P&G TAKES ON THE TAXMAN AND WINS VAT CASE

C O N F I D E N T I A L MOSCOW 001432 SIPDIS STATE FOR EUR/RUS, EEB/IFD TREASURY FOR TORGERSON DOC FOR 4231/MAC/EUR JBROUGHER NSC FOR WARLICK FRANKFURT FOR IRS ATTACHE E.O. 12958: DECL: 05/21/2018 TAGS: EFIN ECON RS SUBJECT: P&G TAKES ON THE TAXMAN AND WINS VAT CASE Classified By: CDA Daniel A. Russell, reasons 1.4 (b) and (d) -------------- Summary -------------- ¶1. (C) On April 28, Russian tax authorities cancelled a $28 million back taxes claim lodged against Procter & Gamble Russia in late 2006. The case involved royalty payments to P&G's headquarters for trademarked brands sold in Russia, which the GOR'S tax authorities disputed as a legitimate deductible expense. The international business community followed the case closely for its precedent value. P&G's win was due to their low-key meticulous approach and their successful lobbying of Deputy Prime Minister Kudrin with the Embassy's help. End Summary -------------- P&G Tax Case -------------- ¶2. (SBU) Since entering the Russian market in 1991, P&G estimates that it has paid more than $1.2 billion in taxes and has donated more than $5.5 million to charitable causes. According to Victor Kramerenko, P&G Russia's External Relations Director, the company has frequently had problems with tax authorities over the last 17 years, undergoing regular, rigorous audits. He said this has sometimes resulted in the discovery of errors requiring payment of back taxes and penalties, but more often the company has disputed investigators' findings, appealing through regular Federal Tax Service procedures or, when necessary, going to court. ¶3. (SBU) Kramerenko told us the most serious tax case began at the end of 2006 when, based on a review of expenses P&G deducted during 2003 and 2004, a branch of the Moscow office of the Federal Tax Service determined that the company had underpaid approximately $55 million in value added taxes (VAT). Claiming P&G Russia had improperly paid royalties for the use of certain trademarks to P&G headquarters in the United States, the Service argued this expense was "not economically justified" on the grounds that P&G Russia was involved in the distribution, not the production, of the trademarked goods. ¶4. (C) Kramerenko and other company employees told us they were initially surprised at the large assessment. However, the company believed its accounting was fully in accord with prevailing international standards and was confident it would 
prevail on appeal to higher tax authorities. Financial executives were shocked, therefore, when discussions between the firm and more senior tax officials in late 2007 only reduced the amount owed to $28 million. ¶5. (SBU) The head of P&G Russia, Matthew Price, told us that the most disturbing aspect of the decision was that it endorsed the tax authorities reasoning with respect to royalty payments. Not only did this contravene accepted accounting practices, it put the company in jeopardy at risk of being hit for significant additional back payments for 2005, 2006 and 2007 as well. Adding to P&G's concerns, and those of the foreign business community writ large, in November 2007 the Supreme Arbitration Court refused to hear an appeal from Transmark/SABMiller regarding deductions of similar expenses to market foreign trademarked beers in Russia. -------------- How to Win a Tax Case in Russia -------------- ¶6. (SBU) Faced with a potentially significant tax bill and hoping to avoid a costly and protracted court case, P&G's approach was to meticulously follow all of the tax services required procedures for internal review and appeal. The company drew on its extensive experience and contacts to move the case forward, from one level to the next. According to Kramerenko, working level officials in both the Ministry of Economic Development and Trade (MEDT) and the Ministry of Finance readily agreed that the company's position on royalty payments was correct and that if the tax authorities won it would have repercussions with the foreign investment community. ¶7. (C) Kramerenko said these officials advised that it would be helpful to make Deputy Prime Minister Kudrin aware of the issue. The company subsequently asked for Embassy assistance. We reached out to the Ministry of Finance, laying the groundwork for P&G executives to meet with Kudrin informally on the margins of the Davos meeting in January where the company received assurances that its case would be reviewed appropriately. After several months passed with no resolution in sight and with an end-of-April deadline for filing a formal court appeal rapidly approaching, the Embassy again raised the issue with high levels of the Russian government, leading to a meeting between P&G executives and one of Kudrin's Deputies, Sergei Shatalov. ¶8. (SBU) On April 18, the Russian tax authorities cancelled the back-taxes claim. In de-briefing us afterward, a grateful P&G management said the key to resolving the case had been getting high-level GOR attention, which would not have been possible without the Embassy's attention and active support. -------------- Comment -------------- ¶9. (C) Business in Russia, like politics, is still highly personalized. Luckily,Kudrin and his ministry understood this complicated accounting issue and the chilling effect an adverse ruling could have had on foreign investment in Russia. RUSSELL