The Government of Mongolia has proposed to amend its regulatory framework for investment activities in a bid to reverse a decline in foreign investment and to revive the economy. Last week, the Government submitted the draft Law of Mongolia on Investment ("Draft Investment Law") to Parliament for consideration during an extraordinary session to be held from 16 September to 27 September 2013. If adopted, the Draft Investment Law will replace the Law of Mongolia on Foreign Investment, enacted on 10 May 1993, as amended ("Foreign Investment Law") and the Law of Mongolia on the Regulation of Foreign Investment in Business Entities Operating in Sectors of Strategic Importance, enacted on 17 May 2012, as amended ("SFI Law").

The current version of the Draft Investment Law on Parliament's website is a work in progress that will undergo further changes in content and wording during the extraordinary session. It reflects the intention of the Government to return to a less complicated registration process that had made Mongolia an attractive private foreign direct investment ("FDI") destination, compared to other emerging jurisdictions in years past. While this will be a step welcomed by foreign and domestic investors alike, the effectiveness of the new law will depend upon whether the Government has the political will to streamline its bureaucracy and facilitate registration procedures in order to increase capital flows into Mongolia.

OVERVIEW

Since its adoption in 1993, the Foreign Investment Law has been the key piece of legislation providing the main regulatory framework for FDI in Mongolia. Under the Foreign Investment Law, the Government set up a two-step registration process for the establishment of foreign-invested entities. A foreign investor needed to register with the state administrative body in charge of matters related to foreign investment (presently, the Foreign Investment Registration and Regulation Department of the Ministry of Economic Development, or "FIRRD") and thereafter register its business entity with the Legal Entity Registration Office ("LERO"). The two-step process required relatively few supporting documents and considerably less time than other jurisdictions competing with Mongolia for capital.

In 2012, the enactment of the SFI Law considerably altered the investment landscape by expanding the discretionary approval authority of the Government or Parliament for private and state-owned foreign investment in strategically important sectors, namely minerals, banking and finance, and media and telecommunications. Further, changes in the equity structure of strategically important foreign-invested business entities also could trigger mandatory discretionary approval procedures.

The SFI Law stipulated that any investments by a foreign state-owned entity required Government approval as a mandatory precondition. The term "foreign state-owned entity" was left undefined.

On account of shifting policies toward FDI, the authorities did not issue implementing regulations to clarify many of the broad terms of the SFI Law until March of this year. This resulted in an extended period of inactivity in relation to new investments, which partly contributed to a reported 43% decline in foreign investment in the first six months of 2013 as compared to 2012.

The Draft Investment Law removes some of the uncertainties under the SFI Law:

  • It consolidates the approval process by stipulating that private investment from foreign or domestic sources need only register with LERO.
  • It removes the classification of strategic economic sectors for foreign investment.
  • It defines a foreign state-owned legal entity ("FSOE") as a legal entity in which a foreign state directly or indirectly holds more than 50 per cent of the entity's equity.
  • It states that the Ministry of Economic Development ("MED") is the approval authority for all investments by FSOEs.
  • It authorizes the Investment and Business Promotion Agency ("IBPA"), a separate agency to be established under the MED, to issue a "tax stabilization certificate" to qualifying entities. Holders of such tax stabilization certificates are entitled to enjoy stable treatment in respect of certain types of taxation for a certain period of time.

Earlier drafts of the law called for the creation of an "Foreign Investment Board" similar to that seen in the Australian regime, however this concept has been removed from the latest draft submitted to Parliament.

In addition to the repeal of the SFI Law and the Foreign Investment Law, 11 other laws, including the Law of Mongolia on the State Registration of Legal Entities, enacted on 23 May 2003, as amended ("Legal Entities State Registration Law"), will be amended in order to implement the Draft Investment Law.

SCOPE OF THE LAW

The scope of the Draft Investment Law extends to the regulation, protection and promotion of investment by foreign and domestic investors in Mongolia. "Investments" are classified into two categories; direct investments and portfolio investments. The distinction between these two types of investments is the degree of involvement by the investor in the management of the investee. Portfolio investments do not fall within the ambit of the Draft Investment Law unless they are made by FSOEs.

The amount of investment determines whether the entity may apply for a tax stabilization certificate. Under the Draft Investment Law, "investment" is calculated by reference to a balance sheet test applicable to both foreign and domestic investors according to relevant financial reporting and accounting standards.

The Draft Investment Law expressly does not apply to investments in Mongolian state authorities using State funds nor to investments by international organisations, NGOs and private persons in the form of donations or ex gratia grants.

STATE REGULATION OF INVESTMENT

The MED will continue to have the main authority to implement state policy and laws and regulations on investment. Among other powers, the MED issues approvals for an investment made by an FSOE.

Further, the MED will create the IBPA with a mandate to promote, advertise and regulate investment activities in Mongolia. This agency will also be in charge of issuing tax stabilization certificates as well as ongoing monitoring and inspection of the activities of holders of such stabilization certificates. Unlike FIRRD, the IBPA will not have any role in registering foreign-invested entities established by private investors.

GENERAL FRAMEWORK FOR INVESTMENT

Subject to approval requirements for FSOEs, investors may invest in any production or services sector which is not prohibited or restricted by law. Prohibited sectors are specified as narcotics, gambling, pornography, or pyramid sales or marketing. Certain regulated sectors are also subject to licensing requirements.

Registration Framework for Foreign Investment

Under the Draft Investment Law, foreign investors may establish a presence to do business in Mongolia through a foreign-invested business entity or a representative office. No other form of corporate vehicle such as a branch, is currently provided for. It is also unclear whether foreign individuals or foreign limited liability partnerships may establish a presence in Mongolia through a foreign-invested partnership. Although a reference is made to "business entity" which may include any corporate forms for profit-making activities, in practice a limited liability company is the most common vehicle used to establish a presence in Mongolia.

The Draft Investment Law expressly provides that a foreign or domestic investor may make an investment on the basis of registration of a legal entity in accordance with the Law of Mongolia on Companies, (as revised) enacted on 6 October 2011, the Legal Entities State Registration Law and other relevant laws and regulations. This is identical to the process under the Foreign Investment Law where foreign entities need to be registered with FIRRD and LERO, save that the twostage process has become a one-step registration. However, an FSOE may only make an investment upon obtaining approval as specified in the Draft Investment Law.

Accordingly, investment made by private foreign or domestic investors will no longer be subject to general approval requirements, other than registration to the extent required, and licensing or other requirements under sector-specific legislation.

Regulation of Investment by an FSOE

The Draft Investment Law stipulates that an FSOE must fulfil the MED's approval procedures for all investments (both direct and portfolio investment) or operations, or for the acquisition of a 25 per cent or more interest in Mongolianincorporated legal entities. In the event of a breach of this requirement, the MED may impose an administrative penalty including the revocation of licences or termination of the operations of the related Mongolian entity.

GENERAL LEGAL GUARANTEES AND OBLIGATIONS

To ensure a stable regulatory framework, the Draft Investment Law provides that any proposed amendment to or repeal of the Draft Investment Law will only be effective upon the affirmative vote of at least two-thirds of members of Parliament. This could help to prevent arbitrary or sudden changes in the investment environment. Nonetheless, this provision may raise constitutional issues in the event that a simple majority of the members of Parliament enact the Draft Investment Law.

Further, the State may issue a guarantee for stable tax treatment upon request by an investor in accordance with the Draft Investment Law. If approved, an investor would be entitled to enjoy stable tax treatment for a specific period of time.

The Draft Investment Law provides general legal guarantees of investments such as protection from nationalization (by setting out conditions under which nationalization is permitted), protection of intellectual property rights, the right to repatriate profits (following the payment of relevant taxes), and freedom to choose a dispute resolution forum.

Further, the Draft Investment Law sets out general rights and obligations of investors in relation to their operations. Both foreign and domestic investors are obliged:

  • to comply with Mongolian laws and regulations;
  • to provide work and services that are in compliance with national and international standards;
  • to maintain accounting records and registers in accordance with applicable standards;
  • to provide necessary information to relevant state authorities;
  • to implement investment activities that are in the interests of customers, environment-friendly, and supportive of human development;
  • to recognise and observe workers' rights under the relevant legislation and to provide training and improve the professional skills of employees;
  • to introduce good corporate governance principles; and
  • to respect the traditions and customs of the Mongolian people.

Failure to comply with the statutory obligations will attract an administrative penalty following a 6 month grace period allowed to cure the breach. Imposition of sanctions for noncompliance with such open-ended obligations could be problematic in the absence of specific criteria.

PROMOTION OF INVESTMENT

To promote large-scale investment in Mongolia, the Draft Investment Law proposes to introduce so-called tax stabilization certificates ("Stabilization Certificate"), which will entitle the holder to enjoy stable tax treatment for a period of up to 10 years in the case of heavy industry and 5 years in the case of light industry. Further, in the event the stabilised tax rates are reduced, a holder of the Stabilization Certificate is entitled to the more favourable tax treatment.

The Stabilization Certificate will stabilise the applicable rates for the following taxes: (i) corporate income tax; (ii) customs duties; (iii) value-added tax; and (iv) minerals royalties.

A Stabilization Certificate may not be issued in respect of investment made in activities relating to production, import, and sale of tobacco products or alcoholic beverages. Further, investors who already have entered into investment or stability agreements with the Government would not be eligible to apply for a Stabilization Certificate.

The IBPA may issue a Stabilization Certificate if the investment:

  • exceeds MNT 15 billion in value (as of September 2013, approximately US$ 8.7 million);
  • is environmentally friendly;
  • creates new jobs; and
  • introduces new technology.

The Draft Investment Law sets out the procedures to apply for, issue, and terminate a Stabilization Certificate.

As currently drafted, it appears that the Stabilization Certificate will become the only way of providing stable tax treatment in Mongolia and will replace the process for investment and stability agreements that provided tax stabilization guarantees for mining and larger-scale projects with foreign investment under existing legislation.

SUPERVISION OF INVESTMENT

Unless provided otherwise in sector-specific laws, the MED and its relevant agency will monitor investment activities.

Holders of Stabilization Certificates have an obligation to issue annual investment reports and submit the same to the IBPA and the relevant tax authority. Failure to comply with these reporting obligations will attract a financial penalty.

SANCTIONS

Non-compliance with the Draft Investment Law attracts administrative penalties as specified above. Further, a financial penalty will be imposed on those who breach the regulations relating to the application, issuance and maintenance requirements for Stabilization Certificates.

CONCLUSION

If passed, the draft law is a welcome development which should assist to stimulate the development of domestic and foreign investment in Mongolia. It has the benefit of removing the concept of strategic sectors for domestic and foreign investors, thereby eliminating some confusing and discretionary approval criteria that were set out in the SFI Law. It further will simplify the registration process before a single body in place of the previous dual registration with FIRRD and LERO. The concept of tax stabilization certificates suggests a more routine handling of significant investment from now on rather than individual, discretionary grants of tax stability or investment agreements for specific investors.

The above said, Parliament could take the opportunity of enacting the Draft Investment Law to further clarify other aspects of the Mongolian investment regime.

The Draft Investment Law does not expressly provide that foreign investors may form a limited liability partnership or a branch. During the deliberation about the law, Parliament could include these investment structures that are important for financial institutions, auditing firms, and law firms as vehicles available to foreign business entities.

There also remains a discretionary approval system for investment by FSOEs and relatively undefined and subjective criteria for tax stabilization certificates, such as the creation of new jobs, introduction of new technology and environmentally-friendly investment.

The inclusion of general obligations on domestic and foreign investors to provide work and services in compliance with international standards, implement investment activities that are in the interests of customers, or support human development, introduce good corporate governance principles and respect the traditions and customs of the Mongolian people also appear to have a high degree of subjectivity that may be subject to argument, and could result in selective enforcement if not better defined or consistently applied. This is especially important as non-compliance would be subject to an administrative penalty.

Further, neither the law nor the supporting amendments at this stage address the issues in the current registration process, such as the lack of an online company registration process, the inability to conduct routine company searches, protracted registration handling times, and the complex company name selection and business scope approval process.

While the Draft Investment Law is an important step in the direction of encouraging domestic and foreign investment and streamlining the process, the fundamental point is whether there is full policy support for its effective implementation. Certainly the investment environment could benefit from a focus on removing the practical day-to-day obstacles to business as opposed to ambitious projects that may take many years to implement. As sagaciously noted in an old Mongolian proverb, "it is better to eat lungs today than steak tomorrow".