Identifier
Created
Classification
Origin
05MINSK1145
2005-09-20 12:04:00
UNCLASSIFIED
Embassy Minsk
Cable title:  

Trade with Russia Falls under New VAT Rules

Tags:  ECON ETRD BO 
pdf how-to read a cable
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INFO RUEHMO/AMEMBASSY MOSCOW 3135
RUEHKV/AMEMBASSY KIEV 2912
RUEHVL/AMEMBASSY VILNIUS 3363
RUEHRA/AMEMBASSY RIGA 1411
RUEHWR/AMEMBASSY WARSAW 3032
RUEHVEN/USMISSION USOSCE 0661
RUEHBS/USEU BRUSSELS
RHMFISS/HQ USEUCOM VAIHINGEN GE
RUFOADA/JAC MOLESWORTH RAF MOLESWORTH UK
UNCLAS MINSK 001145 

SIPDIS

SIPDIS

E.O. 12958: N/A
TAGS: ECON ETRD BO
SUBJECT: Trade with Russia Falls under New VAT Rules

Refs: (A) Minsk 171, (B) Minsk 174, (C) Minsk 247

UNCLAS MINSK 001145

SIPDIS

SIPDIS

E.O. 12958: N/A
TAGS: ECON ETRD BO
SUBJECT: Trade with Russia Falls under New VAT Rules

Refs: (A) Minsk 171, (B) Minsk 174, (C) Minsk 247


1. Summary: In January Belarus and Russia switched the way VAT on
bilateral trade is paid. President Lukashenko and other GOB
officials constantly state this change benefited Belarus, and
bilateral trade has increased. However, the GOB's own statistics
show a 8.9 percent drop in commerce with Belarus' main trading
partner. Anecdotal evidence also points to bilateral trade being
sharply affected. Additionally, a leaked government memo
highlights the damage this has done to local industry, and
concludes this switch hurt Belarus' economy. Meanwhile, Lukashenko
has issued several temporary decrees to mollify Belarus' small
entrepreneurs, who protested the VAT change last spring. Still,
the seeds for further protest by this group have been planted. End
summary.


2. On January 1 Belarus and Russia switched their mechanism for
collecting VAT on bilateral trade from the country of origin to the
country of destination principle. The GOB originally anticipated
earning an additional USD 200 million in taxes annually from this
move. On September 19, Deputy Finance Minister Ivan Shunko
announced the GOB may even earn an additional USD 300 million from
VAT in 2005. Because of the way this policy change was
implemented, and the lack of preparation in both countries,
bilateral trade dropped sharply in January (ref A). GOB officials
have repeatedly stated that VAT restructuring has not resulted in
any problems and that trade with Russia is booming. In February
the Ministry of Statistics even announced that Belarusian foreign
trade (roughly half of which is with Russia) increased 37 percent
in January.


3. However, recently released trade statistics for the first half
of 2005, anecdotal evidence, and a leaked government memo all lead
to the conclusion that January's restructuring of VAT has had a
large, continuing and negative impact on Belarus' trade with
Russia.


The Statistics
--------------


4. According to the MFA, trade between Belarus and Russia for the
first half of 2005 fell by 8.9 percent, to USD 6.9 billion,
compared to the same period in 2004. Belarus' exports to Russia
fell by 8.7 percent, to USD 2.656 billion, and its imports from
Russia fell by 9.1 percent, to USD 4.289 billion. Russia accounts
for 36 percent of Belarus' exports and 60.5 percent of its imports.

Belarus' main exports to Russia include tractors, trucks, metals,
tires, household appliances, and foodstuffs. Belarus imports from
Russia oil, natural gas, electricity, coal, ferrous metals,
engines, metal working machinery and chemicals.


5. Despite these official statistics, GOB officials continue to
assert everything is fine. Prime Minister Sidorsky announced
September 6 at the opening of the first Belarus-Russia Economic
Forum that Belarus' trade with Russia increased by five percent in
the first half of 2005. President Lukashenko at the same event
stressed at length the strength and growth of Belarusian-Russian
trade. However, Russian Prime Minister Fradkov replied in his
address that he hopes bilateral trade levels for 2005 do not drop
too far, "after many problems, such as VAT redirection." Two
Russian officials, First Deputy Mayor of Moscow Yury Roslyak and
Aleksey Kaulbars, a department head at the Ministry of Economic
Development, both stated at the forum the drop in bilateral trade
is the result of difficulties arising from the new VAT structure.


Everything is Good, But...
--------------


6. In July Lukashenko admitted, "There was a big VAT problem early
this year, now there is almost no problem." He went on to claim
that tax revenues are up by BYR 800 million [USD 372,000] for the
year and that the new VAT scheme led many companies to increase
their profits, some by 50 percent. Despite Lukashenko's claims,
several businesses have reported otherwise to Emboffs. The owner
of a Vitebsk brick factory said he lost all his trade to Russia
because of the new VAT mechanism, and had to close half his
factory. He said this was typical in Vitebsk. Officials at the
Minsk Automobile Factory, Belarus' fourth largest company, admitted
sales to Russia fell in 2005. According to the Ministry of
Statistics (MoS),truck sales to Russia fell 8.7 percent and the
import of Russian cars fell 6.2 percent in the first half of 2005.

7. According to the MoS, the new VAT scheme increased taxes paid to
the state, up 100 percent from the year before to BYR 2.286
trillion [USD 1.063 billion] in the first half of the year. VAT on
goods imported from Russia accounted for roughly 40 percent of that
amount, BYR 457 billion [USD 213 million]. The GOB insists it lost
an estimated USD 200 million a year to Russia under the old VAT
scheme, and is demanding the GOR pay USD 1.2 billion in restitution
as a precondition to any currency union.


But Some Say it is Bad for Belarus
--------------


8. Despite the increase in tax revenue, in an internal GOB memo
leaked to the press in August, Presidential Aide Sergey Tkachev
argued this change was actually harmful to the Belarusian economy.
He wrote that Russian suppliers of raw materials are not deducting
the previous amount of Russian VAT from the cost of goods exported
to Belarus, so Belarusian firms are paying last year's prices for
imports (with the previous amount of Russian VAT now going to the
Russian company) as well as an 18 percent Belarusian VAT. In one
example, the GOB insisted earlier in the year that Gazprom reduce
the price of natural gas by 18 percent (from last year's rate of
USD 46.68/thousand cubic meters) to compensate for a change in the
VAT mechanism. Gazprom refused, and continues to charge USD 46.68.
Even though Beltransgaz is a state company, it still has to pay VAT
on gas imports, effectively raising the price of gas by 18 percent
as of January 1.


9. Tkachev also argued the apparent rise in VAT revenues is a
mirage. When Belarusian exporters ship goods to Russia, they have
to supply the GOB with proof VAT is paid on those goods in Russia.
Business contacts tell Emboffs in many cases obtaining such proof
is impossible. When no paper work is available, the Belarusian
exporter must pay VAT to the GOB, plus a large fine. Even when
paperwork is available, in many cases the Belarusian firm has to
pay VAT to the GOB on goods it exports. Once the company submits
the paperwork proving VAT was paid in Russia, the GOB should
reimburse that VAT. Tkachev wrote that the GOB owes Belarusian
exporters BYR 465.5 billion [USD 217 million] in overdue VAT
reimbursement from the first half of 2005. This accounts for 20
percent of taxes collected during that period. Further, he argued
that Belarusian exporters face liquidity problems because the GOB
has not reimbursed them for paid VAT, forcing them to seek loans to
compensate or be delinquent in paying other bills. Valery
Dashkevich, an economist at BelGazpromBank, told us because the GOB
has not been reimbursing exporters for VAT paid in Russia, most
major Belarusian exporters have stopped paying VAT to the GOB,
arguing their current taxes are offset by what the GOB owes. This
is likely to lead to sharply reduced tax revenues in the second
half of 2005.


10. Tkachev concluded, "Our revenues have shrunk, we get dearer
Russian raw materials, the prices for which have risen - maybe not
by the value of the VAT, but by a significant share. We should
also think about to whom to sell, to go through the complex method
of confirming, returning and offsetting VAT. It all causes a
growing inventory of finished stock... . The Union State has lost
much." Ivan Ivanov, head of the local International Finance
Corporation office, agreed with Tkachev's assessment, "I do not
think the new mechanism is more profitable for Belarus. It was
easier to trade with Russia, the main trading partner, before."


Not all Bad
--------------


11. Even though trade with Russia fell, some analysts state the
problems with VAT forced Belarusian companies to divert their trade
away from Russia. According to the MFA, trade with Ukraine rose 65
percent in the first seven months of the year, largely based on
increased sales of Belarusian agricultural equipment, televisions,
refrigerators, glass, potash and oil to Ukraine. According to the
IMF, exports to western countries also surged. As a result,
Belarusian exports as a whole rose 19.6 percent, to USD 7.4
billion.


Entrepreneurs Satisfied, for Now
--------------


12. Belarusian entrepreneurs protested the new VAT rules in
February and March (refs B and C). In response, Lukashenko
exempted individual entrepreneurs from paying the new VAT for six
months. On August 1 the GOB implemented a temporary rule, valid
until December 1, allowing business owners to pay a fixed rate for
VAT if no documents accompany the imported goods. [Note: Thousands
of Belarusian small businesses import small amounts of goods from
Russia for resale, often in kiosks. Because of the nature of this
shuttle trade, and the customs free border with Russia,
accompanying documents are usually impossible to obtain.] The
fixed rate ranges from USD 230 to 325 per month, depending on the
type of business and its location. Perspektiva, an NGO that works
with small businesses and which organized the February and March
protests, believes this VAT will force many small businesses into
bankruptcy. Small scale traders will have to raise their prices 10
to 50 percent, based on their volume of sales, and will not be able
to compete with wholesale importers who pay the same rate but deal
in much larger volumes. However, these moves by the GOB have
apparently diffused the earlier anger of many entrepreneurs, which
led to last spring's protests.


Comment
--------------


13. The GOB appeared to rush into the decision to change the way
VAT on trade with Russia is paid, focusing solely on the perceived
increase in taxes, and not thinking about repercussions on
industry. [Note: One official told Econoff the decision was only
made in September 2004, three months before the change was
implemented, with details worked out afterwards.] While some
businesses have managed to redirect their exports, others have seen
a sharp drop in sales and had to reduce their production. Despite
GOB claims of constant growth and success (part of Lukashenko's
endless propaganda that all is well in his Belarus),many appear to
have been hurt by this move. The entrepreneurs are quiet now, but
that could change as businesses collapse or the GOB's temporary
mollifying measures expire.


KROL