OPTIONS IN TRANSACTIONS INVOLVING SHARES IN LIMITED LIABILITY PARTNERSHIPS IN THE REPUBLIC OF KAZAKHSTAN

The topic of options in transactions with partnership interests and their enforceability is becoming more and more relevant due to the growth of foreign investments in the country. In this article we will consider the extent to which it is possible to resort to this institution of civil law from the point of view of the legislation and law enforcement practice of the Republic of Kazakhstan.

ADMISSIBILITY AND ENFORCEABILITY OF THE OPTION UNDER THE LAW OF THE REPUBLIC

The Civil Code of the Republic of Kazakhstan (hereinafter, the Civil Code) does not contain provisions relating to an option contract or to an option to conclude a contract. However, under paragraph 2 of Article 380 of the Civil Code, the parties may enter into a contract either stipulated or not stipulated by law. Thus, the legislation of the Republic of Kazakhstan allows the conclusion of such an option.

This conclusion is also supported by judicial practice. For example, in one case, the plaintiff and the defendant entered into an option agreement whereby the seller intended to sell to the buyer a 50% interest in the share capital of a limited liability partnership ("LLP"). Subject to the provision set out in the agreement, the seller undertook to sell the interest to the buyer under a separate sale and purchase agreement, and the buyer's right to require the seller to sell him the interest held by the seller is referred to as the "Call Option". The defendant, in breach of the call option agreement, contracted to transfer a 50% interest in the share capital of the LLP to another company free of charge. The plaintiff demanded invalidation of the agreement, arguing that the defendant had alienated the share to a third party in violation of the option agreement. The court invalidated the transaction on alienation of shares as it contradicted the terms of the option agreement, which, in turn, was not in compliance with legal requirements. The court also stated that the transaction had been made for a purpose known to be contrary to the rule of law.

STRUCTURING AND SECURING THE OPTION

Given the judicial practice in Kazakhstan, where courts generally recognise and are guided by the parties' obligations under an option, it is not necessary to structure the transaction through statutory mechanisms (through a conditional transaction; through a preliminary agreement; through a waiver; through an irrevocable offer).

Moreover, as far as the civil legislation in general is concerned, the structures of an option agreement as well as an option to conclude a contract are provided for in the legislation on investment and venture capital funds. If an option agreement is challenged on the ground of invalidity due to lack of its stipulation in the Civil Code (there have been such cases in the court practice, but the court does not accept such arguments referring to paragraph 2 of Article 380 of the Civil Code and voluntarily undertaken obligations under a respective agreement), the court may apply the Law "On Investment and Venture Funds" by analogy of law pursuant to paragraph 1 of Article 5 of the Civil Code.

Regarding certification of such an option, Article 29 of the LLP Act stipulates the only case of mandatory notarisation when a natural person is a party to the contract of alienation (assignment) of the right of the partner who is retiring on the partnership's share. Therefore, notarisation of such an option is not legally, required, but we recommend that such transactions be concluded in the form of a notarisation.

THE NOMINAL REDEMPTION PRICE AND THE MAIN TAX CONSEQUENCES

In practice, when incorporating an option into the memorandum of association or entering into a separate relevant agreement, the question arises: is it possible to set a nominal price for redemption under such an option, and what would be the tax consequences of setting a nominal redemption price under such an option if the company is redeemed significantly below the market price?

The answer to the first question is positive, i.e. a nominal price for redemption under the option can be set. Based on practice, we recommend that the price should not be set lower than the value of the share on the share capital.

The tax consequences of setting a nominal redemption price under such an option if the company is redeemed significantly below the market price will be expressed in value added tax on the disposal of participatory interests in a legal entity in accordance with paragraph 8 item 9 of Article 645 of the Tax Code of the Republic of Kazakhstan (hereinafter, the Tax Code).

On the basis of sub-paragraph 1 of paragraph 3 of Article 228 of the Tax Code, if a participating interest is sold at a price higher than its initial value, income will be recognised as a positive difference between the sale value and the initial value (contribution). If the sale is carried out at the actual value of the participatory interest in the LLP, there will be no object of taxation.

In accordance with subparagraph 5, paragraph 1, Article 646 of the Tax Code, income of a non-resident from an increase in value on sale of participatory interest shall be subject to withholding tax at the rate of 15%. A person who sells shares, participatory interest or immovable property must provide the purchaser - tax agent with a copy of a document confirming the value of the acquisition (contribution).

The obligation and responsibility to calculate, withhold and remit income tax at source to the budget rests with the tax agent paying the income. At the same time, a non-resident legal entity is recognised as a tax agent regardless of the presence or absence of a permanent establishment in the Republic of Kazakhstan, as well as a structural unit whose activities do not result in a permanent establishment in accordance with the provisions of the Tax Code or an international treaty (Article 650 paragraph 8 of the Tax Code).

Pursuant to Article 650 paragraph 11 of the Tax Code, a non-resident receiving income in the form of capital gains on disposal of an interest from a person who is not a tax agent shall calculate income tax independently by applying the rate established by Article 646 of the Code to the amount of such income.

JUDICIAL PRACTICE CONCERNING THE CONSEQUENCES OF A BREACH OF AN OPTION

It is worth bearing in mind that option agreements are rarely used in Kazakhstan. However, the available court practice, in most cases, takes the side of option holders with respect to the consequences of a breach of such options and obliges the opposing party to perform the voluntarily assumed obligations under the relevant agreement.

NOTARISATION OF THE OPTION AND PUBLICATION OF THE FACT OF THE OPTION

Business entities often ask: Is there a requirement for mandatory notarisation of options and/or publication of information on the fact of conclusion of an option?

As stated above, the legislation of the Republic of Kazakhstan does not contain a requirement for mandatory notarisation of such kind of options or for publication of information on the fact of conclusion of an option. Nevertheless, in order to reduce the associated risks when choosing the structure of an option, we recommend notarisation of the transaction.