BACKGROUND ON DOE RUN'S TAX DISPUTE

UNCLAS LIMA 02056 SIPDIS SENSITIVE SIPDIS DEPT FOR WHA/AND, WHA/EPSC, EB/IFD/OFD, EB/CBA, EB/IFD/OIA TREASURY FOR OASIA/INL, DO/GCHRISTOPOLUS COMMERCE FOR 4331/MAC/WH/MCAMERON USTR FOR BHARMAN E.O. 12958: N/A TAGS: EINV ECON ETRD PGOV PE SUBJECT: BACKGROUND ON DOE RUN'S TAX DISPUTE Ref: 05 Lima 4228 Contains Sensitive Business Information, not for Internet Distribution. ¶1. (SBU) Summary. While the GOP has resolved many of the outstanding commercial disputes with U.S. firms, Doe Run Peru continues to have significant differences with SUNAT (the tax agency) over tax assessments. The dispute focuses on three central points: first, whether Doe Run was entitled to revalue its assets after its 1997 merger with a Peruvian company; second, whether the revaluation of assets was done correctly; and third, whether the company qualified for Value Added Tax (VAT) rebates on exported metal concentrates. SUNAT claims that the company owes more than $160 million in back taxes. The company disputes SUNAT's assessment. This cable outlines the steps underway to promote resolution. End Summary. Background on Tax Disputes -------------- ¶2. (SBU) In 1997, Doe Run Peru entered the Peruvian metal market after it merged with a local metal refining company in La Oroya. Since 2003, the company has faced challenges from SUNAT, Peru's tax agency, on three tax issues. ¶3. (SBU) "Economic Substance" Issue: In December 2003, SUNAT conducted an assessment of Doe Run, claiming that the 1997 merger had no economic substance. As such, Doe Run Peru should not have revalued its assets for the purposes of calculating depreciation. SUNAT assessed that Doe Run owed $9 million in fines and back taxes, reducing its income tax credit for 1998 from 32 million soles to 9 million soles. Doe Run contends that it has clearly demonstrated the economic substance of the merger and therefore was eligible to deduct for tax purposes. In December 2004, SUNAT, after reviewing Doe Run's 1999-2001 income taxes, assessed the company with additional fines. The company filed several appeals against SUNAT's assessments. As of December 31, 2005, Doe Run's tax liability for the 1998-2001 assessments was estimated to be more than $110 million. ¶4. (SBU) Correct Reevaluation of Assets: SUNAT has lost several high profile cases where it argued that the merger of privatized companies with the new foreign operator's firm lacked economic substance. For that reason, SUNAT offered to drop that claim against Doe Run if the company agreed to have CONATA, the Peruvian Appraisal Agency, conduct a binding valuation of the company's fixed assets. According to Bruce Neil, President of Doe Run, the company decided in February 2006 to hire CONATA to evaluate 10 percent of the company's holdings as a test. The results were lower than Doe Run's own appraisal by 30 percent. Neil reported that the CONATA appraisal valued the company's assets individually (as one would do in a liquidation) rather than as part of an integrated profitable enterprise. He has requested that CONATA conduct an integral assessment, which Neil believes would provide a higher value of Doe Run's assets. Doe Run has not yet accepted SUNAT's offer of a binding CONATA appraisal. Neil explained that the company is interested if CONATA falls within its ballpark because Doe Run is considering major new investments in Peru. He does not believe the company's board will approve the investment plan until tax liabilities have been clarified; Using a CONATA appraisal would resolve the depreciation dispute faster than going through the courts. (Note: While the assessment of assets dispute is, on face, similar to Luz del Sur's case (reftel),Doe Run's situation is distinct. U.S.-owned Luz contracted for three separate independent evaluations and used the most conservative; Doe Run conducted one. It is unclear whether the Doe Run appraisal is a conservative or aggressive valuation. End Note.) ¶5. (SBU) Application of VAT: In September 2004, as a result of Doe Run's request for a VAT credit, SUNAT conducted a full audit of Doe Run's January-July 2004 tax documents, inquiring why the company did not pay VAT on some zinc and copper sales. Doe Run used a different system for the sale of concentrates and refined metals than most (though not all) refiners. This gave rise to a highly technical dispute about whether the sales were "domestic" (which do not qualify for VAT rebate) or "export" (which do.) In November 2004, SUNAT assessed that Doe Run owed more than $2.2 million in back VAT payments and offset this amount against the refund for VAT credit. SUNAT then began an audit of Doe Run's VAT documents dating from 1999-2001. As of December 31, 2005, Doe Run has an assessed VAT liability of $44 million for the years 1999-2001. In January 2006, SUNAT began another tax audit of Doe Run, this time for the 2002-2003 period. This audit is still in process. While the audits continue, SUNAT refuses to grant Doe Run credit on VAT refunds, which total more than $100 million. Where The Cases Stand Now -------------- ¶6. (SBU) According to Patricia Paz Soldan, Doe Run Peru Vice President for Legal and Institutional Affairs, the company is not required to make any payments on the income tax assessments while the case is in administrative appeal. Doe Run, coordinating with Peru Disputes Coordinator Aurelio Loret de Mola, continues to work with CONATA on the methodology to assess Doe Run's assets. ¶7. (SBU) The Ambassador, during a meeting with Prime Minister Pedro Pablo Kuczynski (PPK) on May 9, raised the Doe Run tax issues. On the income tax issue, Ambassador Struble requested that CONATA consider Doe Run's proposal that the assessment value the company as a functioning, integrated business. On the VAT issue, PPK noted that this may be the easiest problem to resolve, as many companies face the same VAT problem with SUNAT. The Ministry of Finance is in the process of drafting a Supreme Decree that should resolve the issue. Timing Issues -------------- ¶8. (SBU) As noted earlier, Doe Run is considering a major expansion of its La Oroya smelting facilities and wants these tax issues resolved before it goes to the board for approval. Bruce Neil informed the Ambassador that the company is trying to use the U.S. Congressional consideration of the free trade agreement to drive resolution by June. Doe Run has urged the Missouri delegation to vote against the FTA unless the issue is resolved. ¶9. (SBU) The Peruvian Government recognizes the urgency of the Doe Run case, but almost certainly cannot put it to bed in June. Disputes coordinator Loret de Mola is working with CONATA to redo the appraisal of Doe Run's assets, which may take several months. Once the appraisal is complete, the case goes back to SUNAT to determine any back taxes owed by Doe Run. It is unclear whether SUNAT, an autonomous agency, will issue its decision in a timely fashion, although the GOP will urge a quick decision by SUNAT. The Ministry of Finance is currently working on the Supreme Decree that will resolve the VAT issues; it is possible that the decree may be issued by June. STRUBLE