Oil and gas tax regime in Russia: proposed changes

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1 ECU Alert Oil and gas tax regime in Russia: proposed changes 25 October 2016 EY s Russian Tax & Law practice was named a leading tax firm in Russia in World Tax 2015, an annual guide published by the International Tax Review. On 13 October 2016, the Government of the Russian Federation approved draft tax policy guidelines for 2017 and further plans for Pursuant to the guidelines, the Ministry of Finance developed a draft law, titled On Amendments to Parts One and Two of the Tax Code of the Russian Federation and other regulations of the Russian Federation, and submitted it to the Russian Government for approval. On 17 October, the Russian Government approved and tabled the bill in the State Duma 1. The bill amends the current oil and gas tax regime to introduce new definitions and make changes to the calculation methodology for Mineral Extraction Tax (MET) on crude oil, natural gas and gas condensate. It also establishes new excise duty rates on petroleum products for the period According to the accompanying statement, the amendments are intended to reduce Russia s budget deficit. However, the draft tax policy guidelines say that the proposed long-term increase in the tax burden on the oil industry would dramatically increase the likelihood of an accelerated output decline in mature oil provinces, and work is under way to develop an alternative mechanism to raise additional budgetary revenue without increasing pressure on the oil refineries. 1

2 Impact assessment of the proposed changes According to estimates of the EY Moscow Oil & Gas Center, the refining margin of an average oil refinery in Russia totaled RUB 1,000 per metric ton in Q The proposed increase in excise duty on petroleum products paid by refineries may have an adverse impact on the economics of refining projects, given that it is difficult to shift the fiscal burden onto consumers as the oil retail business can do. For instance, an increase in excise duty of RUB 2,700 per metric ton for Grade 5 gasoline and of RUB 1,707 per metric ton for diesel fuel in 2017 versus the current 2017 plan might increase the amount of tax paid by refineries by around RUB 300 per metric ton* given the limited flexibility in price set by the refineries to their customers. The tax burden on upstream projects that do not enjoy any incentives, determined as a percentage of revenue, can vary from 42% to 65% in different pricing scenarios in 2017 and beyond. According to our estimates, the bill in question would drive this tax burden up by 1% to 3% in , depending on macro fundamentals. Tax burden increase for upstream projects (compared with current conditions for 2017)** 3 % 2 % 1 % 0 % USD/bbl, 75 RUB/USD 50 USD/bbl, 62 RUB/USD 80 USD/bbl, 42 RUB/USD * excluding the impact of excise duty on other petroleum products and other factors, with 50% of the excise duty increase to be shifted onto consumers ** compared with the current economics of projects that do not enjoy any incentives. Tax burden = (Export duty on crude + MET on crude) / Revenue. 2

3 Term subsurface site The bill would add a provision to the Tax Code to define the term subsurface site as follows: a subsurface site is a subsurface area, whether or not limited by depth, the dimensional boundaries of which are identified by the geographic location of corner points as determined by the subsoil use license, including any mining and geological allotments. The current version of the Tax Code does not provide for this definition, and taxpayers have been guided by other laws and regulations, namely the Law on Subsurface Resources. However, the tax authorities often disagree with taxpayers over the issue when the application of reduced MET rates is at stake. Defining this term would eliminate the ambiguity in terminology. MET on natural gas At the end of 2015, a coefficient for natural gas (Cgp), standing for the export margin of one unit of fuel equivalent, was added to the formula used to calculate the coefficient Usf ( unit of standard fuel ) for determining MET rates on natural gas. Previously, the Usf formula, which is based on the prices of natural gas and gas condensate, as well as on the quantity of output, included a multiplication factor of 0.15 that was effectively raised to for taxpayers owning Unified Gas Supply System facilities and their affiliates in It was initially planned that increased MET rates on natural gas and gas condensates would only be applied in However, the bill submitted to the State Duma stipulates that for taxpayers owning Unified Gas Supply System facilities and their affiliates the 0.15 multiplication factor will be adjusted by a Cgp coefficient that will be equal to: in in in 2019 MET on gas condensate In 2016, the above multiplier of was also used to calculate the amount of MET on gas condensate. Since taxpayers that own Unified Gas Supply System facilities and their affiliates do not receive any economic rent from gas condensate production, a decision was made to provide for a mechanism to compensate these producers for the increased Usf coefficient. In particular, the bill stipulates that the adjusting factor (Ccm) used in the gas condensate MET formula should be divided by the respective Cgp coefficient to equalize MET rates on gas condensate for both the above organizations and independents. MET on crude oil Under the reform known as the big tax maneuver, export duty on crude oil was to gradually lower from 42% in 2015 to 36% in 2016 and to a further 30% in The planned reduction in the maximum rate from 42% to 36% in 2016 was later postponed, however, the maximum rate of export duty on crude oil is to be lowered to 30% in MET rates on crude oil are to be raised to reduce the national budget deficit. A new value is expected to be added to the formula used to calculate Em, a coefficient representing oil extraction factors. This value is due to be set at: 306 in in in 2019 Excise duty on petroleum products The bill provides for a further increase in excise duty rates on petroleum products in Oil products Grade 5 gasoline Tax rate, Russian rubles per metric ton 2017 (previo usly) ,430 10,130 10,535 10,957 Other gasoline 12,300 13,100 13,100 13,100 Straight-run gasoline 12,300 13,100 13,100 13,100 Diesel fuel 5,093 6,800 7,072 7,355 Middle distillates 5,093 7,800 8,112 8,436 3

4 Please note that the bill can undergo changes during discussion in the State Duma. We will continue to monitor the legislative process and keep you up to date with key developments in our subsequent reports. Authors: Rustam Nizametdinov Dmitry Dzyuba Anna Sokolova 4

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