Azerbaijani market is generally open for foreign businesses[1]. A foreign company wanting to enter Azerbaijani market does not have to partner with a local person. If for business reasons the company needs to establish a joint venture, there are couple of options. We assume that all or substantial of the business activity is carried out in the territory of Azerbaijan.
Registered (Equity) JV
Perhaps most popular and widely used, especially outside the oil and gas industry, form of a registered joint venture (JV) is a limited liability company (LLC). Most privately held companies in Azerbaijan are established in the form of an LLC[2]. The partners join to set up an LLC in which each holds a certain shares. LLCs must be registered with the Azerbaijani Ministry of Taxes.
When setting up a joint venture the parties need to carefully consider the terms of LLC’s charter. Charter of an LLC is the LLC’s constitutional document, which regulates, among other things, governance in the LLC. The charter must be registered with the Ministry of Taxes. In addition to the charter, we typically recommend that partners enter into shareholders or similar agreements. These agreements should govern matters, which for either practical or regulatory reasons, cannot be included in the LLC’s charter.
An LLC typically has 3 governing bodies: general meeting, supervisory council (or similar supervising authority) and executive body. Having a supervisory council is not necessary – it is optional. Under Azerbaijani law certain matters, e.g., liquidation or reorganization, distribution of dividends, approval of annual balance etc., fall within the exclusive authority of the general meeting. Only the general meeting is authorized to decide these matters. Outside this “exclusive authority” and few other requirements, there are no limitations on allocation of authorities among the LLC’s corporate bodies. Partners in JV typically want to establish control mechanism to oversee JV’s executive body – i.e., director or general manager or similar officer. For instance, an LLC’s charter may require that a transaction above certain value be approved by the general meeting or supervisory council. Most of these mechanisms would be included in the LLC’s charter, although there are number of contractual mechanisms that should be in a shareholders or similar agreement.
In terms of allocation of cash flow rights, dividends must be distributed in proportion to share percentage in the LLC’s capital. If, for instance, partner A has 30% and partner B has 70% in the capital of the LLC, dividends must be distributed in that proportion – i.e., 30/70%. While most of the time JV partners are happy with this kind of arrangement, some, however, may want more flexibility in allocation of cash flow rights. Shareholders or similar agreements may be helpful, however, additional tax obligations may arise from allocation of dividends not in proportion to shareholdings.
Exiting the JV is not particularly difficult. A partner may either sell its shares in the JV or withdraw by demanding from the LLC value of its share. While selling a share provides easier exit route, Azerbaijani law does not govern withdrawal in detail.
Contractual JV
JV partners may set up a contractual joint venture – they do not register a joint company, but instead sign agreement on joint operations. The agreement must be detailed to govern, among other things, decision making, distribution of profits, allocation of costs and withdrawal. Contractual joint ventures are widely used among companies engaged in oil and gas industries.
For practical reasons, even if the partners do not form a joint company, if they are engaged in day-to-day operations in Azerbaijan, they have to have some form of legal presence in Azerbaijan. For instance, either one or both parties may register a branch office in Azerbaijan.
Azerbaijani law does not specifically provide for or govern contractual joint venture agreements. Instead, these agreements would be governed by general contractual provisions of relevant laws, most importantly the Civil Code of Azerbaijan. A local lawyer’s assistance is necessary in case of contractual joint ventures, as these agreements must not contradict mandatory requirements of Azerbaijani law.
One of the key issues in contractual JVs is the use of bank accounts. It is important that parties decide how they would use bank accounts that would be used for receiving payments in connection with the joint business. In Azerbaijan only the entities with registered legal presence may open bank accounts. In other words, if a foreign company has not registered any office in Azerbaijan, it will not be able to open a bank account with any local bank. In case of contractual joint venture parties may open a joint bank account. Disposal of funds from such account can be done with consent of the JV partners.
Tax Matters
Generally income from business activities in Azerbaijan is subject to 20% of profit tax. This tax is calculated from the net profit, which is the difference between income and deductible expenses and exclusions. There is also value added tax at the rate of 18%. The burden of VAT falls on an end-user of the product or service.
Dividend distributions are subject to 10% of dividend withholding tax.
In case of registered JV (as discussed above) in addition to 20% of profit tax, there will also be 10% of tax on dividends, which the JV decides to distribute to its shareholders. As a result, there is double taxation of income, which is finally distributed to the JV partner. The Azerbaijani Tax Code provides that (i) further distribution of dividends is not subject to dividend tax, and (ii) in case the receiver of dividends is the “factual owner” (essentially, beneficial owner), the dividends are not subject to any other tax – i.e., they are subject to profit tax in the hands of the person, who receives dividends. It is not clear who is considered “beneficial owner” for the purposes of the second type of exemption. This matter can be subject to dispute.
In case of contractual JV, the contractual JV fulfills its VAT payment obligations and partners pay taxes on the profit, which they receive from their joint business. Therefore, there can be tax benefit in contractual JV depending on the circumstances.
Given Azerbaijani tax regulations are generally not clear on some of the key issues concerning JVs, it is always best to ask advice from the professional before making any final arrangements.
This material is not and is not meant to constitute a legal advice. Each case is different. You must seek professional advice on your particular case.
[1] Some limitations maybe in regulated industries, such as banking and insurance
[2] For more information on forms of legal entities in Azerbaijan please see the material in the following link: http://remells.com/files/Investing_and_Business_In_Azerbaijan_2014.pdf