior to zero turnovers. This decision was addressed to companies engaged in international shipping.

Let us recall that under the Tax Code, international shipping, as well as the export of goods, is subject to zero rate VAT. The procedure for refunding the excess VAT for shipping companies and exporters is single, i.e. the shipping companies refund the excess VAT from the budget also under a procedure prescribed in Article 272 of the Tax code.

Later on 17 October 2013 the Advisory Council issued another decision on the refund of excess VAT, where they explained that the procedure for refunding excess VAT accumulated in connection with field development prior to the export of goods, that is, prior to the zero turnovers, is not regulated in the tax law.

The Advisory Council confirmed that companies engaged in international shipping have the right to a refund of the excess VAT accumulated prior to the zero rate turnovers; however, they did not confirm this right in respect of subsoil users exporting minerals. The conditions and procedure for exercising the right to the refund of the excess VAT are regulated by Article 272 of the Tax Code, which stipulates the same conditions for all taxpayers, regardless of the nature of business.

Thus it seems the provisions of Article 272 of the Tax Code are unequally applied to entities, which contradicts principles enshrined in the Kazakhstan tax law and the Constitution.

The Courts’ Stance

The Supreme Court of Kazakhstan supports the tax authorities’ position. Reasons on which the judgements are based do not differ per se from the explanations of the tax authorities, i.e. the courts believe that only excess VAT accumulated once goods have been exported is subject to refund.

To summarize, the practice of the state bodies is not only illegal, but also results in double taxation of Kazakh domestic goods. Double taxation, in turn, leads to goods becoming uncompetitive on the world market. The obstacles to VAT refunds created by the tax authorities have an ultimately negative impact on Kazakhstan’s investment image. We firmly believe that one of the most important conditions to create an attractive economic climate in Kazakhstan is predictability and certainty in the field of taxation.

[1] Refund of excess VAT to be offset against the amount of assessed VAT resulting from the acquisition of goods, works and services used for export turnovers will hereafter be referred to as “excess VAT”;

[2] VAT is an indirect tax;

[3] The Code of the Republic of Kazakhstan “On taxes and other obligatory payments to the budget” of 10 December 2008;

[4] Code of the Republic of Kazakhstan “On taxes and other obligatory payments to the budget” of 12 June 2001.

Offshore energy projects in Denmark

Articles, Energy and Natural Resources, Latest News,

By Per Hemmer, Bech-Bruun

The Danish offshore industry has grown continuously larger in the past couple of years. Offshore industry growth is in line with the focus and ambitions of the Danish energy policy. This article explores the possibilities for joining Danish offshore energy projects and the related legal framework.

  1. Offshore and near shore wind farms

In 2013, 24.6 % of the total Danish energy consumption was renewable energy.

In recent years the use of wind power has increased, as it is a political aim that renewable energy in the longer term is to replace fossil energy completely. The establishment of wind turbines and wind farms has been especially popular in Denmark.

There are currently 13 offshore wind farms in Denmark. The wind farms Anholt, Horns Rev I, Horns Rev II, Rødsand II and Nysted are large-scale wind farms.

As it is a political aim to increase the use of renewable energy, the Danish government has authorised the Danish Energy Agency to launch several offshore wind farm projects, including the large-scale wind farms Horns Rev III and Kriegers Flak.

International companies are finding Danish wind power an attractive investment. E.ON Vind Sweden AB has established the Rødsand II wind farm, and Vattenfall AB owns 60% of the Horns Rev I wind farm.

The Horns Rev III wind farm tender has just been concluded with Vattenfall AB as winner of the tender. The tender for the six near shore wind farms was published on 26 February 2015. The deadline for submission of applications is on 26 May 2015.

The contract notice for large-scale wind farm Kriegers Flak was published on 6 May 2015.

The application deadline regarding Kriegers Flak is 1 October 2015. The capacity of Kriegers Flak will be 600 MW, making it the largest wind farm in Denmark. Sweden and Germany have also chosen the Kriegers Flak area in the Baltic Sea as sites for wind farms.

If the cooperation between the countries is becoming a reality, Kriegers Flak will be the first international offshore grid in the world. Kriegers Flak is expected to be put into operation as of 31 December 2018.

The establishment of large-scale offshore wind farms and near shore wind farms can follow two different procedures: A governmental tendering procedure administrated by the Danish Energy Agency, or an open-door procedure.

In the government tender procedure the Danish Energy Agency announces a tender for an offshore or near shore wind farm project of a specific size within a specifically defined geographical area. A government tender is carried out to execute a political decision to establish a new offshore wind farm at the lowest possible cost.

In the open-door procedure, the project developer takes the initiative to establish an offshore or near shore wind farm of a chosen size in a specific area. The area and the size of the project are decided by the project developer. This is done by submitting an unsolicited application for a license to carry out preliminary investigations in the given area. The application must as a minimum include a description of the project, the anticipated scope of the preliminary investigations and the size and number of turbines.

The most important legal frame regarding wind power is the Danish Renewable Energy Act.[1] The provisions of the act apply to both offshore and near shore wind farms.

The act sets forward provisions regarding, inter alia, subsidies to wind farms, regulation of electricity production by wind farms established through tenders, and technical and safety standards of wind turbines. However, the Renewable Energy Act is supplemented by sections from several other Danish Acts.

The Renewable Energy Act stipulates that an applicant must obtain the following licenses in other to establish an offshore or near shore wind farm:

  • Preliminary survey license
    The permission allows preliminary surveys concerning the possible establishment of a wind farm. It is usually valid for one year. With respect to tenders, the preliminary surveys will be conducted by the government-controlled Energinet.dk.
  • The applicant must often conduct an EIA (“Environmental Impact Assessment”). With respect to tenders, the EIA will be conducted by the governmental controlled Energinet.dk.
  • Establishment license
    The establishment license allows the establishment of the wind farm in question. The license can, and will most likely, include conditions set by the Danish Energy Agency which the applicant must comply with.
  • Exploitation license
    The license must be granted prior to the initialisation of the wind farm. Moreover, the applicant must document that the conditions contained in the establishment license are observed and complied with. If the capacity of the wind farm is more than 25 MW, an additional electricity production licence is required.

It follows from the tender documents from the latest tenders that the applicant must document sufficient financial capacity to establish the wind farm. Subsequently, the applicant must submit a statement of the applicant’s overall revenue for the last three financial years and equity ratio as a percentage of total assets for the last financial year as well as copies of the full annual reports (including notes and appendices) and audited accounts for each of the previous three financial years.

If more than one economic operator submits an application for pre-qualification (e.g. a consortium, a joint venture), all the joining parties must submit their own documentation and information.

Citizens aged 18 or more, living within a 4.5 km radius from a site where a wind turbine is about to be established, or who are living in a municipality where a wind turbine is about to be established, are entitled to purchase shares in the wind turbine at cost price. At least 20% of the wind turbine project must be tendered to the local residents. If a house is located close to a wind turbine, the house owner may be compensated for the depreciation of his house.

A subsidy is paid to Danish-based wind power. The size of the subsidy with regard to tendered offshore wind farms may vary, as the size of the subsidy is calculated as the difference between the market price and the bidding price.

  1. Hydrocarbon exploration in the North Sea

There are 55 platforms and 19 operating hydrocarbon fields in the Danish part of the North Sea. Mærsk Oil and Gas A/S operates 15 fields, while DONG E&P A/S operates three fields and Hess Denmark ApS operates a single field. In 2013, a total of 10.2 million cubic meters was extracted from the 19 fields.

More than 2/3 of the licensees are international companies, for instance from France, the United Kingdom and Germany.

In 2013, 54.9% of total Danish energy consumption was hydrocarbon-based (36.8% oil and 18.1% natural gas).

The political aim for the Danish Minister for Climate, Energy and Building is to continue with the hydrocarbon extraction and production over the next 10 years.

The Danish subsoil belongs to the Danish state, and a license under the Danish Subsoil Act[2] is a prerequisite for the exploration and extraction of hydrocarbons in the Danish subsoil. A license can be obtained in two ways; either through a tender or through the open door procedure.

The seventh licensing round regarding hydrocarbon exploration in the North Sea is in progress. 25 different oil and gas companies have applied for licenses in the North Sea. This is a record-high number. Licenses are expected to be issued at the beginning of 2015.

The Danish Energy Agency has announced that licensing rounds will be held annually in the coming years. Consequently, the Danish Energy Agency expects to invite to the eighth licensing round during the second half of 2015.

As licensing rounds will be held on an annual basis, the opportunity to apply for licenses has improved. Oil and gas companies now know approximately when it is possible to do so.

A license is obtained by application to the Danish Energy Agency. In order to be awarded a license, applicants must document that they have the required expertise and financial resources.

The quality and scope of the proposed work programme and the attendant documentation demonstrating the applicant’s willingness and ability to thoroughly explore for hydrocarbons in the area comprised by the application, is also a selection criterion. The applicant must describe what he considers to be a complete work programme for the area, and on this basis he must expressly indicate whether he is offering to perform the complete work programme, or which parts of it he intends to carry out.

The licensees’ liability for damages under the Subsoil Act must be covered by insurance. The insurance must provide reasonable coverage, in light of the risks involved in the operation of the business and the premiums to be paid. If the licensee is a subsidiary, the ultimate parent company of the licensee must assume an unconditional and irrevocable parent company guarantee as a surety with primary liability without any limitation in time, for the due satisfaction of all existing and future obligations and liabilities incurred by the licensee under activities carried out under the license. The parent company guarantee is covering obligations and liabilities incurred by the Danish state and Nordsøfonden. The Danish Energy Agency has published a standard parent company guarantee for the purpose.

Nordsøfonden, the Danish state’s oil and gas company, must be party to all new licenses in the Danish area of the North Sea with a 20% interest.

The licensees are not to pay any royalty or dividends to the Danish state besides taxes and duties. Taxes and duties are calculated as a 25% corporate income tax, which is deductible from the basis for assessing hydrocarbon tax, and a 52% hydrocarbon tax. In determining the basis for assessing hydrocarbon tax, a 5% hydrocarbon allowance is granted for investments over 6 years (a total of 30%).

It is a condition for obtaining a license that the concession parties enter into a joint operating agreement that sets up the legal frames for the parties’ operations when carrying out exploration of hydrocarbons. The Danish Energy Agency has created a standard joint operating agreement that the concession parties must use. The concession parties must also appoint an operator among them.

  1. Conclusions

The opportunity to invest in Danish-based energy projects is great. Wind farms are being established through tenders, and hydrocarbon licensing rounds regarding oil and gas are held annually.

The license and compliance regime in relation to the establishment of wind farms and in relation to hydrocarbons might be seen as extensive. Subsequently, it is recommended to seek advice before entering into wind power projects.

Bech-Bruun has vast experience in dealing with matters relating to wind farms and hydrocarbons. As an example, Bech-Bruun has been advising E.ON on their sale of 207 MW wind farm Rødsand 2 to Seas-NVE.

[1] Act No. 122 of 6 February 2015

[2] Act. No. 960 of 13 September 2011

The developing mining sector in the Republic of Macedonia

Articles, Energy and Natural Resources, Latest News,

In recent period one of the most dynamic and attractive business sectors in the Republic of Macedonia is the mining sector. The mining sector, as the third largest export sector has significant contribution to the Macedonian economy as it represents around 15% of the industrial production and contributes around 1.5% of the Country’s GDP.

In regards to the increased business activities and investments in the mining sector, in 2012 new legislation was passed in order to develop this dynamic sector. The new legislation introduced shorter, simpler and faster procedure for granting mining permits and concessions. Also the new mining legislation incorporated positive legal practices for further development of the mining sector and dealing with the modern challenges of working in this sector. One of the new developments in the mining legislation, which is incorporated with the new legislation in order to provide more legal possibilities for the concessioners to develop their mining project in the Republic of Macedonia, is the option for merging concessions.

With this new stipulated possibility it is provided that, for the purpose of rational and effective exploration or exploitation of minerals, two neighbouring concessions can be merged or embedded. This merging or embedding of two neighbouring concessions is conducted upon a request from the concessionaire. With the placement of this option in the hands of the concessioners, the new legislation provides the investors-concessioners with the necessary tools to further develop their investments and mining projects in the Republic of Macedonia.

In accordance with Macedonian legislation, a concession also can be expanded. Expansion of a concession for detailed geological exploration can be granted to a holder of such concession for further exploration on an area that borders with the exploration area from the existing concession. A concession for exploitation can be expanded for the purpose of increase of ore reserves and expansion of the period of exploitation and increase of the infrastructural capacities that are in function of rational exploitation. These legal solutions provide more flexibility in the planning and developing, as well as running the mines in Republic of Macedonia.

This new legal framework resulted with increase in the submitted requests for mining concessions and also with increase in the granted mining concessions. In the past the investments in the mining sector were solely in acquisitions and expansions of the already existing mines in Republic of Macedonia. With the new legal framework in place the mining sector started to attract new investors ready to make green field investments in mining in Republic of Macedonia. Parallel with the process of developing a new mining legislation, the Government of the Republic of Macedonia had announced a public call for granting concessions for over 80 new locations for mine development.

Today, several projects for opening new mining sites for exploitation of mineral ores are under way or in their final stage of development, including the Ilovitza project, a green field investment of the company Euromax Resources. This project should result in opening one of the largest by production mines in South-eastern Europe.

Financing of mining projects, especially mining projects of such scale as the Ilovitza project, an investment estimated at more than $500 million for opening a new mine for exploitation of copper and gold, is not a simple task. All mining projects especially green field mines require significant investment. The required funds for such green field mining projects can be obtained partially by equity investments, but in the larger part it needs to be financed through loans from banks and other financial institutions and lenders. Naturally, the lenders and creditors will require their investment to be secured. Usually the security for the investment is done with the project company`s assets, but in the green field mining projects the value of the movable and immovable assets of the project company is not sufficient to cover the claims of all investors and creditors. In fact, the most valuable asset that a mining company has is its exploration or exploitation concession.

The current Law on mineral raw materials which regulates mining and concession issues, regulates the transfer of concession, however it does not provide clear provisions regarding the possibility of assigning the concession as a mean of security or establishing pledge over the concession. Currently, according to the positive Macedonian mining legislation, concession means obtaining rights and obligations, so the concession cannot be pledged. Having in mind that all investments in previous years were realized in the already existing mines through acquisitions of the mining companies, the question regarding security over the investment did not pose an issue.

However, with the new dynamic changes and development in the mining sector and the newly appeared high interest for opening new mining sites in the Republic of Macedonia, the question for security of the investment gained on significance. The lack of provisions regarding the use of concession as a mean of security in the Law on mineral raw materials posed an issue for the investors regarding the completion and development of their mining sites in Republic of Macedonia. If this important issue was not to be resolved, the sustainability and further development of the green field projects would have been threatened.

The answer to this newly appeared question and issue regarding green field mining investments can be found in the current Macedonian legislation. This issue about the security of the claims of the lenders and creditors can be resolved through the fact that to all the issues regarding concessions which are not regulated with the Law on Mineral Raw Materials (lex specialis) the Law on Concessions and Public Private Partnership shall apply as lex generalis. In accordance with this, the concession agreement which is concluded between the Government of Republic of Macedonia and the concessionaire may include a provision that allows transfer of the rights and obligations from the concession to the creditors – lenders as mean of security for their claims.

Furthermore, regarding the transfer of the concession agreement, it is important to emphasize that the exploitation concession agreement can be transferred and the transfer procedure is fully regulated. Namely, the Law on mineral raw materials stipulates that the concessionaire can transfer his concession by concluding an agreement for transfer of the exploitation concession with the transferee to which the concession is to be transferred and upon written consent by the Government of Republic of Macedonia. Obviously, certain conditions that are subject to Government`s evaluation should be met by the transferor and the transferee.

One more question regarding the mining legislation is pointed out by some of the investors and that is the legal provision determining the bankruptcy as a reason for termination of a concession. Namely, the Law on mineral raw materials stipulates that the concession is terminated in case of bankruptcy, but it does not prescribe exactly in which moment of the bankruptcy procedure. It is important to emphasise that according to the Macedonian legislation even if a bankruptcy procedure is opened, it doesn’t mean that the entire business shall be wound up, i.e. not every bankruptcy procedure ends up with liquidation of the company.

Having in mind that in the case of a company that is a holder of a concession its` entire operations depend on the concession, and the fact that opening a bankruptcy procedure does not mean that the company necessarily shall be wound up, some of the investors have pointed out this question as a potential problem for their business and they proposed this issue to be resolved by precisely determining the moment when the concession shall be terminated in case of a bankruptcy procedure. Furthermore, there are suggestions for amending the current legislation in order for the termination of the concession to be possible only after the company is given the possibility to get through the reorganization procedure and after the same was either not accepted by the creditors or was not successful at the end. The Ministry of Economy is also considering this issue and they are working on solving this issue in alignment to the above mentioned suggestions through implementation of EU directives and international standards.

Due to the above mentioned investment activities, and in order to further develop and harmonize the legislation regarding the mining sector, some amendments to the legal framework that regulate the area of mining and concessions are in sight in order to keep the pace with recent developments. Also, there is an active process for harmonizing and improving the by-laws with the contemporary methods of work and the applicable technological solutions. Having in mind that the mining sector in the Republic of Macedonia has been long time underdeveloped, this new changes are welcomed. The legal framework offers good opportunities and is a solid base for development of the mining sector, which tends to attract green field investments. Furthermore, the new investments in the mining industry are bringing international know-how and also the practice that is being established, as well as the Governmental support for this sector shall contribute for even more efficient regulation of this area and overcoming of all difficulties that occur in the course of work.

We, MENS LEGIS as a legal consulting firm, in synergy with our clients, are working together on identifying such and similar issues that derive from carrying on a business in the Country, as well as on proposing the best legal solutions for solving the issues that arise from the regular activities of the companies and the legal framework in which they operate.

The Regulatory Framework of the Gas Industry in Brazil: a brief overview

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The regulation of the gas industry in Brazil is peculiar, since the activities within the gas supply chain are regulated both in federal and state levels by general provisions of the Federal Constitution, as well as by a number of different federal and state laws.

The Federal Constitution of Brazil, enacted in 1988 and amended by Constitutional Amendment No. 05/1995, sets forth a clear division of power between the Federal Government and the state governments concerning the activities developed within the gas industry.

Pursuant to articles 20 and 176 of the Federal Constitution, gas reserves located within the Brazilian territory, including continental shelf, territorial sea and exclusive economic areas, are considered assets of the Federal Government. Therefore, article 177 of the Federal Constitution grants to the Federal Government the monopoly on the upstream activities, such as prospection, importation, exploitation and production of gas, as well as the transportation of gas along the Brazilian territory. These are considered economic activities that can be performed by both state-owned companies and private companies, under federal authorization. The hiring of state-owned or private companies for the execution of these activities is regulated by Federal Law No. 9,478/1997 (the Petroleum Law) and Federal Law 11,909/2009 (the Gas Law). In practice, most of the upstream activities in the gas industry are still carried out by the state-owned company Petrobras, because, prior to the Constitutional Amendment No. 05/1995, Petrobras was the exclusive representative of the Federal Government for the execution of its monopoly on the gas industry.

The regulatory agencies vested with power to regulate gas activities on the federal level are: (i) the Ministry of Mines and Energy (MME), responsible for planning the use of natural gas; (ii) the National Energy Policy Council (CNPE), responsible for fostering rational use of Brazil’s energy resources, ensuring proper functioning of the national fuels inventories system, reviewing energy matrixes for different regions of Brazil and establishing guidelines; and (iii) the National Agency of Oil, Gas and Biofuels (ANP), in charge of regulating, contracting and supervising all the economic activities related to the gas industry.

On the other hand, article 25, section second, of the Federal Constitution, as amended by Constitutional Amendment No. 05/1995, grants to the states the prerogative on the local distribution of piped gas to final users within the territory of each state. Unlike the upstream activities, the distribution of piped gas is considered a public service, subject to a different number of rules and regulations that govern the rendering and the concession of public services in Brazil, such as Federal Law No. 8,987/1995 (the General Law of Concessions) and Federal Law No. 8.666/93 (which sets out the general rules for bidding procedures). Moreover, each state is entitled to enact its own set of rules regulating the piped gas distribution, as well as to create its own state regulatory agencies. Consequently, each state regulatory agency is responsible for the regulation of the distribution of piped gas within its respective territory.

Traditionally, scholars justify this division of competences set forth by the Federal Constitution based on the interests underlying each step of the supply chain. The economic activities of prospection, exploitation and production, importation and transportation along the country’s territory are driven by the public interest of the entire population. Such activities seek the satisfaction of collective needs, providing all Brazilian citizens and residents with adequate and diversified energy resources. On the other hand, the public services of local distribution of piped gas are driven by the individual interest of each of the final users of piped gas, seeking to provide them with a specific volume of gas to satisfy their individualistic needs.

In view of this legal framework, the interaction among different players along the gas supply chain may become somewhat complex, since their activities may be regulated by different laws and agencies.

A good example to illustrate this complexity is a controversy that arose between the State of São Paulo and a joint venture formed by Petrobras and White Martins on the interpretation of articles 177 and 25, section 2 of Brazil’s Federal Constitution, which is considered Brazil’s leading case in the gas sector.

In 2006, Petrobras and White Martins formed a joint venture to produce and sell liquefied natural gas (LNG). Under their agreement, Petrobras would supply natural piped gas to an industrial facility held by White Martins in the City of Paulínia, State of São Paulo, which would then produce LNG out of the natural gas, through an industrial process called liquefaction, which involves cooling natural gas to extremely low temperatures to shrink its volume 600 times, making it easier to store and ship it to final users. On Petrobras’ view, the direct supply of piped gas to White Martins would qualify as transportation of gas (economic activity under the federal monopoly, regulated by federal law), since White Martins would not burn or use the gas as a final consumer, but liquefy it and sell it to third parties.

The State of São Paulo had a different view on the same issue. According to the State of São Paulo Regulatory Agency for Energy and Gas (CSPE), White Martins should qualify as a local industrial user of piped gas and, consequently, should purchase gas from the State concessionaire, Comgás. On CSPE’s view, Petrobras would be prevented from supplying natural piped gas directly to White Martins’ industrial facilities, since this activity should be qualified as distribution of piped gas to a final consumer, being under the prerogative of the State of São Paulo and its concessionaries, as per article 25, section 2 of the Federal Constitution. Therefore, CSPE enacted the Ordinance No. 397/2005, prohibiting LNG producers from purchasing piped gas from any distributors other than the State concessionaries.

Petrobras and White Martins filed a lawsuit before the Federal Court of São Paulo seeking the suspension of the State’s prohibition. A preliminary injunction was granted in favor of the Plaintiffs suspending the Ordinance No. 397/2005, on the basis that the direct supply of natural piped gas from Petrobras to White Martins should be qualified as transportation of gas, being therefore subject only to federal regulation.

Both the Federal and State Regulatory Agencies, as well as the State of São Paulo and the Federal Government, joined the dispute on opposites sides, asserting different interpretations of the constitutional provisions that govern the division of competences in the gas industry. The case was then remitted to the Brazil’s Supreme Court (Claim No.4210/2006), which has exclusive jurisdiction to hear disputes among government entities on opposite sides.

The Supreme Court has not come to a final decision yet. However, the Court has so far ruled in favor of the State of São Paulo and the State Regulatory Agency, granting a preliminary injunction recognizing the states’ power to regulate over the supply of natural piped gas to industrial facilities that aim to use it as raw material for producing liquefied gas. In fact, the preliminary injunction, rendered by Presiding Justice Cármen Lúcia, found that the supply of gas directly from Petrobras to White Martins seems to be a local service of distribution of piped and, therefore, the State concessionaire, Comgás, is the only one allowed to provide it.

This decision was the first ruling by Brazil’s Supreme Court regarding the division of competence between the Federal Government and the States on gas matters, being thus of capital importance for the gas sector.

Local Fracking Bans: A Viable Threat or Mere Nuisance

Articles, Energy and Natural Resources, Latest News

Hydraulic fracturing is experiencing tremendous growth throughout the world. As is inevitable with any large and profitable industry, hydraulic fracturing has been the recipient of a variety of legal challenges. Parties have filed lawsuits, alleging a myriad of claims, such as trespass, nuisance, and negligence. Legislators have proposed bills to prohibit or substantially curtail fracking. Groups have also lobbied the federal government to issue heightened regulations concerning hydraulic fracturing. These efforts have generally failed to inhibit the development of hydraulic fracturing operations. One of the more recent trends in attacking hydraulic fracturing is the enactment of local fracking bans.

These local fracking bans have taken a variety of forms. Some bans are written as outright prohibitions and specifically target hydraulic fracturing. For example, the recently enacted ban in San Benito County, California prohibits hydraulic fracturing “throughout all unincorporated areas” of the county. Likewise, the ban adopted in Denton, Texas was drafted in a similar manner. Other bans resemble a bill of rights that oftentimes encompasses far more than simply hydraulic fracturing. For instance, Athens County, Ohio adopted “a community bill of rights” that prohibited “shale gas and oil extraction and related activities.” Indeed, fracking bans styled as bills of rights can be quite expansive, especially when compared to other hydraulic fracturing bans. A fracking ban adopted by Mora County, New Mexico demonstrates the sheer breadth of these anti-fracking measures. Mora County’s ordinance purported to prohibit “the extraction of oil, natural gas, or other hydrocarbons” as well as “the extraction of water from any surface or subsurface source . . . for use in” oil and gas operations. In fact, the ordinance also barred companies from importing “water or any other substance . . . for use in” oil and gas operations and constructing or maintaining “infrastructure related to” oil and gas operations. The ordinance actually went so far as to prohibit parties violating the ordinance from raising preemption arguments and to strip corporations violating the ordinance of their constitutional rights.

Irrespective of which approach localities follow, there are several legal stumbling blocks for local fracking bans. For example, the anti-fracking measures are susceptible to preemption arguments. Admittedly, the viability of a preemption argument depends on the scope of the state law applicable to the anti-fracking measure. However, several state courts have already invalidated local fracking bans on the basis of preemption. Colorado state courts have held that the Colorado Oil and Gas Conservation Act preempted anti-fracking measures enacted by Lafayette, Longmont, and Fort Collins, Colorado.[1] Similarly, a ban against hydraulic fracturing in Morgantown, West Virginia was also invalidated on preemption grounds. A divided Ohio Supreme Court has also weighed in on the validity of fracking bans. In the case, Beck Energy Corporation challenged the ability of Munroe Falls to prohibit it from engaging in drilling operations without a municipal permit although the company had a permit from the state. The Ohio Supreme Court stated that the local ordinance was preempted by state law. The court acknowledged that Munroe Falls possesses certain authority under the doctrine of home-rule; however, in the court’s view, that authority was insufficient to support the city’s fracking ordinances that contradicted with state law.

Preemption arguments have even been effective when hydraulic fracturing bans have taken proactive steps to stave off preemption defenses. The Mora County anti-fracking measure contained a provision stating that preemption arguments could not be raised; that provision proved to be ineffectual, at best. The federal district court reviewing the challenge to Mora County’s ordinance easily rebuffed Mora County’s attempt to constrain when preemption law would apply to its anti-fracking measure. The court reasoned that “[i]f a county could declare under what conditions federal law preempted its laws, federal law would not be preemptive at all.” It appears that cities are beginning to recognize the likelihood that local fracking bans will be invalidated. Compton, California adopted a hydraulic fracturing ban that it later retracted after the Western State Petroleum Association (WSPA) filed a lawsuit against the city to challenge the anti-fracking measure. The primary argument raised by the WSPA was that state law preempted Compton’s ordinance. In fact, the Department of City Planning for Los Angeles advised the city to not enact a hydraulic fracturing ban. This recommendation was based, in part, on the ban’s susceptibility to preemption arguments.

The latest preemption debates concerning hydraulic fracturing bans are currently pending in Texas, Colorado, and New Mexico. Several parties have sued Denton, Texas to challenge the hydraulic fracturing ban enacted by the city. In each of the lawsuits, the plaintiffs argue that the fracking ban is preempted by state law authorizing state agencies to regulate the oil and gas industry in the state. Based on the number of courts that have invalidated local fracking bans, the odds are strong that Texas courts will also find preemption arguments persuasive. There is also an additional lawsuit pending in Colorado state court that challenges a hydraulic fracturing measure adopted by the city of Broomfield. The suit is brought by the Colorado Oil and Gas Commission (COGC), the same plaintiff in the lawsuits filed against Lafayette, Longmont, and Fort Collins. The COGC is raising arguments that are similar to those it made in the prior suits. As for the suit pending in New Mexico, the lawsuit is simply another challenge to the Mora County anti-fracking measure and is pending before the same court that already issued a ruling that the ban is preempted.

Another argument raised by parties challenging local fracking bans is that the bans constitute an unconstitutional taking. Denton is facing a lawsuit from several mineral rights owners alleging that the city’s anti-fracking measure amount to an unconstitutional taking. This lawsuit was actually filed before the city enacted its fracking ban. The plaintiffs are challenging the fracking moratorium enacted by Denton before the fracking ban. Likewise, parties challenging Mora County’s expansive fracking ban also raised takings claims. Although the district court held that the takings claim was not ripe, the court’s reasoning suggested that the plaintiff would have a viable takings argument. The court noted that Mora County’s anti-fracking measure “effectively destroy[ed] all economic value that [the plaintiff] has in its leases.”

Certainly, some local fracking bans have been upheld. For instance, the New York Court of Appeals upheld a local ordinance that would undoubtedly impact the ability of companies to engage in oil and gas drilling operations. The court reasoned that the local measure did not run afoul of state law because it primarily concerned zoning, an area in which the city had authority to legislate pursuant to the doctrine of home rule. Moreover, although the Mora County ordinance was invalidated, the district court acknowledged that state law allowed concurrent jurisdiction with localities for oil and gas operations. That said, the majority of courts to weigh in on the validity of local fracking bans have invalidated them. Localities weighing the costs and benefits of enacting fracking bans must consider the high likelihood that the anti-fracking measures will be invalidated.

[1] Longmont and Fort Collins have appealed these holdings.

NI 51-101 Amendments Promote Improved Disclosure Of Oil & Gas Resources

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The Canadian Securities Administrators (the “CSA”) have published amendments (the “Amendments”) to National Instrument 51-101 – Standards of Disclosure for Oil and GasActivities (“NI 51-101”) and the related companion policy to NI 51-101 (the “Companion Policy”). In its announcement, the CSA indicated that the Amendments will promote improved disclosure of resources other than reserves and associated metrics while simultaneously providing increased flexibility for oil and gas issuers that operate and report in different jurisdictions and recover product types not previously recognized. While the effective date of the Amendments is July 1, 2015, reporting issuers are required to immediately follow the latest requirements of the Canadian Oil and Gas Evaluation Handbook (the “COGE Handbook”) including ROTR Guidelines and Bitumen Guidelines. The CSA expects the Amendments to be adopted in each jurisdiction of Canada, following the satisfaction of applicable ministerial approval  requirements.

Access a complete copy of the Amendments or the amended Companion Policy.

Summary Of The Amendments

Set forth below is a summary of the key changes resulting from the Amendments.

Alternative  Resources Evaluation Standard

Under the current rules, issuers are prohibited from making public disclosure of reserves other than estimates that have been prepared in accordance with the COGE Handbook. This has been problematic for certain reporting issuers who are also subject to, or wish to comply with, the reserves disclosure requirements of other regulatory regimes, including the Securities and Exchange Commission of the United States (the “SEC”). In the past, certain issuers have obtained exemptive relief allowing them to disclose reserves prepared in accordance with U.S. requirements in addition to their reserves prepared under NI 51-101.

The Amendments will allow for supplementary disclosure of resources using evaluation standards other than the COGE Handbook (referred to in the Amendments as an “alternative resource evaluation standard”). The disclosure under the alternative standard must be accompanied by the disclosure required by NI 51-101 and, among other things, be made in respect of a regime which is comparable to the COGE Handbook. In addition, the estimates must be prepared by a qualified reserves evaluator or auditor. In the revisions to the Companion Policy, the CSA has indicated that alternative resource evaluation standards that the CSA would consider acceptable include the SEC’s oil and gas disclosure framework and the Petroleum Resource Management System prepared by the Society of Petroleum Engineers.

Product Types andProduction Group

The Amendments have imported the product type definitions from the COGE Handbook including “bitumen”, “coal bed methane”, “conventional natural gas”, “shale gas”, “synthetic crude oil” and “synthetic gas” and have refined those definitions for securities disclosure purposes. In addition, the concept of “production group” has been deleted from NI 51-101 and accordingly, the requirement to disclose a reporting issuer’s reserves by production group will no longer be required in the annual statement of reserves data prepared in accordance with Form 51-101F1 – Statement of Reserves Data and Other Oil and Gas Information (“Form 51-101F1”).

Contingent  and Prospective Resources

Under the Amendments, if a reporting issuer chooses to include contingent or prospective resources in an appendix to its annual statement of reserves  data (prepared in accordance with Form 51-101F1) the reporting issuer will be required to include a summary of the future net revenue associated with such resources based on forecast prices and costs (comparable to the summary provided for reserves data) and the estimates of the resources and related future net revenue must be evaluated or audited by an independent qualified reserves evaluator or auditor. In addition, Section 5.9 (Disclosure of Resources Other than Reserves) of NI 51-101 has been amended to require issuers to include a description of resources recovery projects including estimated total cost to achieve (and estimated date of) commercial production, recovery technology and whether a project is a conceptual or pre-development study.

Oil and Gas Metrics

“Oil and gas metric” means a numerical measure of  a reporting issuer’s oil and gas activities and includes finding and development costs, BOEs, reserves replacement and netbacks. Under the Amendments, Sections 5.11 (Net Asset Value and Net Asset Value perShare ), 5.12 (Reserve Replacement ), 5.13 (Netbacks ), 5.14 (BOEs and McfGEs ) and 5.15 (Finding and Development Costs ) of NI 51-101 will be deleted in their entirety and replaced with a “principle-based” approach to disclosure. Pursuant to the Amendments, if a reporting issuer discloses an oil and gas metric, the reporting issuer must identify the standard and source of the oil and gas metric, provide a description of the method used to determine the oil and gas  metric, provide an explanation of the meaning of the oil and gas metric and caution readers as to the reliability of the oil and gas metric. If there is no identifiable standard for an oil and gas metric, the reporting issuer must also include a brief description of the parameters used in the calculation of the oil and gas metric and provide a cautionary statement that the oil and gas metric does not have any standardized meaning and should not be used to make comparisons.

Marketability of Production and Reserves

The Amendments will require disclosure of resources or of sales of product types or associated byproducts at the “first point of sale” provided that a reporting issuer may disclose resources or sales of product types or associated byproducts with respect to an “alternate reference point” if, to a reasonable person, the resources, product types or associated byproducts would be marketable at the alternate reference point. If a reporting issuer chooses to disclose resources or sales of product types or associated byproducts with respect to an alternate reference point, the reporting issuer must state that fact, disclose the location of the alternate reference point and explain why disclosure is not being made with respect to the first point of sale.

Abandonment  and Reclamation Costs

The CSA noted in its request for comments that there is inconsistency in the determination of what constitutes abandonment and reclamation costs for the purposes of oil and gas disclosure. In order to provide clarity, the Amendments define “abandonment and reclamation costs” in NI 51-101. In addition, Item 6.4 (Additional Information Concerning Abandonmentand Reclamation Costs ) of the current Form 51-101F1 has been repealed in its entirety and reporting issuers will instead be required to include a discussion of any significant abandonment and reclamation costs in the significant factors and uncertainties disclosure in the annual statement of reserves data prepared in accordance with Form 51-101F1.

Other Amendments

With the introduction of IFRS 11, the Amendments refer to the COGE Handbook for the purpose of determining ownership and allow for flexibility in the manner of presenting resources for which a reporting issuer does not have control. In connection with the foregoing, Items 2.3 (Reserves Disclosure Varies with Accounting) and 2.4 (Future Net Revenue Disclosure Varies withAccounting ) of Form 51-101F1 have been repealed.

Under the Amendments, the requirement to obtain the consent of the independent qualified reserves evaluator before disclosing results from the annual evaluation outside of the required annual filings has been removed.

The Amendments will require reporting issuers that cease to be engaged in oil and gas activities to file a notice in the form of Form 51-101F5 – Notice ofCeasing to Engage in Oil and Gas Activities not later than 10 days after ceasing to be engaged in oil and gas activities.

The revised Companion Policy clarifies that a qualified reserves evaluator or auditor should not revise an evaluation using information in respect of events occurring after the effective date of that evaluation  for disclosure purposes. The revised Companion  Policy also clarifies that reporting issuers that have no reserves do not need to retain an evaluator or auditor, and that the reporting issuer should make clear that it has no reserves and is therefore not reporting related future net revenue.

The revised Companion Policy also includes new guidance with respect to the disclosure of after-tax net present value. In the revised guidance the CSA has stated that, if a reporting issuer discloses after- tax net present value, it should generally include, as appropriate, one or more of the following:

  • a general explanation of the method and assumptions used in the calculation of after-tax net present value, worded to reflect the reporting issuer’s specific circumstances and the approach taken. The revised Companion Policy states that major aspects should be addressed, such as whether tax pools have been included in the evaluation; and
  • an explanatory statement to the effect that the after-tax net present value of the entity’s oil and gas properties reflects the tax burden on the properties on a stand-alone basis, does not consider the business entity-level tax situation or tax planning, does not provide an estimate of the value at the business entity and that the financial statements and related MD&A of the entity should be consulted.

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UK Government Publishes Response To Further Consultation On Changes To Financial Support For Solar PV

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On 25 November 2014, the UK government published its response to its further consultation on changes to financial support for solar PV projects which opened on 2 October 2014 and closed on 24 October 2014. The response introduces a 12 month grid delay grace period applying in situations where a project, due to commission on or prior to 31 March 2015, fails to reach commissioning due to circumstances outside of a developer’s control.

The further consultation considered the introduction of a possible grid delay grace period of three months for new solar PV capacity above 5MW under the Renewables Obligation, following the decision to close the Renewables Obligation to new solar PV generating stations above 5MW from 1 April 2015. Following the responses received to the government’s further consultation, the government has decided to extend this period to 12 months with projects qualifying for the grace period needing to commission and have an accreditation date on or before 31 March 2016. Such projects will benefit from the ROC level in force on the date of accreditation (currently 1.3 ROCs for the period from 1 April 2015 to 31 March 2016).

The evidence required to qualify for the grid delay grace period is outlined below:

  • A grid connection agreement consisting of a grid connection offer; acceptance of the offer; and a document from the network operator estimating or setting a date no later than 31 March 2015 for delivery of the connection;
  • A written declaration by the generator that to the best of their knowledge, the generating station would have been commissioned on or before 31 March 2015 if the connection had been made on or before the estimated grid connection date; and
  • A letter or email from the network operator confirming that the grid connection was made after the estimated grid connection date and that in the network operator’s opinion, the failure to make the grid connection on or before the estimated grid connection date was not due to any breach of the grid connection agreement by the generator/developer.

This will provide some solace for generators and developers, who, following the recent decision to close the Renewables Obligation to new projects above 5MW, were faced with a situation where they may be denied funding under the Renewables Obligation even where connection to the grid was delayed through no fault of their own.

A link to the government’s response can be found here.