1. (SBU) A recent change to taxation law means Croatian NGOs
will again be required to pay VAT on purchases financed with
foreign donations. Though some NGOs have raised alarms over
alleged unfairness and lack of transparency, GoC efforts to
clean up its tax policy are welcome steps. Although the
government was completely within its legal rights to suspend
VAT exemptions, its failure to adequately explain the
decision to the NGO community has put the GoC on the
defensive. USG assistance programs remain VAT exempt. END
SUMMARY

LET'S TAX LIKE IT'S 1997


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2. (U) The April 30 national gazette published a Ministry of
Finance decree revoking VAT exemptions for NGO purchases
financed with foreign donations. The original 1997 law on VAT
provided for narrow tax exemptions to humanitarian
organizations. The GoC expanded these exemptions in 2001 to
include human rights, minority rights, women's rights, and
democracy-building NGOs.



3. (U) As of May 8, VAT has been levied on in-country
purchases of goods and services by NGOs financed with foreign
assistance. NGO purchases financed with local assistance will
continue to be assessed VAT. VAT will not/not be assessed on
the receipt of foreign assistance itself. All existing
bilateral agreements on VAT exemption, such as those with the
USG and the European Commission, will remain in force.

NGOS CONDEMN GOVERNMENT DECISION BUT IGNORE OLIVE BRANCH


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4. (U) Three of the largest NGOs in Croatia -- BaBe (women's
issues), GONG (democracy-building, election monitoring), and
Green Action (environment) -- immediately and publicly
criticized what they call the decision's harmful impact of
civil society development. Two NGOs allege that the GoC
attempted to bribe them with preferential tax treatment in
exchange for dropping the issue.



5. (SBU) GONG alleges government intimidation in the form of
a June 1 audit by state tax inspectors. While all NGOs we
spoke with expressed outrage at so-called retaliation for NGO
protest, the Tax Administration has assured us audits are
aimed only at the enforcement of tax laws and prevention of
abuse.



6. (SBU) Moreover, the Ministry of Finance accepted an NGO
proposal to form a working group consisting of
representatives from the Ministry of Finance, Tax
Administration, NGOs, donors, and unions to brain-storm how
best to support civil society without VAT exemptions. Since
May 27, the GoC has attempted to work with key NGOs to
establish public benefit criteria -- in line with European
Union guidance -- that would allow for VAT refunds from the
state budget for qualifying organizations.

IT'S NOT ABOUT THE BUDGET


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7. (SBU) No one claimed the VAT change was aimed at filling
state coffers. BaBe and GONG told us that in their dealings
with MinFin, the Ministry had no idea how much revenue the
change would generate. In a separate meeting, MinFin
officials told us that they are scouring tax regulations to
close loopholes -- as much for tax policy reasons as revenue
generation.



8. (SBU) The GoC contributed 17 million kuna ($2.9 million)
from its 2003 state budget to civil society development. The
recently-created Foundation for Civil Society Development
will work with the GoC, local administrations, and NGOs on
increasing transparency in how state money is distributed to
civil society organizations.

TAX AGENCY HAS "NO INTEREST WAGING WAR WITH NGOS"


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9. (SBU) On June 30, Deputy Director of the Tax
Administration Zlatko Fabijancic told us that charging NGOs
VAT was in no way about increasing state revenues, but rather
was about simplification of the tax code and eliminating a
potential source of abuse. His agency hoped to insure that
VAT exemptions are fully in accordance with the 1997 law on

taxation. This measure would also combat tax evasion, as
individuals have created or fabricated NGOs with the
intention not just to evade VAT but also income tax.



10. (SBU) Fabijancic explained that the Tax Administration
feels that eliminating NGO VAT exemptions constitutes a
much-needed correction to the 2001 change -- exemptions the
Tax Administration long warned was out of step with EU norms.
Correcting what he saw as a clear aberration from both
Croatian and EU law is a necessary part of harmonization with
EU tax law.



11. (SBU) Fabijancic defended the GoC against NGO allegations
of disinterest or ill-intent. He denied "bribery"
allegations. Asked about allegations of intimidation,
Fabinjancic declared, "We have no interest in waging war with
NGOs."



12. (SBU) In a separate meeting, a high-level contact in the
Ministry of European Integration told us she personally does
not/not see VAT exemptions for NGOs as inconsistent with EU
policies nor does she believe EU harmonization demands taxing
NGOs. She expressed hope that the GoC would be able to
continue financial support for civil society while closing
this tax loophole.

COMMENT


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13. (SBU) Eliminating VAT exemptions for NGOs makes sense for
Croatia's fiscal policy -- it simplifies the tax code, it
closes a loophole, it eliminates a likely source of abuse,
and it may even generate a modest amount of revenue. Based on
our reading of the EC directive on VAT and discussions with
the OSCE mission in Croatia, the GoC has done nothing
inconsistent either with EU legislation or with best
practices in EU member states. It has, however, failed to
effectively explain its position to the NGOs.



14. (SBU) Moreover, the GoC has shown a clear willingness to
compromise with NGOs, offering to institute VAT refunds for
organizations that meet public benefit criteria. Despite good
faith efforts by the GoC to support civil society without
manipulating the tax code, NGOs have stubbornly refused to
discuss anything other than more exemptions. We are confident
the GoC will continue to work with the NGO community to find
a way to support civil society without resorting to
manipulation of the tax code.



15. (SBU) Discontinuing the VAT exemption looks worse than it
is. In the assessment of large, internationally-funded NGOs
we spoke with, NGO operations will continue despite a decline
in purchasing power. In fact, the effectiveness of NGO
pressure in generating MinFin's refund proposal is evidence
that Croatian NGOs are alive, well, and not shying away from
a fight. END COMMENT.
FRANK


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