DOMINICAN STANDOFF ON REPEAL OF PROTECTIONIST TAX

UNCLAS SECTION 01 OF 04 SANTO DOMINGO 006699

SIPDIS

SENSITIVE

STATE FOR WHA/CAR, WHA/EPSC, WHA/USOAS, EB/TPP/BTA,
EB/IFD/OMA;NSC FOR SHANNON AND MADISON;LABOR FOR ILAB;
USCINCSO ALSO FOR POLAD; TREASURY FOR OASIA; USDA FOR FAS
(SHEIKH, GRUNENBAUM);STATE PASS USTR FOR VARGO, RYCKMAN,
MALITO, CRONIN
USDOC FOR 4322/ITA/MAC/WH/CARIBBEAN BASIN DIVISION
USDOC FOR 3134/ITA/USFCS/RD/WH; DHS FOR CIS-CARLOS ITURREGUI

E.O. 12958: N/A
TAGS: PGOV PREL ETRD EFIN DR
SUBJECT: DOMINICAN STANDOFF ON REPEAL OF PROTECTIONIST TAX

REF: SANTO DOMINGO 6609


1. (SBU) Summary: President Fernandez on December 14 implied
he would veto a bill to repeal a the protectionist 25% tax on
fructose-sweetened beverages if the Dominican Senate does not
remove all of the "compensatory" tax breaks for agribusiness
and industry that have been added to the original draft
submitted by the executive. Fernandez warned that the
country cannot not afford to lose either the free trade
agreement with the United States and Central America (CAFTA)
or to disrupt the agreed terms for a new IMF standby. The
senators preparing the legislation have asserted to the
Embassy that the bill with slightly modified tax breaks
represents the "last chance" to repeal the 25% tax and keep
the Dominican Republic in CAFTA. The senate special
commission conducted lengthy meetings today with
administration fiscal officials and business interests; they
have adjourned after deciding to appoint a subcommittee to
negotiate with the administration and other interests. There
will be no vote today, December 15, and it is not clear when
a text will be ready for consideration by the general Senate.
End summary.

Against Tax Breaks: President Fernandez and the IMF
-------------- --------------


2. (SBU) President Fernandez in public remarks December 14
strongly reiterated his support for CAFTA and warned that
"compensatory" tax breaks that have been added to a bill to
repeal a protectionist 25% tax on fructose-sweetened
beverages must be removed to gain his approval of the final
legislation. He said that the tax breaks place special
interests above the national interest, which, he asserted, "I
will not permit." As an example, he cited a proposed
exemption from a 10% foreign exchange surcharge of capital
goods for all domestic industries. Fernandez emphasized that
the 25% tax must be removed to clear the way for ratification
of the Dominican Republic's free trade agreement with the
United States and Central American countries(CAFTA). He
reminded the press that the country sends 80% of its exports
to the United States and cannot afford to stay out of CAFTA.
Congress must repeal the 25% tax to ensure Dominican
participation in CAFTA, he said.


3. (SBU) Internal Revenue Director General Juan Hernandez and
Customs Director General Miguel Cocco met with key senators,
including Senate President Andres Bautista (PRD),on December
15 for three hours, seeking to iron out the differences. A
close advisor to Hernandez said the government was sticking
to its guns: tax repeal yes, tax breaks no. Cocco is
advocating that compensation for industry should be dealt
with separately, and perhaps later. Senate president Bautista
told Charge Kubiske late on December 14 that he needed to
work with the government to find out the limits of how much
the bill could offer in tax breaks without compromising IMF
targets.


4. (SBU) On December 13-14 IMF representative Ousmene
Mandieng publicly opposed the "compensatory" tax breaks,
which, he said, would result in an unacceptable loss of
revenue to the government. Mandieng told us on December 15
that anything causing deviation from agreed fiscal targets
means trouble for the tentatively agreed IMF standby
agreement. He said the bill submitted last week (reftel)
included such wide-open tax exemptions that it it was
impossible to quantify the fiscal impact. If revisions to
the bill result in measures with calculable fiscal costs, the
Dominicans will have to identify other measures to offset the
fiscal impact. He said that the financing gap projected for
2005 for the non-financial public sector of 0.7 percent of
GDP is already a problem and expressed skepticism that
funding offsets could be found. Mandieng commented that the
IMF does not renegotiate its technical agreements or
micromanage governments.

For Tax Breaks: Senate and Business
--------------


5. (SBU) Embassy officers met December 14 with Senator Juan
Morales (PRD),chairman of the special committee considering
the tax repeal bill, and committee members Senator Alejandro
Santos (PRD) and Angel Perez (PRD). The senators spoke with
one voice: the Senate had failed four times to pass the
government's original bill, because many senators have
obligations or links to the traditionally powerful sugar
industry. Only with "compensating" tax breaks would a
majority of Senators vote to repeal the 25 percent tax
enacted in September. The repeal bill including the tax
breaks, which passed a first reading March 7, was designed to
help the sugar sector and other industries prepare to compete
effectively in a free trade environment. The senators shared
a calculation of the fiscal impact of the tax exonerations on
imports of capital equipment, prepared by former Technical
Secretary of the Presidency Carlos Despradel, of RD $831.5

SIPDIS
million (US $28 million) per year -- not a showstopper, in
their view. Senator Santos, who also chairs the Senate's
industry and trade committee, subsequently told the press
that the IMF representative's criticism of the bill had been
"disrespectful and precipitate."


6. (SBU) The senators December 14 outlined proposed revisions
to the draft bill (previously faxed to State, Treasury, and
USTR) to mitigate the fiscal impact while leveling the
playing field for Dominican businesses:

-- In Article 5, the exemption from the 10% foreign exchange
surcharge on imports (set to rise to 13% in 2005) would be
limited to machines, equipment, and replacement parts for
industry; the application to "inputs for the sugar industry"
would be deleted as open to abuse. This "inputs" provision
had provoked revenue chief Hernandez's recent off-the-cuff
estimate of annual revenue losses of RD $4.5 billion (US $158
million). The bill's author, Senator Ramon Alburquerque
(PRD),has argued that Article 5 as a whole will maintain
incentives for investors, in competition with alternative
foreign destinations. The exchange surcharge mechanism,
voted by the Monetary Board instead of approved by Congress,
is being challenged in the courts as unconstitutional.

-- In Article 4, Paragraph IV, the compensation for
value-added (ITBIS) paid to suppliers would not be automatic
(the government deems this to be unworkable),but the law
would require the government to adjudicate it and deliver the
accounting two monoths after the deposit of ITBIS (VAT).
Business interests maintain that the government is in arrears
on these reimbursements to the tune of RD $1.2 billion (US
$42 million). Except for the reduction of a considerable
"float" in retained payments, the proposed improvement in
administration of existing tax law would be essentially
revenue-neutral for the government, but would reduce costs to
business.

-- In Article 2, sub-para 2.1., the cap of 5 percent of
assets on deductions for capital depreciation and
improvements in agroindustry would be removed. This, they
said, would move in the direction of establishing a level
playing field in CAFTA for Dominican businesses, since
Central American counterparts have no limits on such
deductions. Senator Alburquerque has stated that this
provision would benefit thousands of small and medium sugar
growers ("colonos"),not just "three or four rich families."


7. (SBU) The senators emphasized their desire to level the
playing field. They displayed a chart, reflecting business
sentiment, comparing the tax levels businesses pay in the
production process in the Dominican Republic and the five
Central American nations. Total taxes on production
(including VAT),import duties on machinery, and foreign
exchange surcharges),according to this analysis: Dominican
Republic 31 percent, Costa Rica 1 percent, Guatemala 12
percent, El Salvador 13 percent, Nicaragua 15 percent, and
Honduras 2 percent.


8. (SBU) Business associations, previously divided on the
repeal of the 25% tax (sugar sector against, free zone
exporters in favor) have begun to converge behind the current
package of repeal plus compensation. The prestigious
National Associaion of Private Enterprise (CONEP) and
Association of Industries of the Dominican Republic (AIRD)
have both issued supportive statements in recent days, as has
the country's largest sugar exporter, Central Romana.
However, the Chamber of Commerce and Production of Santiago
-- the nation's second largest city, which depends on
free-zone manufacturing for export -- criticized the
controversy over repeal of the 25% tax as "lamentable,
inopportune, and counterproductive."

Next Steps
--------------


9. (SBU) After a long day of meetings with fiscal authorities
and businesses, the Senate commission appointed a
subcommittee and adjourned. The private sector leaders intend
to meet with President Fernandez. The outcome of these
various engagements, brokered as possible by the subcommtiee
will determine the timing of a Senate special committee
meetings and the session of the full Senate to consider the
bill, and subsequent consideration by the Chamber of Deputies
(lower house of Congress).


10. (SBU) Chamber of Deputies president Alfredo Pacheco (PRD)
told Charge Kubiske early on December 15 that he expected the
obstacles to removal of the 25 percent tax to be resolved
that day, even though the actual voting process in both
houses would take longer. Chamber finance committee chairman
Marino Collante (PRSC) said to us December 14 that once the
Senate approves the repeal bill, he could move it though his
committee to the Chamber floor in 2-3 days. He, Pacheco, and
a solid majority of the deputies favor repeal. Collante said
that they would have to consider the fiscal impact of the
"compensation," and he would prefer to omit it from the bill.
But if the impact is "mild," he believes the measure will be
approved. Senate president Bautista commented that he hopes
to achieve final legislative approval by December 24;
Congress will adjourn January 12, but could be called back
into special sesion by the President.


11. (SBU) In the event the Chamber of Deputies amends the
bill as passed by the Senate, the modified bill would have to
go back to the Senate for its approval of the changes,
according to Article 40 of the Dominican Constitution. Then
the approved bill would go to President Fernandez for
approval.
KUBISKE