exxonmobil comparative advantage in malaysia

International Tax & Investment Center June 2007 SpecialReport Some Fiscal Parameters of the Investment Climate in Select Countries of Eurasia Editor’s Note Douglas Townsend Senior Advisor, ITIC Consistent with the ITIC mission to promote fiscal reform in the interest of developing private business thereby stimulating a general rise in prosperity, this tenth annual Special Report focusses on fiscal transition in certain countries of the “Eurasia” land mass—Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyzstan, Russia, Tajikistan, Turkmenistan, Uzbekistan, Ukraine—of interest to ITIC sponsors. Some of the priority concerns of regulators and investors in these jurisdictions with fiscal policy and administration are addressed in the articles contained in the Report. In addition to the detailed comparative tax systems’ Matrices which traditionally provide the core of this annual Report, a separate table highlights some wider comparative fiscal data on select jurisdictions currently of greater interest to ITIC sponsors—Azerbaijan, Kazakhstan, Russia, Ukraine, Uzbekistan. These data and the views expressed in the articles should not however be taken as the definitive guide to investment decisions. ITIC shares the belief that the comparative method can be useful for stimulating reform, partly through raising awareness of global and regional trends and thereby encouraging competitiveness. A plethora of comparative analyses produced by all kinds of private and official financial organisations tends to confirm this belief: and membership of key IGOs and IFIs requires competitiveness. Nonetheless, each jurisdiction has an unique environment in which financial and economic policy needs to be conducted, so that progress in reform is not linear. There can be, for example, a greater or lesser need and/or appetite for foreign investment, with corresponding consequences for the effectiveness of reform forces in the public policy debate on the fiscal regime. Moreover, the business “climate” can vary significantly in one jurisdiction across its geographical regions and between its economic sectors. It is nonetheless apparent from international competitiveness studies that their fiscal systems drag down the overall ratings of the countries of the region. A Report by the International Tax & Investment Center in conjunction with Deloitte Ernst & Young and PricewaterhouseCoopers The region continues to experience significant growth, with real GDP perhaps averaging over 6 percent in 2007 in the case of the oil-exporters, very much higher. Continued high commodities prices, strong global growth, a favourable international financial environment and generally-sound policies underpin this performance. Inflation is however rising, fuelled by rapid demand growth and continuing strong foreign inflows; and it could average some 9 percent in 2007. “Dutch Disease” also threatens in some oil-exporting countries. Economic priorities vary nationally but, overall, tend to include investments to boost social and physical infrastructure and economic diversification. Measures to promote macroeconomic stability and reforms to improve the business environment and strengthen the financial sector, particularly for oil-exporters grappling with a flood of money, also are a priority. Fiscal consolidation needs to be a priority for some regional countries with high fiscal deficits: further efforts to broaden tax bases, strengthen tax administration and reduce subsidies would be involved. Concurrently, there is significant policy and operational development in the direction of their closer economic integration, both regionally and globally. While progress in this development is not even across the Region, these countries are being drawn into WTO accession, towards international capital mar- kets listings and foreign assets acquisitions, a process accompanied necessarily by the need further to modernise their regulatory and corporate frameworks in order to meet international standards. Investors and other economic operators have a direct interest in the design and application of fiscal institutions and instruments which influence both their in-country and their regional and global activities. For the latter, some of the more prominent include the VAT, Double Tax Treaties, Transfer Pricing and Competent Authority cooperation. For the former, Corporate Income Tax and Individual Income Tax as well as Social Tax are relevant to competitiveness in economies seeking to establish comparative advantage in a sometimes-difficult geographical location. In all cases, governance standards are critical. Investors and taxpayers generally respond better to a comprehensible system embodying basic policy principles of revenue adequacy, economic neutrality, encouragement of savings and investment, fairness, low statutory rates and simplicity. Further, they and the authorities benefit from a system which is consistently, coherently and cleanly administered. Still some distance to go! The Implications of the New Political Economy of Energy outside the OECD: The Gulf, Russia and the Central Asian Republics Marat Terterov Senior Advisor on the Former Soviet Union Global Marketing Briefings Ltd. While the decade of the 1990s will forever remain in the memory as one of economic downturn and political uncertainty in Russia and the former-Soviet bloc (CIS), the present decade is becoming firmly associated with impressive growth, a stronger – albeit more centralized – political performance, and resurgence in the international arena. This trend is evident beyond the CIS bloc, however, and applies to non-OECD regions in a broader sense, including the coalition of states currently dubbed as BRICS (Brazil, Russia, India, China), as well as the dynamic Arab monarchies of the Gulf Cooperation Council (GCC). Russian GDP growth has increased by over 50% since the August 1998 financial crisis and GDP growth across the CIS has demonstrated a similar growth curve. The dynamic GDP growth in emerging economies such as India and China is well documented and many analysts are now forecasting that the BRICS economies will outgrow OECD economies by GDP size by 2030. The improved economic performance in non-OECD economies is underscored by the burgeoning power of national energy corporations such as Saudi Aramco, Venezuela’s PDVSA, and particularly Russia’s Gazprom, which last year overtook Royal Dutch Shell to become the world’s third largest public energy company by capital size. The dominance of state-controlled ITIC Washington, D.C. Tel: 1 202 530 9799 Fax: 1 202 530 7987 E-mail: Washington@iticnet.org ITIC London Tel: 44 20 7 484 5001 Fax: 44 20 7 484 5101 E-mail: London@iticnet.org ITIC Moscow Tel: 7 495 203 3669 Fax: 7 495 203 6155 E-mail: Moscow@iticnet.org  ITIC Almaty Tel: 7 3272 67 69 02 Fax: 7 3272 50 73 84 E-mail: Almaty@iticnet.org ITIC Astana Tel/Fax: 7 3172 71 79 68 E-mail: Astana@iticnet.org ITIC Kiev Tel/Fax: 38 067 408 1515 E-mail: Kiev@iticnet.org ITIC Baku Tel/Fax: 994 124 97 13 81 Tel/Fax: 994 124 97 13 82 Tel/Fax: 994 124 97 72 72 E-mail: Baku@iticnet.org ITIC Manila Tel: 63 2 8982913 Fax: 63 2 8982617 E-mail: Manila@iticnet.org energy companies from non-OECD jurisdictions is perhaps the most evident shift in global political economy which is resulting from the unprecedentaly high growth rates in these countries. Saudi Arabia is clearly the “central banker” of the international oil industry, given that Riyadh commands close to a quarter of the world’s oil reserves. Russian oil output has increased dramatically since 1998, however, and Russian/CIS oil exports are now the main non-OPEC driver for the international energy economy. This is demonstrated by the fact that between 1998-2005, for example, Russian energy companies raised the country’s oil production from 6 million barrels per day (bp/d) to nearly 9.5 million bp/d, while exports increased from 2.5 million bp/d to 4.5 million bp/d during the same period. A recent study measuring the shift in power in global energy markets reveled that seven major state controlled energy corporations from non-OECD countries (i.e. Saudi Aramco, Gazprom, PDVSA, China’s CNPC, Iran’s NIOC, Petrobras of Brazil and Petronas of Malaysia) presently control over 30% of global oil and gas production & over 30% of reserves, while the original seven (now four) OECD-based energy blue chips which have dominated global energy markets since World War II (i.e. Exxonmobil, BP, Chevron, Shell) now control just 10% of production and 3% of reserves.1 Recent reciprocal visits by heads of states from Russia and the Gulf taking place since 2003 signal each side’s recognition of each other’s leading position in the international energy business, whilst contemplation of further price collusion between energy suppliers (particularly in the gas industry) is heightening energy security concerns in OECD consumer countries, particularly within the EU bloc. Furthermore, given the high oil price environment of recent years, Russia has now accumulated substantially high revenues from its energy exports sufficient to withstand price shocks which would have led to default less than a decade earlier. The Russian oil stabilization fund – equivalent to the sovereign wealth or future generations funds of Gulf oil exporters – now stands at over $108 billion and Russia’s currency reserves (approximately $250 billion) are amongst the highest in the world. This is a major turn around from the country’s defaulting economy of the 1990s. As global energy demand for the major fossil fuels continues to accelerate, vigorous policies of “energy nationalism” coupled with occasional disruptions of energy supplies to transit states, have elevated major energy suppliers such as Russia into a neo-strategic role as self proclaimed guarantors of international energy security. European consumers of natural gas have, in particular, become highly sensitive to any notable shifts in strategy by Russia’s Gazprom – be it the announcement to invest into new export pipelines either eastward or those threatening to circumvent transit states, collusion with other supplier countries to form supplier blocs, or to seek downstream energy assets outside the CIS – as these have major resonance on their security of supply. The present state of market power of monopolists such as Gazprom is compelling energy consumers (i.e. the EU) to invest in the cultivation of alternative export routes for securing its energy supply. Consumers’ strategies of diversifying their source of energy supply is, for its part, enhancing the role of new supplier regions such as the Caspian, as well developing new gas markets such as LNG. Furthermore, as already discussed above, the fact that the majority of the world’s recoverable energy reserves are now controlled by national champions outside of OECD jurisdiction is further underscoring a shift in market power in global energy markets to countries where governance issues, policy priorities and national strategies are not always in accordance with the expectations of consumers. Despite the fact that non-OECD national champions seek to promote themselves as “good corporate citizens”, the emergence of countries like Russia as the “guarantors of international energy security” is likely to ensure that a highly challenging international energy environment is set to continue as the trend into the medium term. Much of the Russian strategy of enhancing its role as a guarantor of energy security is premised on Moscow’s priority of re-asserting its political influence in CIS space, including over transit states such as Ukraine and Belarus, as well as other supplier states with substantial hydrocarbon reserves of their own, particularly the Central Asian republics of Turkmenistan, Kazakhstan and Uzbekistan. While Moscow is currently seeking to reduce its reliance on Ukraine and Belarus as transit routes for its energy exports to Europe (by investing in alternative export channels such as the North European Gas Pipeline, for example), it has also increasingly been setting the terms over the development of the Central Asian oil and gas industries by signing long-term supply agreements and announcing new regional pipeline projects which will pass through Russia, as opposed to passing through Turkey and the Caspian (i.e. the routes backed by Washington or Brussels). The race to control Eurasian energy resources has been on since the early 1990s when, during Russia’s relative weakness, powerful Western energy corporations concluded energy deals with Central Asian governments. However, as Central Asian regimes’ relations with the West have cooled due to lack of progress in domestic reform, continued human rights concerns and hints of state failure, Moscow has been quick to capitalise. Gazprom has been acquiring substantial gas industry assets in Uzbekistan, upping its control over regional energy transport-pipeline infrastructure, and the manner in which it will court the new regime in Asghabad – a central source of Russian reserves of gas exports to Europe – will need to be closely observed by energy consuming nations. One should also note that vigorous Russian energy nationalism towards the region has been accompanied by expanding military ties between Moscow and the Central Asian states, evident particularly in the case of Russo-Uzbek and Russo-Kyrgyz relations. The consequences of Moscow’s energy policy adventurism towards the Central Asian states, if continued unabated in the medium term, are likely to be substantial. Domestic reform, democratisation and civil society movements in the Central Asian states are all likely to lose any sense of initiative, as regional regimes will consolidate their power amidst Moscow’s backing. Russian influence, if not control, over the region’s energy resources will have major repercussions for international energy security, while the role of Russian business in the region will also likely expand. The initial years of optimism during the 1990s, for independent development of the Central Asian republics, may indeed suffer a turn-around which may take many years to reverse. 1. See the article in the Financial Times, “The new seven sisters: oil and gas giants that dwarf the west’s top producers”, March 12, 2007.  Recent Trends in the Application of the “Substance Over Form” Doctrine in Russia Sergei Voropaev, Partner, Deloitte History The “substance over form” doctrine allows the tax authorities to disregard the apparent “form” of a transaction and to look instead to its actual substance in order to combat the use of artificial structures for tax avoidance purposes. This concept, well-known in international tax practice, was included for the first time in the Russian Tax Code on 1 January 1999. It is, however, important to bear in mind that the Tax Code establishes a fundamental guarantee for Russian taxpayers whenever the “substance over form” principle is applied by the authorities: the Russian tax authorities cannot collect related taxes, interest and penalties without going to court. The Yukos case launched in 2003 was a classic example of the “substance over form” principle being applied in practice. Following this case discussion of the concept was very widespread in Russia. However, in applying the approach the Russian tax authorities and courts effectively substituted the much vaguer “mala fide taxpayer” or “bad faith taxpayer” concept. In other words, the tax authorities and courts did not make much effort to determine the nature of the actual business relationships of taxpayers, but rather picked up various and sometimes irrelevant circumstances to suggest that a tax payer was acting in bad faith and that the form of a particular transaction should therefore be ignored. For example, the tax authorities cited use of borrowed funds to pay counterparties, making payments within 1 day, a counterparties’ failure to submit tax returns. Frequently the tax authorities issued huge tax assessments simply stating that the taxpayer “acted in bad faith”. This oversimplification also gave the tax authorities grounds to disregard the above-mentioned restriction on collection of taxes, interest and penalties without court process as, formally, they did not reclassify any of the taxpayer’s transactions. Guarantees The Resolution sets out a number of important guarantees: Firstly, the Resolution establishes the key principle that the possibility of a taxpayer achieving the same economic result in a less tax-effective manner does not by itself result in tax benefits being unjustified. Secondly, the Resolution states that the choice of a particular method of financing does not impact a taxpayer’s ability to obtain tax benefits. This should stop taxpayers’ costs and related VAT being disallowed where the transaction was financed via loans or funds raised in an IPO. Thirdly, unjustified tax benefits received by a taxpayer should not, in general, affect the taxpayers’ rights provided by Russian tax law, e.g. the statute of limitations. And finally, citing Article 45 of the Tax Code, the Resolution reinforced the message that whenever the “substance over form” principle is applied, back taxes, interest and penalties can only be collected via court proceedings. Liability for counterparties In the past Russian taxpayers suffered additional tax cost (mostly disallowed costs and input VAT) due to their counterparties’ failure to settle their tax liabilities. Now the Resolution establishes a clear general rule that the mere fact that the counterparty does not fulfill its tax liabilities should not result in the taxpayer’s tax benefits being unjustified. The following important exceptions to the general rule are specified: • where the taxpayer must have known about violations committed by the counterparty (e.g. due to interdependence); • where the taxpayer executes transactions mostly with counterparties which do not fulfill their tax liabilities. No more “bad faith” taxpayers? On 12 October 2006 the Plenum of the Russian Supreme Arbitrage Court issued Resolution #53 which is binding on all Russian arbitrage courts and effectively eliminates the “mala fide taxpayer” concept by introducing a presumption that a taxpayer has acted in good faith and by introducing the “unjustified tax benefit” concept. Most importantly, the Resolution establishes the following key circumstances that may result in a taxpayer obtaining unjustified tax benefits: • the substance of transactions do not coincide with their legal form; • there is no real economic activity (i.e. the transactions are only aimed at obtaining tax benefits); • the transactions are “fictitious” (i.e. they could not be actually performed by the taxpayer because of lack of resources, appropriate technology or other reasons). On the other hand, the Resolution establishes a list of circumstances which may not, by themselves, trigger any negative tax consequences for taxpayers. These, in particular, include setting up a legal entity shortly before carrying out a particular transaction, participation of related parties in transactions and carrying out a particular transaction at a place different from the taxpayer’s location.  The Future The Resolution was discussed by the Supreme Arbitrage Court with the business, legal and academic community and tax officials for over 6 months and during this process many arguments of the business community were heard (including a suggestion that the “bad faith” concept should not be part of tax law). Such a dialogue was very hard to imagine even a couple of years ago. Also, it is encouraging that the Resolution has introduced taxation principles which have been working effectively for decades in more developed tax jurisdictions. The Resolution provides a reasonable balance between public and private interests. On the one hand, it provides tools for the authorities to pursue taxpayers who only formally comply with the law. On the other hand, it provides strong guarantees against taxpayers’ property being seized without court process. And finally, inspired by the Resolution and the preceding discussions, the legislators are working on changes to the Tax Code aimed at legally establishing these principles which should make the application of Russian tax law more predictable. M & A in Kazakhstan: Some Tax & Legal Aspects Gerard Anderson, Tax Partner and Safkhan Shahmammadli, Senior Manager Tax & Legal Practice, Ernst & Young Kazakhstan Kazakhstan has seen a rapid growth in merger and acquisition activity in recent years. During 2006 major changes were made to tax and subsurface legislation to bring offshore M&A transactions within the reach of the Kazakh state. This article discusses certain important tax and legal aspects of such transactions. In general, the Kazakhstan income tax regime taxes only income and capital gains which are either earned by Kazakh resident individuals and enterprises or earned from sources in Kazakhstan. If an equity interest in a Kazakhstan entity is sold by another Kazakhstan resident entity, the tax treatment is straight forward: the seller will have to pay a tax on realized capital gain at the regular corporate income tax rate, which is currently 30%. When analyzing the tax implications of a sale by a non-resident the following main questions have to be considered: • does the sale give rise to Kazakhstan source income under the Tax Code? • is there a withholding requirement for the buyer? • are there any registration, reporting or payment obligations for the seller? • is there any protection available under an applicable double tax treaty? In general, under the Tax Code any sale of equity interest in (i) Kazakhstan resident companies or (ii) non-resident companies if more than 50% of the value of that entity is derived from property in Kazakhstan gives rise to Kazakh source income. This type of gain realized by non-residents is taxable in Kazakhstan at 20%, unless specifically exempt from tax either according to Kazakhstan domestic tax law or by virtue of an applicable double taxation treaty. Depending on the equity interest being disposed of and the residence of the buyer, two possible reporting and payment procedures exist that may apply to this type of capital gain: withholding at source or self-compliance. taxable transaction, then the seller will have to register with the Kazakhstan tax authorities and be solely responsible for reporting and paying its tax in Kazakhstan under Article 183 of the Tax Code. As of 1 January 2007 there appears to exist two conflicting versions of Art. 183. On 5 June 2006, the President of Kazakhstan signed a Law No. 146-III on Amendments to various legal acts on the issues related to creation of Almaty Financial Centre. This law, among other things, introduced an important amendment to Art. 183. According to that law, the article introducing that amendment enters into force on 1 January 2007. Subsequently, on 11 December 2006 No. 201-III another Law was passed on Changes into Tax Legislation that provided for an altogether different set of amendments into Article 183 that ignored the above mentioned amendment and conflicted with it. That law also enters into force on 1 January 2007, making it difficult to identify which of the two laws should prevail. Currently, there are no formal explanations on this issue, although in practice both taxpayers and the tax officials appear to refer to the Law of 11 December, without any obvious legal ground for this. For the purpose of this Article we disregard this ambiguity and assume that the version adopted under the Law of 11 December is effective. By way of a general summary, the current state of the tax regime applicable to sales by non-resident legal entities of their interests in (i) Kazakhstan resident companies or (ii) non-resident companies deriving more than 50% of their value from Kazakhstani property can be illustrated by the following table: Buyer is a resident (or a PE) Type of Interest Should the buyer withhold? Should the seller register, report and pay? Security NonSecurity Buyer is a non-resident Security NonSecurity No Yes No No Taxation by Withholding According to the Kazakhstan Tax Code, the withholding procedure applies to any taxable sale, where the buyer is either a Kazakhstan resident legal entity or a permanent establishment (“PE”) of a non-resident and the disposed share is NOT represented by a security (e.g. an interest in a Kazakhstan LLP). If the transaction is taxable by way of withholding, then the purchaser will be considered a tax agent for Kazakhstan tax purposes, and responsible for calculating, withholding, paying and reporting with respect to any capital gain. However, in order to ensure that the purchaser is able to calculate the gain, the seller would need to provide the purchaser with documentation confirming the tax basis (acquisition cost) that it has in the disposed share. Yes No Yes No A sale where both parties are non-residents and the transferred interest is not a security is a grey area. Even when such sales give rise to Kazakhstan source income, there appears to be no clear mechanism for either party to report and pay the tax. The capital gain on a sale of an equity interest may potentially be exempt in Kazakhstan either under domestic tax law or by virtue of a double tax treaty. Tax Code Exemptions The Tax Code provides full exemption from capital gains tax in Kazakhstan if the gain is derived from sale of shares through an open sale at a stock exchange, provided that the shares are admitted to the highest or second highest listing category at such stock exchange at the time of sale. The current wording is broad enough to cover both the Kazakhstan Stock Exchange and foreign exchanges. However, according to some officials, the original intention was to grant an exemption only with respect  Self-compliance Procedure If the interest is represented by securities (e.g. shares in a Kazakhstan joint stock company or a foreign company), then under the Tax Code, the withholding procedure does not apply. If a non-resident disposes of Kazakh or foreign shares in a to the Kazakhstan Stock Exchange trading and this may be rectified in next year’s amendments. In any case, the “open trading” condition makes the exemption virtually impossible to use for structuring private acquisitions. Protection available under Double Tax Treaties (“DTT”) If the seller is a resident of a country with which Kazakhstan has an effective DTT, the disposal may be exempt from Kazakhstan income tax. Most DTTs would protect any sale of shares from Kazakhstan taxation where the assets of the disposed company do not principally consist (directly or indirectly) of real/immoveable property situated in Kazakhstan. In most cases this exemption is quite difficult to apply, in particular for acquisitions involving subsurface users and real estate development companies. Real estate development companies will clearly be seen to have Kazakhstan real property as their principal assets. As regards subsurface users, although subsurface use rights do not constitute real property under Kazakhstan civil law, most DTTs have a broader definition of real property that appears to cover such rights, though certain treaties may also contain an exemption. There are, however, a few DTTs that exempt residents of those countries from any Kazakhstan capital gain tax on share sales, regardless of the nature of the underlying business assets. Businesses structuring their investments through such jurisdictions may significantly reduce their Kazakhstan tax bill at exit. Another transaction category that requires government preapproval consists of transactions directly or indirectly involving entities holding subsoil use rights. In this case the state’s rights are much broader and under Subsoil Use Law include the priority right to acquire any disposed interest if a deal results in: • a contractor transferring its subsoil use right to any other entity; • the transfer of shares (participatory interest) in a legal entity that holds subsoil rights; or • the transfer of shares or interest in a legal entity (Kazakh or foreign) that can determine or influence (directly or indirectly) decisions of the subsurface user. In addition to the pre-emption right, in certain circumstances the government has the right to prevent any transfer of subsurface use rights or interest in an entity holding subsurface use rights by simply refusing to provide its consent to the transfer (without exercising the priority right) if it considers that the transferee would be unable to perform the contractual obligations or the transfer may jeopardize national security. It is worth noting that unlike competition laws, the restrictions on the transfer of subsurface use rights do not have any deminimis exemptions. For example, the “priority right” provision appears to be worded broadly enough to cover a transfer involving any degree of influence rather than actual control. Moreover, there is no exception for intra-group transfers or publicly traded shares. The broad character of the above laws has significnat implications both for the marketability of Kazakh assets, and the practical enforcement of taxation on offshore sales It will be clear from this article that the tax legislation related to mergers and acquisitions in Kazakhstan continues to evolve, and that at present there are significant uncertainties in some key areas of the legislation. Nonetheless, the types of changes that have happened recently show a real attempt on the part of the authorities to address Kazakhstan’s rapid integration into the worldwide economy. Governmental Approvals and Pre-emption Right In certain cases the acquirer should seek the consent or approval for the deal from various state authorities. One of the widespread types of deals that may be subject to additional scrutiny include transactions resulting in “economic concentration” under antitrust regulations (the Law “On Competition and Restrictions on Monopolistic Activities”, dated 07/06/2006). The scope of the regulations is quite wide and covers many transactions that, on the face of them, do not result in any market domination or otherwise appear to constitute a threat to competitive market. Taking into account significant penalties for non-compliance, its possible relevance should always be examined. Contract Stability and Creeping Expropriation Jean-Francois Wen Associate Professor, Department of Economics, University of Calgary, Canada The inability to guarantee that the terms of a production sharing contract (PSC) will remain more or less constant over the lifetime of a petroleum or minerals project is a problem for both the foreign oil companies and for the host governments. Specifically, a higher discount rate is applied in determining the economic viability of an investment, if an eventual deterioration in the fiscal terms is a serious concern; and this means potentially less foreign investment into a country. On the other hand, changes in income tax rates, VAT rates, customs duties, and environmental regulations are normal events reflecting budgetary needs, citizen preferences, and technological changes. It is neither constitutionally possible, nor economically desirable, to constrain governments from raising tax rates or strengthening environmental regulations, when such policies are the considered decisions of governments. The problem of “creeping expropriation” lies at the intersection of the investor’s need for contract stability and the government’s need for fiscal flexibility. Creeping expropriation refers to a gradual whittling away of the economic benefits of a project mainly as a result of tax increases and more stringent regulations. This raises important questions about what really constitutes creeping expropriation, when it is more likely to occur, and what might be done to protect investors. This note simply touches upon these questions.  A new tax or tax increase may be labeled as creeping expropriation if it is introduced to exploit financially the irreversible investments of a specific industry or a specific type of investor. A tax change that applies across-the-board to all sectors of a reasonably diversified economy should not be described as a form of creeping expropriation; nor should occasional changes in safety and environmental protection laws in the petroleum and minerals sectors, since such policies presumably reflect updates in international best practices, rather than public finance considerations.1 While it is true that petroleum and minerals investments are large and long-term, investors in any industry, including small investors in projects with short horizons, lose profits as a result of tax hikes or tougher regulations; thus there seems little reason to except production sharing contracts (PSC) from general changes in fiscal policy. On the other hand, changes in legislation that burden mainly one or a few industries are opportunistic actions and are examples of creeping expropriation, unless they exclude pre-existing investments. Examples of this in the OECD are the UK renegotiation of license terms and a new form of petroleum taxation for North Sea oil in the 1970s, and the decision of the US House of Representatives in 2006 to renegotiate Gulf of Mexico petroleum leases granted between 1998 and 1999.2 In Canada, the government of Alberta is expected to announce in 2007 higher royalty rates on its oil sands production; it remains to be seen if the changes will exempt investments previously undertaken. Examples outside the OECD are common. For instance, mining companies in Peru had their tax incentives revoked in 2000. In 2003, petroleum investments in Argentina were adversely impacted by new gas price legislation and a 20% export duty, while royalty rates nearly doubled in Venezuela. Creeping expropriation can also take subtle forms. For example, in Mongolia some provincial administrators have usurped legally granted mining right by reclassifying the land as agricultural.3 Contract stability clauses in production sharing contracts are frequently used to provide investors with some protection against adverse policy changes. Attempts to “freeze” the terms of a contract have given way in the past two decades to a more flexible “balance of interests” approach to contract stability. This approach recognizes both the necessity for ongoing fiscal policy decisions of governments and the need to minimize political risks for investors, as discussed above. The balance of interests approach is based on the possibility of renegotiations that are undertaken in good faith when economic circumstances change. For example, the host government might compensate an oil company for a corporation income tax increase with realignment of profit oil shares. In this vein, the PSC of Mozambique states that, if there is any alteration in law or regulation that results in an “adverse change of a material character to the economic value derived from petroleum operations by the contractor,” the contractor can request a meeting with the government to agree on changes to the PSC to restore the original economic benefits. Similarly, in Kazakhstan, the Tax Code states that the contractor and the government may make changes in the PSC “needed to restore the economic interests of the parties” in the event of alterations in the law. The legal bite of these clauses has been questioned by analysts, since the clauses are unclear as to what happens if the parties cannot agree on what constitutes an economic balance. There is little legal experience with the balance of interest approach to stability clauses. However, the 2004 case of Republic of Ecuador versus Occidental, an oil company, provides some insights. Occidental claimed that the host government’s refusal to refund VAT payments on local purchases and imports made in connection with its export activities constituted an expropriation. The company’s PSC contained clauses to make corrections if tax changes had an impact on the “economy” of the contract and if there was an unforeseen modification in the tax regime. The arbitration tribunal ruled that no expropriation had occurred because the deprivation did not affect a significant part of the investment. At the same time, the tribunal explicitly recognized that, when there is evidence that the parties explicitly discussed how VAT payments would be treated during their negotiations, as had apparently been the case with Occidental, then taxes can have the effect of partially expropriating property, even if there is no transfer of title to a property. This case of a “balance of interests” is relatively straightforward, however, since the potential damages are clearly the unrefunded VAT credits. The value of a “balance of interest” approach to mitigating creeping expropriation may lie principally in its use as a declaration by host governments that they recognize the value of private sector consultation and cooperation in making important changes to fiscal policies. The approach can be viewed in some ways as bringing the host governments a step closer to the policy perspective of countries such as Norway, U.K., Australia, USA, and Canada, where investor confidence in the petroleum and minerals sectors lies entirely in the reputation of the governments (including their bureaucracies) to deal more or less fairly with investors, while preserving the discretionary power of the governments to set policy. Thus, while Kazakhstan weakened its stability guarantees in the various Tax Codes adopted since 1995, it has at the same time strengthened its reputation by excluding pre-existing projects from two new taxes introduced in 2003 (on windfall profits and crude oil exports). If the balance of interests approach to contract stability probably affords investors with less protection than the previous generation of stability clauses, what precautions can investors take to avoid or at least anticipate political uncertainty? There are certain warning signs of danger. If a developing country is excessively dependent on the petroleum or minerals sector for public revenues, then there will likely be irresistible popular pressure to unilaterally raise taxes or royalties when oil prices are high. If the PSC refers to a separate Tax Code for determining the hydrocarbon income tax rate and the royalty rates, as in Madagascar, then the investor must be wary of subsequent legislation to increase the rates. Moreover, the more companies there are in the industry, the more tempting it will be to increase the tax and royalty rates. In some countries, such as Libya the national oil company pays the income tax and royalty on behalf of the contractor as part of the PSC, thus insulating the contractor from tax changes. In Azerbaijan, the national oil company indemnifies the contractor against amendments in laws via adjustments in profit oil shares. Where a national oil company does not exist, it would appear more difficult for the investor to obtain protection. In that case, it seems wise to negotiate profit oil shares that are relatively favorable to the government on the “higher” tranches of production, and obtaining in exchange a relatively favorable share of profit oil on the “lower” tranches of production. In this way, there is some reduction in both the political and economic risks of the project for the investor, even if the contractor share is diminished in the “happy” event that a large deposit is found. 1. Less clear are cases where governments use environmental regulations to issue fines. For example, Tengizchevroil was fined around $75m for ecological damage in Kazakhstan in 2001. 2. See Peter D. Cameron, Stabilisation of Investment Contracts and Changes of Rules in Host Countries: Tools for Oil & Gas Investors, Final Report for the Association of International Petroleum Negotiators, July 5, 2006. 3. US Department of State, 2005 Investment Climate Statement – Mongolia, http://www.state.gov/e/eeb/ifd/2005/42091.htm.  Is VAT the Best Way to Impose a General Consumption Tax in Developing Countries? Richard M. Bird, Program Advisor, ITIC; Professor, Joseph L. Rotman Centre for Management, University of Toronto and Pierre-Pascal Gendron, Professor, The Business School, Humber College Institute of Technology & Advanced Learning, Toronto, Canada Ukraine’s VAT has thus clearly become less efficient as a A CASE STUDY: UKRAINE As in many developing and transitional countries, VAT has become the workhorse of the revenue system in Ukraine.1 How well VAT works is a critical determinant of the performance of Ukraine’s entire fiscal system. As Table 1 shows, however, Ukraine’s VAT is in trouble. Revenue has declined relative to GDP, VAT’s “collection efficiency” has also declined, and the “VAT gap” (see below) remains large. Table 1: Ukraine’s VAT is in trouble Year VAT as % of GDP VAT on imports as % of GDP VAT on domestic goods as % of GDP 5.7 5.4 3.8 3.3 3.0 1.2 1.4 VAT productivity (VAT as % of GDP) /20 .36 .32 .28 .26 .30 .24 .25 revenue producer. A commonly used, though crude, measure of VAT “revenue efficiency” is simply to take the VAT share of GDP and divide by the standard rate of VAT (20% in Ukraine throughout this period). The number that results from this calculation depicts the percentage of GDP collected by each percentage point of the standard VAT rate. As Table 1 shows, this number has declined sharply in Ukraine since a “modern” VAT was introduced in 1998, with a particularly marked decline in 2003 and 2004. Although Ukraine’s VAT “productivity” for this period (0.30) is not unusually low by international standards, the marked and continuous decline in the VAT productivity that has occurred in Ukraine in recent years is striking.6 Something is clearly wrong in a country when both income and trade increase, but VAT efficiency declines. 1998 1999 2000 2001 2002 2003 2004 7.3 6.4 5.6 5.1 6.0 4.7 4.9 1.6 1.0 1.8 1.8 3.0 3.5 3.5 Source: Bird, Richard M., “VAT in Ukraine: An Interim Report”, cited in footnote 1. The revenue yield of VAT as a share of GDP has declined steadily since the tax came into full effect in Ukraine in the late 1990s.2 Such a prolonged decline in the VAT yield is both unusual and disturbing. As a rule, the VAT yield rises when GDP grows.3 In Ukraine, however, although real GDP rose by 49% from 1998 to 2004, the VAT-to-GDP ratio actually fell by 33%. Normally, a general consumption tax such as VAT should grow at least at the same rate as GDP: its GDP-elasticity should be approximately 1. But in Ukraine, the arc GDP-elasticity of VAT from 1999 to 2004 was an incredibly low 0.38. In other words, for every UAH 1,000 of additional GDP generated over this period, the VAT revenue rose by only UAH 42.4 The revenue performance of Ukraine’s VAT leaves much to be desired. Another striking fact is that the share of VAT collected at the border in Ukraine rose from less than a quarter of total VAT revenues in 1998 to almost three quarters in 2004. The other side of this growing dependence of VAT on imports is that the VAT collected on domestic consumption in Ukraine fell sharply from 5.7% of GDP in 1998 to only 1.4% in 2004. Of course, any rapid growth in imports such as Ukraine experienced in this period is likely to be reflected in an increase in the share of VAT collected from imports, but it is difficult to think of any other instance in which a country has had such a marked and rapid change in the extent to which it depends on imports for VAT revenue. For example, in 2004 two thirds of the absolute increase in VAT revenues in Ukraine were attributable to increased taxes on imports – even though VAT import revenues actually declined from 6.5% of imports in 2003 to only 3.6% in 2004. In general, increases in imports and increases in total VAT revenues go hand in hand.5 No such relation is apparent in Ukraine: for example, although imports increased by 14% in 2003 and 16% in 2004, VAT revenues as a share of GDP actually declined in these years. Crude calculations may also be made of the size of the “VAT gap” – defined as the difference between the VAT actually collected and that potentially realizable if all consumption were in fact taxed at the stated rate – in Ukraine. To illustrate, if VAT actually taxed all final household consumption at 20%, it would have raised an additional 4.2% of GDP in 2004. The VAT gap calculated this way is thus 46%. This estimate of what has been called the “gross compliance ratio” takes into account both evasion and “erosion” in the form of legal reductions of the tax base through exemptions and zero-rating other than for exports.7 Although a gap of this size is not out of line with that found (by more refined methods) in countries such as Italy and Uruguay, it is much larger than the gap found in countries such as Chile and the United Kingdom which are generally thought to have better VAT administrations.8 A more conservative estimate of the VAT gap may per¬haps come a bit closer to estimating the extent to which the decline in VAT revenues reflects increasing evasion. If VAT productivity as measured in Table 1 had simply remained constant at the 1998 level, Ukraine’s VAT would have raised an additional 1.5% of GDP in 2004. The gap measured this way is about 16%. In other words, if there had been no significant erosion of the VAT base in 2004 compared to 1998 – probably not too bad an assumption in Ukraine – VAT evasion must have increased by at least this amount over this period. (Of course, there was probably a good deal of evasion already in 1998.) There are many problems with such crude numbers, but however one manipulates them, the conclusion seems inescapable: something is rotten in Ukraine’s VAT. Three broad classes of explanations for such poor performance are possible: changes in economic structure, changes in tax structure, and changes in administrative effectiveness. VAT does not (in principle) tax either exports or investment. A rise in GDP attributable to either an export-driven expansion or an investment boom may therefore result in a decline rather than an increase in VAT revenues because input credits (for exports and investment) may build up more quickly than output taxes. From 1998 to 1999, for example, exports as a share of GDP rose by 29.7% in Ukraine, but VAT revenues fell by 11.3% – a result that seems consistent with this story. From 1999 to 2000, however, although exports rose by less (14.9%), VAT revenues fell even more (13.9%) and, from 2000 to 2001, both exports and VAT revenues declined. The explanation for VAT’s poor revenue performance cannot lie in exports.9 Similarly,  investment has not expanded nearly enough since 1998 to account for the observed decline in net VAT revenues. On the whole, Ukraine’s VAT performance cannot be explained by changes in economic structure. Some of the decline in the VAT-to-GDP ratio before 2002 may perhaps reflect base “erosion” in the form of increased exemptions. But no base changes occurred to explain the continued marked decline in 2003 and 2004. In early 2005, some exemptions were eliminated following the change in government, but it seems unlikely that this policy reversal will be sufficient to reverse the trend of declining VAT yields.10 Changes in tax structure cannot explain Ukraine’s VAT performance. The conclusion thus seems inescapable: the major explanation of the VAT’s decline in Ukraine lies in tax administration. There may have been a significant deterioration in the efficiency of VAT administration over this period. But what seems more likely in Ukraine is that VAT administration was never very strong to begin with and that, with time, its inherent weaknesses have been increasingly exploited by the growing private sector. VAT evasion, the size of the underground economy, and corruption are closely linked. A recent study, for example, found a correlation of 0.66 between the estimated level of evasion and the “transparency international” (TI) index of the perception of corruption.11 Of course, nothing is this simple in the policy world. For example, although Ukraine’s corruption index is about the same as in Chile, evasion in the former appears to be more than twice as great as in the latter. Still, when the perceived level of corruption is as high as it is in Ukraine, a high level of tax evasion – about 38% if one simply extrapolated the regressionestimated in the study just mentioned – is only to be expected. Levels of evasion at Ukraine’s levels in all likelihood reflect not just weak administration, but more systematic structural problems such as the prevalence of corruption and a large underground economy. 1. This part draws on Bird, Richard M., “VAT in Ukraine: An Interim Report”, in McGee, R.W. (ed.), Taxation and Public Finance in Transition and Developing Countries (New York: Springer, 2006). 2. Although Ukraine first introduced a VAT in 1991, it was only in 1997 that a modern VAT was introduced which, in principle, frees both investment and exports from VAT. 3. Baunsgaard and Keen, supra note 2. 4. The exchange rate in 2004 was UAH 5.3 = USD 1.00. 5. Baunsgaard and Keen, supra note 2. 6. The conceptually better measures of VAT “efficiency” discussed in 4. are highly correlated in the case of Ukraine. 7. A similar gross compliance figure (45%) for Ukraine was calculated in Gallagher, Mark, “Benchmarking Tax Systems”, 25 Public Administration and Development 125-144 (2005). 8. Data for the countries mentioned may be found in Gebauer, A., C.W. Nam and R. Parsche, “Is the Completion of EU Single Market Hindered by VAT Evasion?”, CESifo Working Paper No. 974, Munich, June 2003; Engel, E., A. Galetovic and C. Raddatz, “Estimación de la evasión del IVA mediante el método de punto fijo”, unpublished paper, Santiago de Chile, April 1998, available at www.sii.cl/aprenda_sobre_impuestos/estudios/ tributarios2.htm; and Coba, P N. Perelmuter and M.P Tedesco, ., . “Evasión fiscal en Uruguay: Un análisis sobre el impuesto al valor agregado”, Mon¬tevideo, no date, available at www.bcu.gub.uy/autoriza/peiees/jor/2005/ iees03j3360805.pdf. 9. As discussed in detail in Bird, supra note 7, this conclusion is especially strong because Ukraine did not, for the most part, refund most of the input VAT accrued on exports in this period. 10. ee World Bank, Ukraine: Tax Policy and Tax Administration (Report No. 26221S UA, World Bank, Kyiv, 2003), showing that there were no significant increases in exemptions in the 1999-2002 period. This report estimated that the cost of the regional VAT concessions (which were eliminated in early 2005) was about 3% of VAT revenues in 2001. Although this cost may have expanded a bit in later years, it seems improbable either that these exemptions account for much of the observed decline in VAT revenues or that their elimination will reverse this trend. 11. he reference is to a study carried out under the auspices of the AFIP T , Argentina’s tax administration; available at www.afip.gov.ar (in 2004, although apparently no longer posted).  Abdulkhamid Muminov, Director, Tax Services, PricewaterhouseCoopers Taxation Azerbaijan Kazakhstan Russia Ukraine Uzbekistan General • Growing economies • Rich in mineral resources • Territorial advantages • Foreign investments – priority • Integration processes General Azerbaijan Territory (sq. km) 2006 GDP (USD Billion) 2006 GDP Growth Population (million) 2006 GDP per capita 2006 Inflation 86,600 14.1 General Kazakhstan 2,724,900 77.3 Russia 17,075,400 1,001.9 Ukraine 603,700 106.1 Uzbekistan 448,900 16.7 GDP Growth Dynamics 35% 30% 25% Azerbaijan Kazakhstan Russia Uzbekistan Ukraine 31% 8.5 1,700 12% 10.6% 15 5,145.9 9% 6.7% 143 7,016.2 9% 7.0% 46.8 2,206.0 11.6% 7.3% 25 669.7 6.8% 20% 15% 10% 5% 0% 2001 2002 2003 2004 2005 2006 General GDP Per Capita Dynamics 8000 7000 6000 5000 4000 3000 2000 1000 0 2001 2002 2003 2004 2005 2006 Azerbaijan Azerbaijan Kazakhstan Kazakhstan Russia Russia Uzbekistan Uzbekistan Ukraine Ukraine General Composition of GDP Services 10% Industry 70% Agriculture 20% Industry 29% Industry 29% Services 43% Agriculture 28% Services 43% Azerbaijan Kazakhstan Agriculture 28% Industry 38% Services 56% Uzbekistan Industry 34% Services 55% Agriculture 6% Russia Agriculture 11% Ukraine 10 Taxes General Taxes Corporate Income Tax Value Added Tax Property Tax Infrastructure Development Tax Revenue taxes (cumulative rates) Taxes Azerbaijan 22% 18% 1% N/A N/A Kazakhstan 30% 14% 1% N/A N/A Russia 24% 18% 2.20% N/A N/A Ukraine 25% 20% N/A N/A N/A Uzbekistan 10% 20% 3.5% 8% 3.2% Individual Taxation Net-to-Gross Ratio – Expatirate Net-to-Gross Ratio – National Azerbaijan 51%-65% 51%-65% Kazakhstan 81%-86% 67.5%-76% Russia 81% 81% Ukraine 78% 78% Uzbekistan 75% 59% Thin Capitalisation Ratio Thin-cap ratio Azerbaijan N/A Kazakhstan 4:1 Russia 3:1 Ukraine N/A Uzbekistan N/A Withholding Taxes Dividends WHT Interest WHT Royalty WHT Azerbaijan 10% 10% 14% Kazakhstan 15% 15% 20% Russia 15% 20% 20% Ukraine 15% 15% 15% Uzbekistan 10% 10% 20% Common Tendency CIT Rate Reduction CIT Rate Dynamics 40 35 30 25 20 15 10 5 0 2001 2002 2003 2004 2005 2006 Azerbaijan Azerbaijan Kazakhstan Kazakhstan Russia Russia Uzbekistan Uzbekistan Ukraine Ukraine VAT Rates Ukraine and Uzbekistan – 20% over the last 6 years Azerbaijan – 18% over the last 6 years Kazakhstan – decreased from 20% in 2001 to 18% in 2006 Russia – decreased from 20% in 2001 to 18% in 2006 Property Tax rates Azerbaijan and Kazakhstan – 1% over the last 6 years. Russia – increased from 2% in 2001 to 2.2% in 2006 Uzbekistan – decreased from 5% in 2001 to 3.5% in 2006 Total Tax Burden: % of profit & Ranking • Azerbaijan – 44.9% & 136 • Kazakhstan – 45% & 66 • Russia – 54.2% & 98 • Ukraine – 60.3% & 174 • Uzbekistan 122.3% & 155 Subsurface Use Kazakhstan • Royalties • Excess profits tax • Rent tax for export • Bonuses Uzbekistan • Royalties • Excise duty Russia According to World Bank research • Mineral resources extraction tax • Export duties • Royalties 11 Transfer Pricing – Qualification Related Parties Azerbaijan Kazakhstan Russia Y Y Y Transfer Pricing – Safe Harbour Related Parties Azerbaijan N N 20% N N Unrelated Parties Y Y Y (cross-border & 20%) Y (generally, only cross-border) N In-Country Y N Y Cross-Border Y Y Y Unrelated Parties N 10% 20% N N/A Kazakhstan Russia Ukraine Uzbekistan Ukraine Y Y (generally, only related parties) Y Y Uzbekistan Y Y Transfer Pricing – Safe Harbour Goods Azerbaijan Rarely applied Double Tax Treaties • Azerbaijan • Kazakhstan • Russia • Ukraine • Uzbekistan 22 37 67 60 41 Services Not actively applied in practice Not actively applied in practice Not actively applied in practice Not actively applied in practice Not actively applied in practice Kazakhstan Very actively applied to selected commodities Actively applied to hydrocarbons Not actively applied in practice Not actively applied in practice Russia Ukraine Uzbekistan CIT Incentives RUSSIA • tax rate reduction by up to 4% by regional authorities for certain categories of taxpayers • application of accelerated depreciation rates (leasing, aggressive environment, reducing balance for certain fixed assets) • one-time deduction of 10% of the value of fixed assets and/or expenses for re-construction, re-equipping, upgrading, technical refurbishing, or partial liquidation of fixed assets • 10-year loss carry forward • exploration expenses are deductible irrespective of the venture’s success (within certain limits) CIT Incentives • KAZAKHSTAN • exemption from CIT for investment projects implemented by new entities (i.e. established within 12 months prior to applying for incentives) and straight-line depreciation for existing entities • 100% rate reduction (exemption) for eligible petrochemical manufacturers • deductibility of double depreciation rates for new fixed assets in the first year of the assets’ operation • 100% rate reduction (exemption) for eligible entities operating in special economic zones • 100% rate reduction (exemption) for eligible entities operating in Aktau sea port 1 CIT Incentives UZBEKISTAN • exemption from all taxes to producer and service companies during the exploration stage for oil & gas projects • reduction of tax rates if produced goods are exported (except for basic minerals and raw materials) • 3 year deduction of expenses on modernization, technical and technological re-equipment of production, repayment of loans taken for these purposes, and leasing income, less annual depreciation Specific CIT Clauses Kazakhstan • capital expenditures deduction not allowed for rented fixed assets Russia • interest deduction is limited to 15% for currency loans and Central Bank x 110% – for rouble loans Ukraine • expenses for car parking and car maintenance are non-deductible. Only 50% of car rental payments, fuel and lubricant expenses may be deducted. • warranty services exceeding 10% of the value of goods under warranty are non-deductible Specific CIT Clauses Uzbekistan • expenses related to non-obligatory audits of financial statements initiated by shareholders are non-deductible • expenses related to maintenance of office vehicles are non-deductible • interest expenses on overdue loans Specific VAT Clauses Azerbaijan • Only VAT paid via bank payment method could be reclaimed from the State Budget, VAT paid on the cash basis is not allowed to be reclaimed • Damaged or stolen goods are subject to VAT • Output VAT is calculated on the accrual method. However, input VAT is calculated on the cash method Kazakhstan • input VAT on the purchase of motor vehicles is capitalised • input VAT on the purchase/construction of houses is capitalised • VAT refund is allowed for entities which have zerorated VAT turnover of at least 70% of gross sales Specific VAT Clauses Ukraine • no input tax credit for passenger cars, except if used as taxi cabs Uzbekistan • input VAT on the purchase of fixed assets is capitalised 1 ComparativeStudy Dmitry Garaev, Tax Manager, Ernst & Young CIS, Mosco Method of Calculating Profit (Loss) from Sale of Goods (Work and Services) Armenia* Taxable profit is the difference between gross income and the deductions allowed under the profits tax law. Income and expenses are accounted for by the accrual method. General Rule for Composition of Deductible Production Expenditures The following are considered as expenses: material expenses; labor costs; obligatory social security payments; insurance payments; irrecoverable taxes; interest on loans, or other borrowings; advertisement expenses; business trip expenses; court expenses; depreciation; auditing, legal, and other advisory information and administrative expenses, etc. All expenditures connected with the receipt of income, except for expenses on capital assets, which must be deducted through depreciation. All expenses connected with the receipt of income are deductible, with the exception of expenses incurred for the acquisition of fixed assets, their installation and other expenses of a capital nature, as well as expenses that are non-deductible according to the Tax Code of Georgia. Composition of Sales Expenditures Packaging, storage, transportation, loading, advertising, etc. Valuation of Inventory Methods of Fixed Assets Depreciation Historic cost; weighted average cost; FIFO; LIFO. Buildings – 20 years; Hotels – 10, Assembly lines, robot equipment – 3; Computers and calculating devices – 1; Other fixed assets – 5. Fixed assets valued less than 50,000 drachmas are to be depreciated within 1 year. Azerbaijan Annual income reduced by all business expenses except for those specially disallowed by the Tax Code. Not specified in the legislation. Presumably includes packaging, storage, transportation, loading, advertising. Not specified in the legislation. Presumably includes packaging, storage, transportation, loading, advertising. Lower of cost or market; FIFO; LIFO; Average. Depreciated by group method on a declining balance basis, using the depreciation rates set by the Government. Georgia Taxable income less deductible expenses. Special identification value; FIFO; LIFO; Average. Depreciated by groups on a declining balance basis, using the annual depreciation rates set by the Tax Code (5%; 8%; 15%; 20%). Special rules for leased assets apply. New Tax Code of Georgia envisages an alternative approach for depreciation deductibility. Namely, in connection with purchased, leased or produced fixed assets a taxpayer is entitled to deduct the cost of purchase (production) of such assets fully, for leasing — the discounted value of lease payments, in the year when fixed assets use started. Such fixed assets are not included in the book value of the groups mentioned above. If the taxpayer employs this alternative method, it is liable to use it in the future for all purchased, produced or leased fixed assets and not entitled to change it within 5 years. Declining balance basis with marginal rates established for four groups of assets (10 – 40%). New classification introduced from 2006. Kazakhstan Income from the sale of goods (work, services) less deductible expenses for production and distribution of goods (work, services). Expenses connected with the receipt of sales income. A list of deductible expenses is not determined by the legislation: under the general rule, only justified expenses can be deducted. Special identification value; FIFO; LIFO; Average. Kyrgyzstan Gross income less expenditures Expenses should be related to receipt of provided by the Tax Code. income. Not defined. Not defined by the Tax Code. Declining-balance method using the depreciation rates set by the Tax Code. 1 ow, Russia CORPORATE PROFITS TAX: DETERMINATION OF TAXABLE PROFIT (LOSS) FROM SALE OF GOODS (WORK AND SERVICES) Deductions Subject to Certain Limitations Non-deductible Items Non-deductible Items Subject to Capitalization Methods of Intangible Assets Amortization The amortization period of intangible assets is specified by the taxpayer on the basis of the possible period of effective use. In case of impossibility to determine the useful life, it is set at 10 years, though not to exceed the period of the taxpayer’s activity. Amortized by group method on a declining balance basis at a rate of 10% per annum (25% for geological surveying & exploration). Amortization is applied on an individual basis in proportion to its limited useful life. In case it is impossible to define their useful rate, then it is amortized at 15% as a separate group on a declining balance basis. Expenses not deductible from gross income, if exceeding the limits specified by the Government: payments above norms for pollution of the environment; advertisement, marketing (market analysis, promotion) outside Armenia; training of staff outside Armenia; expenses for food and uniforms for employees; business trips; representation/hospitality; maintenance of old–age homes, nurseries, leisure and sport institutions; interest above the Central Bank’s rate multiplied by two. Foreign exchange losses and expenses that are not deemed to be connected with the company’s economic activity. Interest penalties and fines, except those arising from a breach of contractual obligations, are not deductible. None. Business trips, interest and repair expenses, therapeutic nourishment, milk and similar products provided to employees. Entertainment and meal expenses and various other expenses that are not deemed to be connected with the company’s economic activity. Repair expenses in excess of certain limits established by legislation. a) Interest expenses: the deduction cannot exceed interest expense calculated at the annual 24% rate; b) Doubtful debts can only be deducted in case they have been previously reflected in gross income and have been written off in accounting records; c) Expenses for scientific research, project design, or experimental design, with the exception of expenditures for the acquisition of fixed assets, their installation, and other outlays of a capital nature. d) Representative expenses can be deducted in the amount of 1% of an entity’s economic revenues excluding VAT; e) Charitable expenses: the deduction cannot exceed 8% of difference between gross income and deductible expenses, excluding charity; f) Depreciation charges for fixed assets used in economic activity are deductible only in accordance with the rates and conditions set forth by the Tax Code. g) Fixed asset repair expenses are only deductible in the amount of 5% of the balance of the corresponding group of fixed assets at the end of the year. h) Expenditures on geological surveying and work for preparation of extraction of natural resources (should be capitalized and depreciated). Interest on loans, deposits, debt instruments, leasing payments; reimbursement of business trip expenses and representation expenses; social payments; expenses for education of Kazakh staff incurred by subsoil users; repair of fixed assets. Significant non-deductible expenses include expenses related to “non-economic” activity, (e.g. social expenses, charity expenses (above specified limit) or contributions to non-profit funds); entertainment expenses ; expenses related to receipt of income exempted from profit or income tax; profit tax or income tax paid in and outside of Georgia, as well as interest and fines paid or payable to the budget. Major repair expenses (not current repair expenses) in excess of 5% of the net book value of the asset category to which the repairs were made. Declining balance basis with the rate not to exceed 15%. 1) expenses not relating to the receipt of aggregate annual income; 2) expenses for operations with a taxpayer recognised by a court as a fictitious company; 3) expenses for operations with an inactive legal entity that has been conditionally removed from the state register of taxpayers of the Republic of Kazakhstan; 4) expenses for the construction and purchase of tangible assets, intangible assets and other taxpayers’ expenses of a capital nature, which are not associated with the receipt of aggregate annual income; 5) fines and interest subject to payment (already paid) to the state budget; 6) expenses relating to the receipt of aggregate annual income, which exceed the limits established for deductions by the Code; 7) obligatory payments to the budget, which are subject to payment (paid) in excess of the provisions established by normative legal acts of the Republic of Kazakhstan; 8) expenses relating to the construction, exploitation or maintenance of facilities not used in entrepreneurial activities; 9) the value of transferred property, performed work or services provided by a taxpayer free of charge 10) the amount of an additional payment made by a subsurface user engaging in activities under a production sharing contract. Expenditures unrelated to commercial activity. Repair expenses exceeding established limits; interest for loans received for construction; expenses for geological study and preparatory works incurred by subsoil users. Declining-balance method using Interest, repair and business trip expenses. an amortization rate of 25%. Expenses related to geological studies and works prior to exploration of mineral resources. Acquisition or construction of fixed assets, expenditures on extensions and further equipping (15% of these expenditures can be deducted immediately). 1 ComparativeStudy Dmitry Garaev, Tax Manager, Ernst & Young CIS, Mosco Russia Revenues from sales of goods (work, services) less VAT, excise duties, customs duties, sales tax and expenditures. Expenses are deductible for profits tax purposes if economically justified and documented. The Tax Code provides an open list of expenses which are deductible for tax purposes. For expenses incurred in Russia, documents adhering to Russian statutory documentation standards must exist. Packaging, storage, delivery, loading, many advertising expenses, consulting or similar services, management services, legal services, etc. Historic cost; weighted average historic cost; FIFO; LIFO. Ten groups of depreciable assets are established for depreciation purposes depending on the useful life. Only the straight-line method may be used for buildings, installations, transmission devices with a useful life over 20 years (groups 8-10). Both straight-line and reducing balance methods may be used for other assets. Starting from 2007 taxpayers are allowed to deduct immediately a depreciation of 10% of their capital expenditure. Linear method, annual rates from 7 to 20 % depending on the group. Accelerated depreciation is allowed, using a multiplying ratio not exceeding 2 to annual rates, for fixed assets put into use after December 31, 2004. The method of depreciation and depreciation rates are established by the Government. Straight line method, using the depreciation rates set by the Tax Code; and production method. Tajikistan Total income less deductions provided in Tajik legislation. Deduction of the expenses determined in the Tax Code (a list of expenses). Expenses are deductible if appropriately documented, aimed at receiving income and are related to the company’s business activity. Not defined. Average cost; FIFO; LIFO. Lower of cost or market adjustment allowed. Average cost; FIFO; LIFO. Historic cost; FIFO; average cost. Turkmenistan Sales revenue less VAT, cus- toms duties and expenditures determined in the Tax Code. Expenditures related to a company’s activities Not defined. aimed at receiving income. The Tax Code provides an open list of deductible expenses. Expenditures related to a company’s business Transportation, insuractivities and set in the Cost of Production ance, storage, advertising, and certain other regulations. expenses stipulated in the Cost of Production regulations. All reasonable business expenses are generally deductible, with the exception of those explicitly disallowed or restricted by law. Sales-related costs are deductible except for those specifically disallowed. Uzbekistan Sales revenue (net of VAT and excise) less expenditures on production and sales in connection with the generation of revenues. Ukraine Gross income less deductible expenses and depreciation. Historic cost; average cost; FIFO; LIFO; normative losses method. Declining balance method, four groups of depreciation, buildings – 2% annual, office equipment – 10% annual, computers – 6% annual, other equipment – 15%. 1 ow, Russia CORPORATE PROFITS TAX: DETERMINATION OF TAXABLE PROFIT (LOSS) FROM SALE OF GOODS (WORK AND SERVICES) Continued Deductibility of representational expenses is limited to 4% of payroll Contributions to charter capital; penalties, fines and sancexpenses. Advertising expenses are deductible in full except for gifts tions payable to statutory funds, etc. Interest deductible and prizes. is limited to 15% per annum for foreign currency loans and 110% of the Central Bank rate for rouble loans. Other interest deductibility limitations exist with respect to shareholder loans. R&D expenses are not subject to limitation starting 2007. Acquisition or construction of fixed assets; expenditures on extensions, further equipping, modernization and reconstruction works. Linear method, default rate is 10%. Linear method, annual rate is 10%. Expenses connected with the development and extraction of natural resources, the acquisition of licences and others are amortized at 15%. Interest on loans and leasing interest (<300% of the National Bank rate and 50% of profit plus interest yield when thinly capitalized), insurance premium payments, R&D, fixed asset repair payments, charity. Deduction of representational expenses is prohibited. Income tax paid in Tajikistan or other states, fines and interest paid to the budget, minimal income tax. Any expense not connected with “economic activity” and not appropriately documented. Asset repair expenses in excess of 10% of the net book value of assets at the end of the fiscal year. Representation expenses, business trip expenses and insurance The method of amortization reserves for insurance companies. and amortization rates are established by the Government. Voluntary insurance expenses; representation expenses; business Straight line method over useful life. Where useful life cannot trip expenses; charitable contributions; etc. be determined – over 5 years; and production method. Material assistance, some kinds of compensation that exceed norms set by the Government, loans, dividends, the value of goods transferred free-of-charge. Litigation costs, losses fro fixed assets disposal (used less than 3 years), interest and fines. Expenses related to the acquisition of fixed assets and intangible assets. Construction and reconstruction works; start-up costs for subsurface users. Linear method, not to exceed 10% annually. Deductibility of advertising and representation expenses is limited to 2% of taxable profit for the previous year. Repair expenses may not exceed 10% of the overall book value of fixed assets; warranty expenses – 10% of the value of goods; lease expenses and automobile fuel – 50% of the relevant expenses; expenses on training employees – 3% of the annual payroll expenses; fees for membership in employers’ organizations – 0.2% of the annual payroll expenses. Contractual interest and fines, interest on a loan extended by a foreign owner holding 50% or more, payments to non-residents in offshore locations, reinsurance payments paid to non-residents. Acquisition or construction of assets designated for use for more than one year whose value exceeds $198. Expenses for repairs of fixed assets, exceeding 10% of the overall book value of all fixed assets groups. * Due to the lack of official information regarding amendments effective on January 1, 2007 we provide information effective in 2006 1 ComparativeStudy Dmitry Garaev, Tax Manager, Ernst & Young CIS, Mosco Tax Payers Object of Taxation (Taxable Profit/ Income) Residents are taxed on profits derived both in Armenia and abroad, while nonresidents are taxed only on profits from Armenian sources. Taxable profit is revenue less deductions provided by the Law Concerning Profits Tax. Gross Profit/ Income Composition Revenue from sales of goods and services; revenue from sales of fixed and other assets; interest; lease payments; royalties; dividends; insurance payments; bad debts, as well as bad debt provisions in accordance with the procedure established by the authorized body of the Government, assets received free-ofcharge, excluding tax exemptions. Trading profit (losses); Capital gains (capital losses can be offset against total income); Profits from financial activities; Other profits. Trading profit (losses); Capital gains (capital losses can be offset against capital gains only. Capital losses in excess of capital gains cannot be deducted against other income); Profits from financial activities; Profit earned from sales of common stocks or shares of a partner of a resident legal person; Profit earned from sales of property, other profits and benefits. Profit (loss) from the sale of goods (work, services), capital gain from the realization of buildings, constructions (with the exception of oil and gas wells, and transmission devices) and assets not subject to depreciation, dividends, interest, other income less corresponding expenses, that are linked with receipt of such income. Adjustments (Deductions) to Gross Profit (Income) Types of Income Taxed According to Special Rules For foreign legal entities: insurance compensation, reinsurance payments and income received from freight are taxed at a 5% rate; dividends, interest, royalties, rental income etc. are taxed at a 10% rate. Profits tax payable by an organizer of a free economic zone in accordance with the customs low is reduced by 100%. Profits tax payable by an operator of a free economic zone is reduced by 100% if at least 90% of its revenues comprise revenue from export sales. Armenia* Both residents and non- residents pay profit tax in Armenia. Entities are deemed to be residents if they are registered with the state (i.e. established) in Armenia. Non-residents are entities registered in a different country. Budgetary appropriations and revenues transferred to the budget by state-owned entities, state bodies of self-administration and state non-for-profit organizations are not subject to tax. The Central Bank of Armenia is not a taxpayer. Azerbaijan Enterprises carrying on activi- ties in Azerbaijan, including enterprises with foreign investment and foreign legal entities operating through a permanent establishment. Gross worldwide income (for Azerbaijani legal entities) or profits earned through a permanent establishment (for foreign legal entities) adjusted for certain items. None Georgia Georgian enterprises and for- Gross income less relevant eign enterprises, carrying out deductions granted under activities through a permanent the Tax Code. establishment in Georgia and/or generating income from sources in Georgia. Profit received as a result of oil and gas transactions based on the “existing contract” defined under the law of Georgia “On Oil and Gas” is subject to taxation at the rate of 10%, if the contract was signed before January 1, 1998. Dividends and interest are subject to taxation at the rate of 10% at the source of payment. Kazakhstan Insurance and reinsurance companies. Foreign legal entities earning profit from a Kazakh source of income, not giving rise to a permanent establishment. Residents: worldwide income adjusted for deductible items. Non-residents: income received through a permanent establishment adjusted for deductible items. Income in the form of insurance premiums subject to receipt (received) from insured and reinsured persons during a tax period under insurance agreements, decreased by the amount of insurance preNot applicable. miums refunded following the annulment of insurance Not applicable. (reinsurance) agreements, and also by the amount of insurance premiums paid under reinsurance agreements, and obligatory contributions to the Fund for the guarantee of insurance payments. Income from a source in Kazakhstan without any deductions. Adjustments to Aggregate Annual Income The following is excluded from the aggregate annual income of a taxpayer: 1) dividends; 2) dividends, interest on debt securities purchased at a special trading floor of the regional financial centre for the city of Almaty; 3) the value of personal shares in excess of their nominal value, which is received by the issuer through share distribution and capital gain following the realisation of personal shares by the issuer; 4) income from a capital gain following an open trade realisation of shares and bonds on the stock exchange, which were in the highest and second highest official stock exchange listing categories on the day of sale; 5) capital gains following the realisation of debt securities permitted on a special trading floor of the regional financial centre for the city of Almaty, in the event civil and legal transactions have been concluded with them on the relevant trading floor; 6) income from transactions with state securities and agency bonds; 7) the value of property acquired in the form of humanitarian aid and used as intended for emergency relief during natural or man-made disasters; 8) the value of tangible assets acquired free of charge by a state company from a state body or republican state enterprise on the basis of a republican decision made by the Government of the Republic of Kazakhstan; 9) investment income, obtained in accordance with legislation of the Republic of Kazakhstan concerning the provision of pensions and paid into individual pension accounts; 10) income from the assignment of a claim to a debt, which is received by a special financial company with respect to securitisation transaction in accordance with legislation of the Republic of Kazakhstan on securitisation; 11) investment income received in accordance with legislation of the Republic of Kazakhstan concerning obligatory social insurance and used to increase the assets of the State Fund for Social Insurance; 12) investment income received by unit and joint stock investment funds in accordance with legislation of the Republic of Kazakhstan concerning investment funds in accounts in custodian banks and investment income in them; 13) income received by a legal entity participant of the regional financial centre for the city of Almaty from the provision of financial services. A list of the financial services indicated in this subpoint should be determined by the Government of the Republic of Kazakhstan; 14) the value of property legalised in accordance with a legislative act of the Republic of Kazakhstan on an amnesty in connection with the legalisation of property. Not applicable. Not applicable. 1 ow, Russia CORPORATE PROFITS TAX: DETERMINATION OF TAXABLE PROFIT to Arrive at Taxable Profit (Income) Deductible Reserves Contributions to a bad debt reserve in accordance with the rates set by the legislation. Basic Tax Rate Tax Exemptions Years of Loss Carryforward (Back) Not defined. 20% Tax Credits For foreign investors with a participation of at least Armenian Drachma 500 mln.: 100% exemption from profit tax during the first two years of investment; 50% reduction in profit tax from the third year to the year defined by the law, however not later than until 2009, after the initial investment (from 2003 and until 2007 only the 2-year 100% exemption will be granted). Legal entities are exempted from tax if income received from the sale of agricultural products exceeds 90% of total income. Profit (income) taxes paid in foreign countries may be credited against Armenian tax imposed on the same income, limited to the amount of Armenian tax on the income. Any excess credit may be carried forward to the next year’s profit tax calculation. None for non-insurance companies. Insurance proceeds, except for any amount that covers a deductible loss. 3 (0) 22% Tax withheld on dividends from other Azerbaijani enterprises. Foreign income tax may be credited against Azerbaijani tax imposed on the same income, limited to the amount of such Azerbaijani tax. Foreign income or profits tax may be credited against Georgian tax assessed for that income or profit, limited to the amount of such Georgian tax. None for non-banking and noninsurance companies. Profit of budgetary, international and charitable organizations, except for profit from economic activity. Grants, membership fees and donations received by an organization. Portion of profit of medical establishments (despite its organizational and legal form) received from medical activities which has been reinvested (rehabilitation of the establishment, provision for technical base) and used for the purposes of employee material incentives. 5 (0) 20%. See also Types of Income Taxed According to Special Rules. Dividends paid by the Georgian enterprise to a physical person or a foreign enterprise are subject to income tax withholding of 10%. Interest paid by a permanent establishment of a non-resident or by a resident, or on its behalf, is subject to taxation at the source of payment at the rate of 10%, if the source of payment is in Georgia. 30%. Permanent establishments of foreign legal entities (except for those having an actual place of management in Kazakhstan) are subject to net income tax at 15%. Banks and organizations engaging in certain types of banking transactions are entitled to deduct provisions (reserves) against the following types of doubtful or bad assets, conditional liabilities, with the exception of certain assets. A subsurface user are entitled to deduct any amounts transferred to funds for the liquidation of the consequences of the development of a deposit (reserve fund) and which are related to the conclusion of subsurface use operations at the deposit in question. Not applicable. Not applicable. “Losses from commercial activities – 3 years, losses from subsoil use contracts – 7 years. Investment tax concessions – exemption from certain taxes or Losses of a special provision of a right to additional deductions from the aggregate financial company annual income. Investment tax concessions are granted on cor- that are received from porate income tax, land tax and property tax. activities performed in accordance with legislaSpecial economic zones: organizations engaging in activities in tion of the Republic of the territories of special economic zones are exempt from corKazakhstan on securitiporate income tax, land tax and property tax. Turnover from sale zation could be carried of certain goods (services, works) on the territories of special forward for the period of economic zones is exempt from value added tax. circulation of the bonds securing a specific Not applicable. asset. No carry back losses.” 1) payments associated with the supply of goods in accordance with foreign trade transactions in the territory of the Republic of Not applicable. Kazakhstan; 2) income from the provision of services associated with opening and maintaining resident correspondent bank Not applicable. accounts and making settlements on them, and also settlements made by means of international payment cards; 3) income relating to capital gains from the realisation of securities; 4) income from transactions involving state securities and agency bonds; 4–1) dividends, interest on debt securities purchased on a special trading floor of the regional financial centre for the city of Almaty. 5) payments associated with an adjustment for the quality of the realisation value of crude oil transported through a single pipeline system to outside the Republic of Kazakhstan; 6) the amounts of cumulated (accrued) interest on debt securities, paid by resident buyers to non-residents upon purchase; 7) interest from the conditional bank deposits of a non-resident; 8) income from a transfer of tangible assets to financial lease under international financial lease agreements. Income from state securities; receipts from leasing of fixed assets (for three and more years with consequent transfer of assets to the lessee). 4% for non-cumulative insurance; 2% for cumulaNot applicable. tive insurance (reinsurance) with the exception of Not applicable. annuity insurance; 1% for annuity insurance. Income from other activities – in accordance with the general rule. From 5 to 20% at the source of payment. Foreign income tax may be credited against Kazakh tax imposed on the same income, limited to the amount of such Kazakh tax. Tax withheld at the source of payment of fees and gains can be credited against corporate tax of the recipient of such proceeds. 1 ComparativeStudy Dmitry Garaev, Tax Manager, Ernst & Young CIS, Mosco Tax Payers Object of Taxation (Taxable Profit/ Income) Worldwide profits (for Kyrgyz legal entities) or profits earned through a permanent establishment (for foreign legal entities). Gross Profit/ Income Composition Profit (loss) from the sale of goods (work, services), fixed assets, capital gains, income from non-sale operations. Adjustments (Deductions) to Gross Profit (Income) Types of Income Taxed According to Special Rules Income received by legal entities with foreign participation is taxed in accordance with the Foreign Investment Law. Interest paid to legal entities (except to Kyrgyz banks) is taxed at the source of payment. Kyrgyzstan Kyrgyz legal entities and foreign legal entities operating through a permanent establishment and earning profit from a Kyrgyz source of income. Russia Russian legal entities and Gross income of the entity foreign legal entities operating reduced by economically justified and documented through permanent establishments and (or) receiving expenses. income from Russian sources. Profits (losses) from the sale of goods (work, services), fixed assets and other property, income from non-sale operations. Income from a share participation (dividends from Russian organizations by Russian organizations – 9%, from Russian organizations by foreign organizations (or vice versa) – 15%) ; income from fiduciary management of assets; income from a participation in simple partnerships; interest on State and municipal securities (15%, 9% and 0% for operations involving particular types of debt obligations); profits from production sharing agreements. Tajikistan Resident and foreign enterprises. Income of the taxpayer defined as total income less allowed deductions (with reference to the list provided in Chapter 19 of the Tajik Tax Code). Foreign legal entities pay tax on profits earned by permanent establishments and gross Tajik source income. All kinds of income except those not subject to income tax, including income received from economic activity which is not contracting work (interest, dividends, royalty, leasing fees); any other income. Income includes all receipts leading to an increase in a taxpayer’s net assets. Profit (losses) from the sale of goods (work and services) and non-sale income. Payments executed by residents in favour of non-residents are taxable at the source of payment at the following rates: dividends, interest – 12 %; risk insurance payments and repayments, international telecommunication and transport service fees – 4%; freight – 6%; royalty from the sale of assets, income from lease of assets, insurance premium, fees for management, financial, transportation, insurance services and other income paid by residents – 15%. Turkmenistan Turkmen legal entities and foreign legal entities operating through a permanent establishment or receiving income from Turkmen sources. Worldwide profits (for Turkmen legal entities) or profits earned through a permanent establishment and/or received from Turkmen sources (for foreign legal entities). Worldwide income (for Uzbek legal entities) or profits earned through a permanent establishment (for foreign legal entities). Dividends paid by Turkmen companies are taxed at 15%. Uzbekistan Uzbek legal entities and for- eign legal entities operating through a permanent establishment. Profit (losses) from the sale of goods (work, services); capital gains (certain capital losses are not deductible); income from non-sale operations. Dividends and interest paid to legal entities (except Uzbek banks) are taxed at the source of payment. Interest on State securities is tax exempt. Profits from production sharing agreements are taxed according to relevant PSAs. Ukraine Ukrainian legal entities and foreign legal entities operating through permanent establishments and (or) deriving income from Ukrainian sources. Ukrainian entities are taxed on income derived both in Ukraine and abroad, while foreign entities are taxed only on income from Ukrainian sources. Adjusted gross income less deductible expenses and depreciation. Income of foreign entities: income from freight – 6%; income from advertising in Ukraine– 20%; capital gains from interest-free bonds and treasury bills – 25%; income on Ukrainian state securities issued abroad–0%. Dividend, interest, royalties and certain other kinds of income derived by non-residents from Ukraine are subject to withholding tax at the rate of 15 % of the income payable. Witholding tax rate can be reduced or the withholding tax may be eliminated by virtue of the respective Double Tax Treaty. Income of Ukrainian legal entities: dividends recieved from foreign entities – 25%; insurance and reinsurance– 0%/3%. Ukrainian dividend paying company should accrue the advance corporate tax at the rate of 25 % of the total dividend amount payable and remit it to the state budget prior to or at the moment of dividend payment. The advance corporate tax is paid at the account of the dividend paying company and may be credit against its current corporate profits tax payable. 0 ow, Russia CORPORATE PROFITS TAX: DETERMINATION OF TAXABLE PROFIT Continued to Arrive at Taxable Profit (Income) Deductible Reserves Bad debt provisions for banks in accordance with the rates set by the National Bank. Insurance reserves for insurance companies in accordance with the rates set by the Government. Basic Tax Rate Tax Exemptions Years of Loss Carryforward (Back) 5 (0) 20% . 5% for insurance companies. Tax Credits Dividends received by legal entities which are Kyrgyz residents. Income received by investment funds under specified requirements. Profits used to cover losses of prior periods. Profit of joint investment trusts acting under the Law of Kyrgyzstan Concerning Investment Trusts. A tax credit is allowed for foreign tax paid (in accordance with international treaties), but it is limited to the lower of actual tax paid and the Kyrgyz tax that would have been paid on the foreign-source income. Expenses for the formation of doubtful debt reserves, warranty reserves. Profits tax rate to regional budget of 17.5% may be decreased to 13.5%. 10 (0) Withholding taxes paid in foreign countries may be credited against Russian tax imposed on the same 17.5 to the Regional income, limited to the amount Budget (may be decreased of Russian tax. For dividends to 13.5). received from foreign countries, credit is given only if envisaged by a relevant double tax treaty. 24%: 6.5 to the Federal Budget. 25% Net profit (profit after tax) of a permanent establishment of a foreign legal entity is additionally taxed at the rate of 8%. A tax credit is allowed for foreign tax paid but the amount of tax credit should not exceed that paid in Tajikistan. Companies can write off bad debts but cannot create a provision. Banks are allowed to deduct up to 90% of funds allocated to the bad debt reserve. Insurance companies have the right to deduct allocations to insurance reserve funds in compliance with the requirements set by the Government and Ministry of Finance. Bad debt reserve. Income of religious, budgetary, intergovernmental and international organizations, charitable proceeds received by non-commercial organizations, income of the National Bank of Tajikistan and its subsidiaries; income of companies where at least 50% of employees are disabled and at least 50% of payroll is spent on disabled employees. Tax holidays are granted for investment in charter capital. 3(0) Investment pension funds, educational institutions, agricultural enterprises, etc. 3 (0) 25% Net profit (profit after tax) of a permanent establishment of a foreign legal entity is additionally taxed at the rate of 8%. A tax credit is allowed for foreign tax paid, but it is limited to the lower of actual tax paid and the tax that would have been paid on the foreign-source income in Turkmenistan. A tax credit is allowed for foreign tax paid (in accordance with international treaties), but it is limited to the lower of actual tax paid and the Uzbek tax that would have been paid on the foreign-source income. For insurance companies – 20% of income (up to 25% of charter capital); bad debt provision for banks in accordance with the rates set by the Central Bank; for other entities – debt on which the statute of limitations has passed (3 years). For newly established companies – in the first year the tax rate is 1/4 of the official income tax rate, in the second year – 1/2 of the official income tax rate. Production companies with foreign participation that are included in a special investment list of the Government are entitled to a 7-year tax holiday. Tax losses can be carried forward for 5 years. However, the amount of carried forward losses can not exceed 50 percent of current year taxable profits. Losses incurred during the profits tax exemption period can not be carried forward. Indefinite (0); annual budget laws regularly establish the restrictions for the losses carry forward. The general profits tax rate is 10% (Except the commercial banks, for which the rate is set at 17%). There is also a local 8% tax on profit after corporate income tax, the base is statutory accounting profit less corporate income tax. 25% Net profit (profit after tax) of a permanent establishment of a foreign legal entity is additionally taxed at the rate of 8%. Only for banks and financial institutions. Full exemption applies to income received from the sale of special children’s food of own production; income on assets of mutual funds and real estate funds, as well as income accrued on such assets; profit of publishing houses, publishing organizations and polygraph companies obtained from publishing books in the territory of Ukraine, except for books of an erotic nature. Withholding taxes paid in foreign countries may be credited against Ukrainian profits tax for the reporting period, not to exceed Ukrainian CPT. Capital taxes, indirect taxes and some other taxes, including taxes on dividends and interest, cannot be credited. A double tax treaty must be concluded in order for the credit to apply. * Due to the lack of official information regarding amendments effective on January 1, 2007 we provide information effective in 2006 1 ComparativeStudy Dmitry Garaev, Tax Manager, Ernst & Young CIS, Mosco EXCISE DUTY ON NATURAL GAS Tax Payers Armenia* Not applicable. Armenia has no excise levy on natural gas. Azerbaijan Not applicable. Azerbaijan has no excise levy on natural gas. Georgia Gas producers. Gas importers and exporters (except natural gas delivered through a pipeline). Persons providing vehicles with natural gas condensate and/or natural gas. The excise payer on the goods produced in Georgia with the client’s raw materials is the producer of the goods. Supply of natural gas condensate and natural gas (except for pipeline gas), its transfer to a customer, import and export. Volume of natural gas condensate and/ or natural gas. 80 lari for 1000 m3 for natural gas condensate and natural gas, except for pipeline gas. Object of Taxation Tax Base Tax Rate Kazakhstan No excise levy on natural gas. Kyrgyzstan No excise levy on natural gas. Russia No excise levy on natural gas. Tajikistan No excise levy on natural gas. Turkmenistan No excise levy on natural gas. Uzbekistan Gas producers. Gas importers. Ukraine No excise levy on natural gas. * Due to the lack of official information regarding amendments effective on January 1, 2007 we provide information effective in 2006 Gas produced and sold. Gas imported. Value of the gas produced and sold at selling price including excise tax. Customs value of the gas imported. Gas produced and sold – 25%. Gas imported – none. EXCISE DUTY ON OIL Tax Payers Armenia Legal entities (including branches and representatives of foreign legal persons) and individuals importing or producing excisable goods. Object of Taxation Oil sold or imported. Tax Base Volume of oil sold or imported. Tax rate 27,000 drachmas per tonne. Azerbaijan Not applicable. Azerbaijan has no excise levy on crude oil. Georgia Oil producers. Oil importers and exporters. Supply of oil, its transfer to a customer, import and export. Volume of oil and oil products. 120 lari per tonne for gas; 350 lari per tonne of oil products; 150-250 lari per tonne of oil distillates – light, medium, heavy. 0% Established by the Government. Kazakhstan Persons involved in production or import of crude oil, gas condensate. Crude oil, gas condensate. Oil sold, oil imported. Volume of produced or imported crude oil, gas condensate. Volume of oil sold or imported. Kyrgyzstan Enterprises and physical persons which produce and/or import oil. Russia Not applicable. Russia has no excise levy on crude oil. Tajikistan Legal entities and individuals producing or importing oil. Turkmenistan Not applicable. Turkmenistan has no excise levy on crude oil. Uzbekistan Oil producers. Oil importers. Ukraine Not applicable. Ukraine has no excise levy on crude oil. Supply (except export), contribution to charter capital, import of oil. Volume (or value) of oil sold or imported. Ad valorem or fixed. Established by the government. Oil produced and sold. Oil imported. Value of the oil produced and sold at selling price including excise tax. Customs value of the oil imported. Oil produced and sold – 0%. Oil imported – 20%. * Due to the lack of official information regarding amendments effective on January 1, 2007 we provide information effective in 2006  ow, Russia ROYALTY Types of Licence extraction of minerals. Tax Payers viduals engaged in the extraction of natural resources. Object of Taxation Natural resources extracted in Armenia. Includes minerals, water, timber, and naturally occurring flora and fauna. Tax Base Volume or weight of minerals extracted. Tax Rate 1–7% per gram, tonne, or cubic meter depending on the mineral. Armenia* Conducting geological exploration, Legal entities and indi- Azerbaijan See contributions for the replacement of the mineral renewal raw material base. Georgia 1. Licence on extraction of minerals; 2. Licence on the usage of subsoil sites; 3. General Licence on the usage of oil and gas extraction: a) Licence on oil and gas prospecting; b) Licence on oil and gas extraction. 4. General Licence on usage of forests: a) Licence on producing wood; b) Licence on hunting economy; 5. Licence on fishing. gas transactions. See contributions for the replacement of the mineral renewal raw material base. Kazakhstan Drilling works and other oil and Subsoil users extracting minerals regardless of whether such minerals are realized during a reporting period or not. Volume of produced minerals or first commercial product from extracted minerals. The value of extracted hydrocarbons is calculated based on the average sale price for the first commercial product produced from the extracted hydrocarbons, less indirect taxes and actual transportation costs. Sliding rates are established based on the volume of extracted oil and gas condensate, which range from 2% to 6%. Kyrgyzstan See contributions for the replacement of the mineral renewal raw material base. Russia 1. Right to carry out geological study. 2. Right to develop deposits. 3. Right to use the waste products of mining. 4. Right to use subsurface resources for purposes which are not associated with the extraction of commercial minerals. 5. Right to collect specimens. Royalty was abolished due to the introduction of the Mineral Extraction Tax. Tajikistan Right to explore and extract all types of mineral resources. For bonuses: a) the right to operate on subsurface resources; b) detection of mineral resources; c) attaining certain volume of extraction. All users of the subsoil, conducting extraction of mineral resources, including resources from technogenic minefields. Volume of extracted minerals or volume of the first commercial product. Bonuses are paid for: a) the right to operate on subsurface resources; b) detection of mineral resources; c) attaining certain volume of extraction. The value of the extracted hydrocarbons, based on the average delivery price excluding indirect tax. Bonuses are stipulated in the contract. Either as a defined percentage on the basis of a sliding scale (for hydrocarbons) or as a fixed percentage payment during a contract period (for solid minerals like gold, silver, platinum and other precious metals). Royalty rate on common minerals and underground waters is a fixed percentage payment defined by the government and paid by all users of subsoil. The Tax Code does not define “common minerals”. However, from the context one can understand that “common minerals” mean natural resources other than precious metals/ stones and such common natural resources as sand, for example. Turkmenistan See Mineral Extraction Tax. Uzbekistan (See Contributions for mineral replacement). In practice the Government establishes royalty rates for certain investment projects. The base and rates are defined on a case-bycase basis. Ukraine Right to explore and extract various types of mineral resources. Subjects of entrepreneurial activities, engaged in extracting mineral resources. Subsoil user fees: Mineral resources extracted in Ukraine. Volume, weight and other units of measurement. Oil – $2.57 per 1 tonne; gas condensate – $2.57 per 1 tonne; natural gas – $0.63 per 1000 m3; other mineral resources – depending on the type of resources.  ComparativeStudy Dmitry Garaev, Tax Manager, Ernst & Young CIS, Mosco CONTRIBUTIONS FOR THE REPLACEMENT OF THE MINERAL RAW MATERIAL BASE Tax Payers Armenia* (payments for the preservation of nature) Any legal or physical person engaged in activities polluting the environment. Object of Taxation Goods polluting the environment, industrial and consumer waste, hazardous substances. Tax Base Volume, weight and market value of pollutants. Not specified. Tax Rate Oil, Gas & Gas Condensate Other Minerals Not specified. Azerbaijan Not applicable. Azerbaijan has no such tax. Georgia Any legal or physical person engaged in activity subject to licensing for the use of natural resources. Natural resources extracted in Georgia. Includes minerals, water, timber, and naturally occurring flora and fauna. Volume of the resources extracted. 21 GEL per tonne of oil, 2 GEL per 1000 m3 of gas. Depends on the type of the mineral. Kazakhstan Not applicable. Kyrgyzstan Subsoil users. Minerals/products from minerals produced. Value of minerals extracted. Oil – 2% for 1 tonne; Gas – 4% for 1000 m3. 2% – 12% Russia Mineral replacement tax was abolished from January 1, 2002 due to the introduction of the Mineral Extraction Tax (Chapter 26 of Part II of the Russian Tax Code) Tajikistan Not applicable. Turkmenistan Not applicable. Uzbekistan (Subsurface use tax.) Legal entities and individuals, extracting mineral resources, using waste, etc. Upon extraction of ore containing rare or precious metals or other minerals and the ore is transferred to another entity for processing (except export), the taxpayer is the entity that processes the ore. (Subsurface use tax.) (Subsurface use tax.) Extracted minerExtraction of natural resources; als at sales value; extracted waste at waste derived from the extracsales value; etc. tion of natural resources; etc. (Subsurface use tax.) Natural gas – 30.0%; Subsoil gas – 2.6%; Gas condensate – 20.0%; Oil – 20.0%. (Subsurface use tax.) 0.4% – 24.0% (for waste – 30% of the rate for main natural resource); etc. Ukraine Rent payments. The pay- Oil, gas, gas condensate, and ers are the subjects of ammonia. entrepreneurial activities, engaged in extraction and/or transportation of oil, gas, gas condensate and ammonia. Volume/weight (extraction) or volume/ weight per 100 km (transportation). Basic rates for extraction: oil, gas condensate – $80–$215 per 1 tonne; natural gas – up to $9.9 per 1000 m3. Rate for transportation: natural gas – $0.33 per 1000 m3 per 100 km; oil, oil products – $0.89 per 1 tonne. The basic rates are adjusted monthly, using coefficients to be established by the Cabinet of Ministers of Ukraine. Rate for transportation of ammonia (transit): $1 per 1 tonne per 100 km. * Due to the lack of official information regarding amendments effective on January 1, 2007 we provide information effective in 2006  ow, Russia EXCISE LEVY ON AUTOMOBILE FUEL Tax Payers Armenia* Persons importing petrol and diesel fuel. Object of Taxation Petrol and diesel fuel imported into or sold in Armenia. Tax Base The volume of petrol or diesel fuel imported in Armenia. Tax Rate Fixed payments (instead of VAT and excise) for import of petrol and diesel fuels are established. For petrol – the equivalent of USD 224 per tone. For diesel fuel – the equivalent of USD 65 per tone. Fixed payments (instead of profits tax) for petrol – 1% of monthly revenue, but not less than USD 5 per tone sold. For diesel fuel – 1% of monthly revenue, but not less than USD 3 per tone sold. 48.96% – 54.03% Azerbaijan Persons producing or importing fuels. Production and importation of oil products. Supply, transfer of goods produced in Georgia from customer’s raw material to a customer, import and export of products. Oil distillates (light, medium, heavy), oils and other products borne from hydrocarbon distillation. Other products produced from crude oil and bituminous minerals. Value of the fuel produced and sold at selling price including excise tax. Customs value of the fuel imported. Weight of oil products. Georgia Fuel producers. Fuel importers and exporters. The excise payer on the goods produced in Georgia with the client’s raw materials is the producer of the goods. 150 – 400 lari per tonne. Kazakhstan Individuals and legal entities producing, selling or importing fuel or diesel fuel. (except for aviation fuel). Fuel (except aviation fuel) and diesel Volume of excisable goods profuel. duced, sold or imported. Rates for producers: Fuel – USD 36 per tonne (for wholesale), USD 40 per tonne (retail sale and self consumption). Diesel fuel – USD 4.4 per tonne (for wholesale), USD 4.8 per tonne (retail sale and self consumption). Rates for importers: Fuel – EUR 23 per litre. Diesel fuel – 0. Established by the Government. For petrol of up to 80 octane – RUR 2,657 per tonne; for petrol of more than 80 octane – RUR 3,629 per tonne; for diesel fuel – RUR 1,080 per tonne, oil for diesel and carburetor engines – 2,951 RUR per 1 tonne; straight-run petrol – 2,657 RUR per tonne. Ad valorem or fixed. Established by the Government. Kyrgyzstan Enterprises which produce Russia Enterprises and private entrepreneurs which sell and/or transfer self-produced excisable goods. and import automobile fuel. Automobile fuel produced or imported. Sale/transfer of petrol, diesel fuel, oils for diesel and carburetor (injection) engines, straight-run petrol by producer. Supply (except export), contribution to charter capital, import of fuel. Sale and processing of automobile fuel which is produced in Turkmenistan. Fuel produced and sold. Fuel imported. Established by the Government. Volume of fuel sold (transferred). Tajikistan Legal entities and individuals producing or importing fuel. excisable goods or provide processing services. Volume (or value) of fuel sold or imported. Value of petrol or diesel fuel sold. Turkmenistan Legal entities which sell Uzbekistan Fuel producers. Fuel importers. 40% Value of the fuel produced and sold at selling price including excise tax. Customs value of the fuel imported. Weight of fuel produced or imported. Fuel produced and sold – petrol 28%, diesel 25%, jet fuel 8%. Fuel imported – 20% (distillates 30%). “Special Petrol – $15,6–25,9 per 1000 kg Automobile Fuel –$77,9 per 1000 kg Diesel Fuel – $38,9 per 1000 kg etc.” Ukraine Subjects of entrepreneurial Petrol, fuel and diesel fuel. activities producing or importing excisable fuel. * Due to the lack of official information regarding amendments effective on January 1, 2007 we provide information effective in 2006  ComparativeStudy Dmitry Garaev, Tax Manager, Ernst & Young CIS, Mosco VAT Sales Tax Property Tax Armenia* 20% on taxable supplies. Fixed payments on imports of petrol and diesel fuel (see Excise-Fuel), 0% on export sales, transit carriage and processing services. None Buildings: progressive tax rate from 0% to 0.8% depending on the property value; 0.3% for public and production use buildings; 0.2% for garages. For transport facilities: from 100 to 1000 drachmas per horsepower depending on the type of the vehicle and its age. 1% of average annual residual value of fixed assets. Azerbaijan 18% (on goods sold and services rendered within Azerbaijan, including imported goods). None Georgia 18%. Supplies of goods and services in Georgia and importation of goods (at customs) are subject to VAT. There is a long list of VAT exempt goods and services. The export of goods and some other operations is taxed at a zero rate. None Property tax rate is up to 1% of the annual average net balance sheet value of non-current assets, both tangible and intangible, of Georgian entities as well as Georgian permanent establishments of foreign entities. This is a local tax as opposed to state-wide taxes, therefore the exact rate for the tax is fixed by local governments. Notably, land and certain movable property (cars, yachts, etc) are taxed based on specific rules set out by domestic tax law. “Tax base for legal entities: average annual net book value of fixed assets and intangible assets. Base tax rate: 1%.” Kazakhstan Tax base: turnover from sales of goods (works, services), if Kazakhstan is recognized as the place of realization, import of goods; except for turnover exempt from VAT according to the tax code. Base tax rate : 14%. Export rate for goods and services and for international carriage: 0%. None Kyrgyzstan 20% on taxable supplies and import operations; 0% – Tax for the performance of chargeexport of goods, international carriage and processing under able services to the public and a special customs regimes. from retail sales at a rate not to exceed 4% on turnover from retail sales. None Real Estate Tax at a rate not to exceed 0.95% of the value of immovable property, and at a rate not to exceed 0.35% of the value of residential immovable property. Russia 18% – basic rate; 0% – export of goods; 10% – sale of cer- tain food products, children’s goods, certain periodic publications and related services, specific medical goods both of domestic and foreign origin. 2.2% – maximum rate which may be set by the regional government of the net book value of fixed assets. Tajikistan 20% – basic rate for the supply of goods, works and ser- vices and taxable import operations (unless they are specifically exempt). 0% – export of goods. “Tax on supply of cotton fiber and aluminium (incl. export) a) 10% on sales of ginned cotton, 3% on sales of aluminium; b) tax on retail sales – up to 3% of the market price of goods.” 10 – 50 – times the rate of land tax. Land tax rate in cities: 150 – 400 somoni/ha. Average land tax rate outside the city depending on cadastral zone and land purpose: 2 – 46.5 somoni/ha. Turkmenistan 15% on the supply of most goods and services and taxable import operations. None 1% of the net book value of fixed assets and average value of inventory. Uzbekistan 20% on the supply of all goods and services, unless they are zero-rated or specifically exempt; imported goods and services, unless they are specifically exempt. Property tax – 3.5% on the value of fixed and intangible assets Tax on the consumption of petrol, diesel and liquid gas in the amount (property tax rate is doubled for the equipment which is not fixed of UZS 80 per litre of petrol and in proper time limits). diesel and UZS 80 per kg of liquid gas (on sales to individuals only). Ukraine 20% – supply of goods and services in Ukraine and import of goods; 0% – export of goods. Certain transactions are VAT exempt, e.g. the majority of bank services, services rendered by the consultants to the foreign customer not having a permanent establishment in Ukraine etc. None None  ow, Russia OTHER SIGNIFICANT TAXES Turnover Taxes Road Users’ Tax None None Export Duty Emergency Fund Contribution None None Import Duty Tax on the Sale of Fuel and Lubricants Housing Tax 0 or 10% of the customs value of imported goods. There is a fixed payment for imports of petrol and fuel (see Excise levy on automobile fuel). None None None None 25% of the difference between the contract price (after deduction of export expenses) and the wholesale price of the goods produced in Azerbaijan as regulated by the Government. None 0 – 15% of the customs value of imported goods. None None None Various None None None None “Export duties are established with respect to export of furs, iron and non-ferrous metal objects. Various, expressed in euros or percentages. From 10 to 30%.” “Various, expressed in euros or percentages. From 0 to 25%. If subsurface use contracts concluded before May 1, 2003 provided that the import of goods is exempt from customs duties, such an exemption is in force until the expiration of the term stated in the contract.” Provided by the customs legislation. See excise levy on automobile fuel. None None Emergency Fund Contribution at rates established by the current legislation. None Provided by the customs legislation. None None None Various. For crude oil and crude oil products – currently USD 179.7 per tonne to the Republic of Belarus and other members of custom association. For gas 30% of customs value, LNG 0%. Determined by the customs rules. Various None 2% of the None sum of deductions (expenses) made during the current tax period (0.5% for trading, procuring, supply and sales agencies). None None None Determined by the customs rules. None None Determined by the customs rules. Determined by the customs rules. Various None (See ‘Sales Tax’). 1.5% of sales None revenue (net of VAT and excise). School Education Fund None contribution at a rate of 1% of sales revenue (net of VAT and excise tax). Pension Fund contributions on sales at a rate of 0.7% of revenue (net of VAT and excise tax). None Scrap ferrous metals: $38.9 per 1 tonne; live c