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)

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Summary
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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

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P&G Tax Case
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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.

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How to Win a Tax Case in Russia
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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.

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Comment
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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