UKRAINE: FINANCE MINISTER ON TAXES, BUDGET, AND

C O N F I D E N T I A L KIEV 002293 SIPDIS SIPDIS DOE FOR LEKIMOF,CALIENDO COMMERCE FOR ITA/LUCYK TREASURY FOR NLEE, BCOX, MGAERTNER E.O. 12958: DECL: 06/13/2016 TAGS: EFIN EPET UP SUBJECT: UKRAINE: FINANCE MINISTER ON TAXES, BUDGET, AND RUSSIAN NATURAL GAS REF: A. KIEV 1370 ¶B. KIEV 1941 Classified By: Deputy Chief of Mission. Reasons 1.4 B) and D) ¶1. (U) This message contains a guidance request, see paragraph 9. ¶2. (C) Summary. In a June 6 meeting with DCM, Minister of Finance Viktor Pynzenyk discussed his concerns about budget performance and energy supplies. He denied the Ministry of Finance had asked the State Tax Administration to delay payment of VAT refunds to companies such as Cargill, which is owed over $40 million. Although Ukraine would be able to address its 2006 budget problems, he said, uncertainty over gas prices and their impact made prospects for the 2007 budget worrisome. Ukraine needed tax and budget reforms that would be difficult to pass in a Rada filled with wealthy deputies. One measure, for which he sought U.S. support, would be to renounce Ukraine's double taxation agreement with Cyprus. Pynzenyk said Russia's energy maneuvers constituted a threat to Ukraine's sovereignty. He feared that UkrHazEnergo would usurp the role of state gas and oil company NaftoHaz, and was acting in the interests of the Russians. End Summary. VAT Refunds: Not My Responsibility -------------- ¶3. (SBU) We requested the meeting specifically to discuss the State Tax Administration's (STA) failure to refund to Cargill over $40 billion of VAT the company had paid for inputs for the exports it ships from Ukraine. While the STA had promised significant refunds in April and May, and had paid as much as $150 million in refunds to other firms, it had made only a token payment to Cargill. DCM noted that in an earlier conversation with Ambassador (ref A),Pynzenyk had suggested that delaying VAT repayments was a deliberate tactic to keep the budget deficit from expanding beyond planned parameters. Pynzenyk responded that he had no authority over the STA, but could write a letter on the matter. He said he had encouraged the STA to stay up to date on VAT refunds, but could not order the STA to repay a specific firm. ¶4. (SBU) He acknowledged that some oblast tax authorities who had fallen behind in their tax collections may be "saving face" by delaying VAT refunds. Budget performance for 2006 was staying within planned parameters (i.e. a deficit below 2.5% o GDP) despite lower revenues in part, Pynzenyk said, because VAT refund claims were two billion UAH lower than expected. He then acknowledged that local STA authorities had failed to submit reports of VAT refunds claimed, making it impossible for the Treasury to disburse the funds. (Comment: Pynzenyk thus indirectly admitted that VAT refunds were suffering in order to meet budget goals, but implied his own Ministry bore no responsibility. End comment.) 2006 Budget in Some Trouble... -------------- ¶5. (SBU) Pynzenyk reiterated that the GOU was collecting less tax revenue in 2006 than in 2005. VAT receipts were 350 million below plan, but the real problem was lower corporate income tax receipts. Rather than increase collections, tax authorities wanted to revise the plan's monthly revenue projections downward. This would make it appear that revenues had met the plan for the first 11 months of the year, but in the 12th month there would suddenly emerge a huge shortfall. He denied anecdotal reports we had heard from some companies that the STA was asking firms to pay taxes in advance as a way of keeping the books close to balanced. He said that the problem was not that oblast tax authorities were failing to turn over their tax receipts to the Treasury; tax receipts automatically went to the Treasury. ¶6. (SBU) Customs offices, however, often delayed turning their tariff revenues over to the Treasury in order to collect interest on the float, Pynzenyk said. The GOU was transferring all Customs accounts to the State Treasury in order to address this problem. To date, the accounts of seven of 50 customs offices were already transferred; the rest would be by the end of the year, he said. ...But We Can Handle It -------------- ¶7. (SBU) Pynzenyk said the GOU would probably not seek revision to the 2006 budget. (Comment: Up to this point, the GOU had led us to believe that such a budget revision would be among the first orders of business for a new Rada.) He said he was afraid of what the new Rada would do to the budget if given the chance, especially if public unrest followed the gas price hikes planned for July 1. Instead, the GOU would muddle through by simply ignoring some budget-busting spending mandates such as expanded social benefits for survivors of World War II that the last Rada had passed during the election campaign. It would delay other spending, and ask the Rada simply for increased spending authority near the end of the year. The new natural gas price structure would help the budget he said. Rather than charging a single price for all consumers, and then using budget funds to subsidize certain categories of consumers as in the past, the new differentiated prices would offer a discount to the formerly-subsidized categories, while raising prices for other consumers. 2007 Budget Could be Worse, Absent Reforms -------------- ¶8. (SBU) Prospects for the 2007 budget were more worrisome, Pynzenyk said, than for the 2006 budget. The impact of any further rises in the gas import price was hard to predict. If energy costs wiped out corporate profits, the GOU would lose corporate income taxes. He suggested several areas ripe for fiscal reforms, although he said he did not know whether a Rada filled with rich deputies would pass them. His suggestions, some of which he had already raised with Ambassador (ref B),included the following: -- the gasoline excise tax was far below European levels and should be raised; -- the VAT exemption for agricultural producers, which made the Cargill VAT refunds so difficult, was an unbounded loophole -- Ukraine's simplified tax option for small and medium businesses, like the VAT exemption for agriculture, created a virtual offshore sector; and, -- the tax exemption on income from interest on bank deposits not only deprived the state of revenue, but attracted money away from the stock markets, which would remain undeveloped as a consequence. Guidance Request: Ukraine-Cyprus Double-Taxation Agreement -------------- --- ¶9. (C) Pynzenyk said that a non-standard double-taxation agreement with Cyprus made capital flight to that country to evade Ukrainian taxes a serious problem. As an example, he cited one company that purportedly paid 200 million UAH/year to a Cyprus subsidiary as a trademark license fee. Ukraine had sought unsuccessfully to revise its agreement with Cyprus to bring it in line with international practices. Now Ukraine would have to denounce the treaty. Pynzenyk said Ukraine would like U.S. support for such a move. Post would appreciate Department's guidance on how to respond to the Ukrainian request for U.S. support. Russia's Designs on Ukraine's Natural Gas Market -------------- --- ¶10. (C) Pynzenyk told DCM he did not anticipate that Ukraine and Russia would sign an intergovernmental protocol on natural gas trade, which some were predicting. What he feared, he said, was that GazProm would conclude an agreement directly with UkrHazEnergo, leaving out Ukraine's state-owned NaftoHaz Ukrainy altogether. (Note: UkrHazEnergo is the joint venture, half-owned by NaftoHaz and half-owned by RosUkrEnergo (RUE),that was set up after the January 4th Russian-Ukrainian agreement as the purchaser of gas imports from RUE. RUE, in turn, is half-owned by Russia's GazProm, and, nominally half-owned by two Ukrainian investors. End Note) ¶11. (C) Pynzenyk then suggested that UkrHazEnergo Board Chairman Igor Voronin represented GazProm's interests more than Ukraine's. Voronin is also Deputy Chairman of NaftoHaz, and was reportedly a key negotiator of the January 4th agreement that put RUE at the center of Ukraine's gas imports. Pynzenyk said "I don't understand how one person can sit at the negotiating table wearing three hats...UkrHazEnergo, NaftoHaz, and RUE, ...and perhaps a fourth (i.e. Gazprom)." Asked explicitly who was behind Voronin, Pynzenyk said quietly, "Russia." He concluded that what was at stake was not Ukraine's energy supplies, but Ukraine's sovereignty. DCM reminded Pynzenyk that the U.S. would work with Ukraine to increase its energy independence and to promote greater transparency in the energy sector. Taylor