RISKING A WTO COMPLAINT TO CURRY FAVOR WITH

C O N F I D E N T I A L SECTION 01 OF 02 YEREVAN 001142

SIPDIS

SIPDIS

DEPARTMENT PLEASE PASS TO USTR

E.O. 12958: DECL: 08/22/2016
TAGS: ECON ETRD AM
SUBJECT: RISKING A WTO COMPLAINT TO CURRY FAVOR WITH
FARMERS AT HOME?


Classified By: A/DCM Robin Phillips for reason 1.4 (b,d).

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SUMMARY:
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1. (C) The GOAM has announced that farmers with an annual
turnover of less than AMD 8 million (USD 20,000) will remain
exempt from value-added tax (VAT). This agreement appears to
run counter to Armenia's WTO obligations and 2002 legislation
requiring that farmers begin paying VAT as of January 1,

2009. A Deputy Trade Minister told us that a minimum
threshold and agricultural subsidies were permissible under
Armenia's WTO commitments, but suggested that the threshold
was set for political rather than economic reasons. We
believe that the majority of Armenian farmers will fall below
the USD 20,000 threshold and will remain exempt from VAT if
this limit is enforced. END SUMMARY.

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A LOGISTICAL CHALLENGE
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2. (SBU) As part of its WTO accession in 2003, Armenia agreed
to begin charging VAT in the agricultural sector. Since
accession, the GOAM has raised concerns about the logistical
challenge of collecting VAT from small-scale farmers.
Indeed, estimates by the USAID-funded Tax Improvement Project
are that the costs of agricultural VAT collection would far
outweigh the financial benefits. The head of the Tax
Improvement Project pointed out, however, that VAT collection
was important as a matter of tax equity, rather than
efficiency, and that uniform collection would help Armenia to
develop a culture of tax compliance. And, of course, food
imports are charged VAT which makes the domestic exemptions
discriminatory trade practice.


3. (U) The new threshold was announced by President Kocharian
and the Minister of Agriculture and seems to have sparked off
a debate between various government ministries. One week
after the announcement, Kocharian chaired a meeting of the
Ministries of Agriculture, Finance and Trade and the State
Tax Service to further discuss the issue. According to press
reports, at that meeting Kocharian tasked the Ministry of
Agriculture to develop a complete proposal more in-line with
Armenia's WTO obligations.

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EXEMPTIONS AND SUBSIDIES
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4. (SBU) Deputy Minister of Trade and Economic Development
Tigran Davtyan told us that, despite appearances, this
decision did not violate Armenia's WTO commitments and was
permissible under existing law. He said the 2002 law which
set the January 2009 date did not address agricultural VAT
administration and therefore, left open the possibility of
setting a minimum threshold, which he described as common
among WTO member countries. Davtyan said the GOAM planned to
pay subsidies (within the WTO limit of 5 percent of domestic
agricultural output) to affected farmers above the threshold
to help offset VAT costs. (NOTE: According to the available
records at post, subsidies were discussed during the
accession agreements, but a minimum threshold was not. By
exempting such a large swath of the farm economy from VAT,
the GOAM is able to apply the full WTO-authorized subsidy to
wealthier farmers, compromising the spirit of a permissible
subsidy. END NOTE.) Davtyan cautioned, however, that the
threshold may change by late 2008, implying that the USD
20,000 minimum may have been set for political rather than
economic reasons. (NOTE: Armenia's next presidential election
is scheduled for 2008. END NOTE.)


5. (SBU) Davtyan also pointed out that a high percentage of
rural Armenians are small farmers, many in remote areas. Not
having a threshold to exempt the smaller producers would
require the tax authorities to hire hundreds of new tax
inspectors and post them in remote mountaintop villages
across Armenia. This would be a costly and inefficient
intrusion of the national government into village life, while
also creating myriad new opportunities for petty corruption.


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NO CONSEQUENCES FOR WTO VIOLATIONS
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6. (C) IMF Resident Representative James McHugh said that he

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was not surprised to see the GOAM moving away from its
agreement to collect VAT in the agricultural sector. He said
the GOAM had been "breaching its WTO commitments from day
one" and would likely continue to do so. The problem,
according to McHugh, is that there is very little incentive
for other WTO members to complain about Armenia's behavior.
He cited the Armenian customs service in particular,
suggesting that the international community's failure to
bring Armenia before the WTO on customs issues, where there
are frequent and flagrant violations of WTO standards (for
example, Armenia's continued practice of using reference
pricing rather than transaction pricing for imports) had set
a precedent allowing the GOAM to believe that it could
blatantly disregard its commitments without consequences.

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COMMENT: WORTH THE RISK?
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7. (C) With elections fast approaching and legitimate
concerns about the logistics of agricultural tax collection,
it is not surprising to see the president trying to find away
around this particular WTO commitment. The USD 20,000 limit
combined with agricultural subsidies would shield the vast
majority of the Armenian agricultural sector in a manner
likely to be found discriminatory under the WTO. Given that
Armenia has until January 1, 2009, to implement agricultural
VAT, however, the GOAM could recover by changing its policy
after the 2008 presidential election to bring it back into
WTO compliance. For the time being, the GOAM appears willing
to risk an unlikely complaint in the WTO in order to curry
political favor with farmers at home. That said, Davtyan's
pragmatic arguments against vastly expanding the tax
inspectorate into every mountaintop hamlet and village market
also have logic on their side. Our next step is to seek
better data on the total market share of producers beneath
the proposed VAT threshold, and to work with the government
to strike the right balance between meeting its free trade
commitments, while not violating common sense in its tax
administration.
EVANS