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). -------------- SUMMARY: -------------- ¶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. -------------- A LOGISTICAL CHALLENGE -------------- ¶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. -------------- EXEMPTIONS AND SUBSIDIES -------------- ¶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. -------------- NO CONSEQUENCES FOR WTO VIOLATIONS -------------- ¶6. (C) IMF Resident Representative James McHugh said that he YEREVAN 00001142 002 OF 002 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. -------------- COMMENT: WORTH THE RISK? -------------- ¶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