The Indonesian Director General of Mineral, Coal and Geothermal ("Director General") issued Regulation No. 376.K ("Regulation 376.K"), which clarified the restrictions on the use of related party mining services companies under Law no. 4 of 2009 (the "2009 Mining Law"). Regulation 376.K opens up the possibility of up to five Izin Usaha Pertambangan (IUP) or Izin Usaha Pertambangan Khusus (IUPK) concession holders using a related party mining services company, which will enable a certain degree of risk and cost sharing between investments.

Prior to the enactment of the 2009 Mining Law, related party mining services companies had been commonly used for two purposes. The first is to enable a foreign party to exercise a degree of operational control over domestic companies holding kuasa pertambangan (KP) concessions under the previous law. The second purpose is to facilitate a degree of risk and cost sharing between mining concessions.

The 2009 Mining Law rendered the first use redundant as it opened up the new IUP concessions for direct foreign ownership. However, a key principle of the 2009 Mining Law was to establish each IUP concession as a separate company with a separate profit centre. As such, a Ministerial Decree was enacted to restrict the use of related party mining services companies without consent from the Director General. Regulation 376.K provides additional colour to the Ministerial Decree by granting approval for IUP holders to use related party mining services companies in which the IUP holder owns at least 20% of the equity.

In practice, the use of related party mining services companies enables an owner of multiple concessions to offset profits from the first producing concession against development costs for future concessions. At the very least, this could result in a significant deferral of taxable revenues - and in the event future concessions proved to be unsuccessful, potentially setting the losses off against profits from earlier successful concessions. By permitting related party mining services companies to conduct the mines operations, Regulation 376.K once again opens up this possibility - although to some extent limited in its application.

As Regulation 376.K requires each IUP holder to own 20% in the related party mining services company, this limits the theoretical number of IUP holders that can use the same service provider to five. In practice, however, a 20% stake is unlikely to be efficient, as post-tax dividend income from the mining services company would be subject to taxation a second time in the IUP/IUPK company level. For this reason, it is likely to be far more efficient to pool services amongst four IUP holders each with a 25% stake in the mining services company, thus enabling the IUP/IUPK holders to rely on a participation exemption against double taxation in portfolio companies. Accordingly, there is a practical limit of four IUP/IUPK holders that can benefit from shared risks and costs through one related party mining services company, with an indicative structure as follows:

We believe Regulation 376.K opens up the potential to add a valuable element of risk and sharing for holders of multiple IUP/IUPK concessions through the use of related party mining services companies.

Furthermore, the variety of sensible options available for mining companies to share the risks and costs between multiple IUP/IUPK concessions is enhanced by combining other structuring options such as the use of common centres for equipment leasing and financing.

O'Melveny & Myers LLP routinely provides advice to clients on complex transactions in which these issues may arise, including finance, mergers and acquisitions, and licensing arrangements. If you have any questions about the operation of the applicable statutory provisions or the case law interpreting these provisions, please contact any of the attorneys listed on this alert.

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