**AZERBAIJAN: CHARTER FOR THE COORDINATING COUNCIL OF SOCAR**

 

TheCoordinating Council is organized by the State Oil Company of the AzerbaijanRepublic (SOCAR) and the international oil consortia operating in Azerbaijan, to establish aforum through which SOCAR, PSA Consortia and other  entities operating within the Azerbaijan Republic canjointly address issues which will effect the commercial and operatingenvironment for hydrocarbon exploration and exploitation projects within theterritorial limits of Azerbaijan Republic.

 

Theseefforts are to be conducted within compliance with the relevant Azerbaijan Lawsand Regulations and in such a  wayas to maximize the cost effective utilization of qualifying Azerbaijani firmsand infrastructure, minimize the cost overall costs to the operating entities, encourage third party capitalinvestment in Azerbaijan, insure all such activities conform to internationalstandards, all within a competitive environment and overall conformity with thedevelopmental  needs andaspirations of SOCAR and Azerbaijan.

 

 The Coordinating Council will developrecommendations in an effort to define, establish and coordinate joint SOCARand Consortia efforts towards the following:

 

              - The identification of critical infrastructure assets which will berequired to implement the combined exploration and development programs of themember Consortia.

              - Develop strategies to formulate and implement appropriate investmentmodels to accomplish the refurbishment, operation and maintenance of these infrastructure to internationalstandards. Any proposals developed as a result of the Initiative would beevaluated through the PSA provisions governing the conduct of the individualmember Consortia for  inclusionwithin their respective Annual Work Programs and Budgets. 

              - Accomplish the above in a cost effective manner while ensuring thecontinuous operational integrity of the assets, encouraging third partyinvestment in the process and maintaining a competitive cost environment.

              - Strive to ensure that the Joint Initiatives complement to the maximumextent possible the needs and aspirations of  SOCAR and Azerbaijan while maintaining the program's need tomeet the business and commercial needs of the member  Consortia.

              - Structure the Initiative's program to conform with Azerbaijani Law,the consortia PSA's and requirements of other  relevant bodies.

              - Foster the establishment of a favorable investment and operatingenvironment for foreign contractors.

              - Create an annual shared usage schedule and cost allocation forinfrastructure of SOCAR/third party JV's, alliances, etc.

              - Provide a forum via which SOCAR and the Consortia can address issueswhich jointly effect or will potentially effect operations within the PetroleumSector in Azerbaijan.

 

 Coordinating Council Proposes - TheRevenue Sharing Agreement (RSA) to the government of Azerbaijan and to  foreign investors:

 

Inorder to offset the strong international and regional competition for venturecapital, to promulgate an alliance structure documented in the form of aRevenue Sharing Agreement (RSA), modeled after the PSA structure, with all itsbenefits and principles that allow an alliance to operate like a foreignsubcontractor, avoiding the adverse tax consequences of the joint venture framework and thereby enhancingforeign investment and profitability of the resultant  RSA alliances. 

 

- Establish the RSA structure as a bridgingconcessionary facility to promote rapid inward investment.

 

Untilsuch time as an RSA framework is put in place, allow alliances to operate as aforeign sub-contractor, while fulfilling the main provisions of the eventual RSA form alliance.

**ProposedLegal Framework**

Theproposal is for an RSA, which operates on the same principles as a production-sharingcontract. It would create a contractual relationship between an Azerbaijani entity and theInternational partner(s).

 

Thereis now precedent for contracts such as a RSA by virtue of the productionsharing contracts negotiated in Azerbaijan and SOCAR is familiar with thenegotiation of such contracts.

 

Itis intended that this RSA framework would provide the contractor/investors withprotection against changes in the laws effecting the resultant alliance.

 

 The revenue received is allocated as perdiagram at Appendix and in the following order:

              2.1 License fees to Azerbaijani partner(s) and alliance operating costs(including applicable taxes)

              2.2 Financing costs to providers of loans

              2.3 Scheduled loan capital repayments

              2.4 Dividend distributions to RSA participators

 

**FISCALISSUES REGIME APLICABLE TO JOINT VENTURE COMPANY PROPOSED REGIME FORECONOMIC  VIABILITY OF REVENUESHARING AGREEMENT (RSA)**

 

**ProfitTax** -Profit Tax rate of 32%

              - Significant amount of business costs non-deductible for tax purposes(e.g., most part of training expenses, interest on

              loans made for a period of one year or more) - Profit Tax rate of 32%

              - Full deductibility of costs incurred for business purposes (similar totax deductibility rules that apply in current  offshore oil production sharing contacts)

               - Foreign subcontractorsengaged by RSA developer subject to simplified tax withholding in respect ifworks and services provided in the Azerbaijan Republic (similar to rules thatapply to oil production sharing contracts)

**ValueAdded Tax**("VAT") - Chargeable at rate of 20% on the invoice amount of works orservices

              - Rate of 16.67% is applied to the markup (gross profit margin) on salesof goods and equipment Exempt with credit zero percent (0%) VAT in respect ofthe import of and purchase of capital equipment, services, goods and materialswith  respect to servicingqualifying operations in Azerbaijan Republic.

**OtherTaxes** -Dividend withholding tax - 15%

              - Taxes paid to the Road Fund

              - Taxes paid to the State Handicap Fund

              - Excise Taxes - Exempt from all other taxes apart from Profit Taxobligation stipulated above and payroll taxes for Azeri  national employees (similar to taxregimes that exist in current offshore oil production sharing contracts)

**Tax Reporting Requirements** - Large amount ofreporting requirements with very high administrative compliance costs-

              Reporting requirements clearly defined and required on a consistentregular basis

**Bankingand Currency Regulations**

 - Restrictiveuse of foreign currency

              - National Bank of Azerbaijan permission needed for offshore bankaccount

              - National Bank of Azerbaijan License needed for receipt of foreigncurrency in large range of cases and foreign currency

              in cash form - Able to operate offshore foreign currency bank accounts

              - More liberal regime for foreign currency operations (similar tocurrency regime that exists in current offshore oil  production sharing contracts)

**AccountingStandards**

 - Booksand records must be maintained in accordance with Azeri standards - Books andrecords  maintained in accordancewith internationally recognized accounting principles (similar to accountingregime that exists in current offshore oil production sharing contracts).

              **Import and Export**

- Import duty, imposed at a rate of 5% or 15%

              - After imposition of Import Duty, Import VAT at a rate of 20% isimposed

              - Customs Processing fee (usually 0.15% of value imported goods)

 - Exemptfrom import duty

              - Exempt from Import VAT

              - Nominal Customs Processing fees (similar to processing fees chargedunder current offshore oil production sharing contracts)

              **Labor Regulations** - Subjects to statutory Azerbaijan RepublicLabor regulations - Statutory labor law is modified to take  account fo more flexible employmentpractices.

 

 

 **ORGANIZATIONAL ISSUES REGIMEAPPLICABLE TO JOINT VENTURE COMPANY PROPOSED REGIME FOR  ECONOMIC VIABILITY OF REVENUE SHARINGAGREEMENT ("RSA")**

 

              **Decision making process** - JV with Azerbaijani Partner would leadto inefficient management layers

              - Board of Directors with six members (three nominated by Azerbaijani Partner,three by foreign partner)

              - Management structure requirements rigid with several layers result induplicate cost structure 

- Steering Committee  would exist in place of Board of Directors

              - 50% of members of Steering Committee derived from Azerbaijani Partner,50% from foreign investor

              - Six members steering committee

 **Day to day operations** - JV Charter stipulatesmanagement positions and nationality requirements for key positions. This  results in duplicate cost structurewhich threatens commercial viability

              - Day to day management carried out by management team in accordancewith restrictions imposed by the Charter Document - Organization of day to daymanagement structure is the decision of foreign investor parties tomaximize  economic efficiency

              - Day to day management carried out by management team

 

**CONTRIBUTIONTO ECONOMIC DEVELOPMENT OF AZERBAIJAN REPUBLIC REGMIE APPLICABLE TO JOINTVENTURE COMPANY PROPOSED REGIME FOR ECONOMIC VIABILITY OF REVENUE SHARINGAGREEMENT ("RSA)**

 

**Employmentand Training**

              - Targets for training and development of Azeri staff not specified

              - Targets ratios for employment of Azeri staff at all levels notspecified

              - Absence of mechanism for monitoring of training and employment targets- Azeri                   employee training targets will be clearly defined in RSA agreement

              - Target ratios for employment of Azeri staff at all levels will bespecified in RSA a                         greement

              - The RSA will include a mechanism for monitoring training andemployment targets

              - The ration and absolute numbers of Azeri employees, will increase astime progresses

** Profit Sharing**

   -In accordance with share holding in the Joint Venture and Joint Venture                                          agreement

              - Would be lower level of profits in the absence of the RSA agreement(see fiscal                              issues)

   -RSA would clearly define net  profit share (after operating expenditures and capital                        expenditures have been recovered)

              - The share (ratio) of net profits awarded to Azerbaijani Partner wouldincrease as time                  progresses

**Ownershipof Assets**

               - Joint Venture partners would own assets in accordance with SHareholdings 

               - All assets (the developed state of the art site)  that were subject to cost recovery                           become the exclusive property of Azerbaijani Partner

** **

**TAXISSUES -  AZERI JOINT VENTURE RSAALLIANCE**

**ProfitsTax** - 32%tax on profits

              - Not all business costs are deductible - 5% tax withheld on revenuesattributable to                           services performed only in Azerbaijan for CONSORTIA

**ValueAdded Tax (VAT)** - Must be paid since Azeri JV's are not covered PSA and tax                                     protocol - Exempt fromVAT

**Dividends**- Taxableat 15% - Not Taxable

**Banking** - Must get permission fromCentral Bank to open foreign bank account

              - Payroll must be in Manats

              - Restricted withdrawals and repatriation of Dollars - No restriction onforeign bank                         accounts

              - No restriction on payroll currency

              - No restriction on Dollar Withdrawals

**Accounting**

- Must be done in accordance with Azeri standards inManats - According  toInternational Practices

            -  Reporting requirementsMany Minimal and well defined Government Audits

            - Subject to various governmental audits - Not applicable

** Labor laws**

- Subject to Azeri Labor Code predating the PSA whichis cumbersome and  not conductiveto international contract activity Subject to provisions which are  consistent with internationalpractices.

 

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