GOVERNMENT RECONSIDERS AMOUNT OF TAX FOR ENERGY USE

C O N F I D E N T I A L REYKJAVIK 000202 SIPDIS TREASURY FOR MYERS AND NORTON NSC FOR HOVENIER COMMERCE FOR DERSTINE E.O. 12958: DECL: 11/10/2019 TAGS: ECON EFIN IC PGOV PREL SUBJECT: GOVERNMENT RECONSIDERS AMOUNT OF TAX FOR ENERGY USE REF: A. REYKJAVIK 191 ¶B. REYKJAVIK 176 Classified By: CDA SAM WATSON FOR REASONS 1.4 (B) AND (D) ¶1. (C) SUMMARY: Recent actions by the government of Iceland (GOI),including a proposal to introduce a significant energy tax in the 2010 budget bill (reftel B),have raised concerns about the current environment for foreign investors. Implementing significant tax increases ex-post-facto, for example, could disadvantage American companies currently operating in Iceland and significantly hinder Iceland's ability to attract needed foreign direct investment (FDI). Over the past few weeks, the Charge d'Affaires (CDA) has conveyed such concerns to various high-ranking members of the GOI including: representatives in the offices of the Prime Minister and President as well as the Ministers of Economic Affairs, Environment, Finance, Foreign Affairs and External Trade, and Industry. GOI officials appear to understand the message and assured CDA that Iceland wants to take steps necessary to attract FDI while also taking into consideration the nation's fiscal challenges. Now the GOI has, in fact, walked back the proposed energy tax and is engaging industry leaders in the process. END SUMMARY. The Aluminum Industry -------------- ¶2. (C) The aluminum industry has been ONE of the more vocal opponents of several recent GOI actions and expressed concern that the GOI wants to kick it out of the country. In recent months, government decisions have resulted in the cessation of plans to build a smelter in Bakki and a delay in construction of a new smelter in Helguvik. Plans to expand a third smelter in Straumsvik are also being called into question. In addition, the first draft of the 2010 budget bill proposed implementing an energy tax of ONE ISK per kWh (0.8 cents) for electricity usage. This proposed tax has generated anger among many businesses, but particularly the aluminum industry because it chose to locate in Iceland for the low power costs and it accounts for about 80% of the country's electricity consumption. Executives from the two American-owned aluminum smelters, Alcoa and Century Aluminum, expressed concern to CDA that such action could violate their existing investment agreements and significantly reduce the companies' profitability. They estimate the tax at ONE ISK per kWh would create an additional expense of 13.2 billion ISK ($106 million) per year. Equally troubling, said aluminum representatives, is that they first learned about the proposed tax in the newspaper. Communication with the government, they complained, has been virtually non-existent since the new government (with the pro-environment anti-aluminum Left Greens as a partner) took control earlier this year. ¶3. (C) GOI officials across the board, including the Minister of Environment Svandis Svavarsdottir, have told CDA that they do not want the aluminum companies to leave Iceland. All recognize the importance of this sector as ONE of the country's largest employers and largest export industries. (Note: the aluminum industry accounts for almost 42 percent of exported goods and 29 percent of overall export revenues for Iceland. End note.) Their size and importance is ONE reason the aluminum industry should not be excluded from rebuilding the country, said Minister of Industry Katrin Juliusdottir. Minister of Finance, Steingrimur Sigfusson, also acknowledged that it would be healthy for some aluminum projects to go forward as they would create additional jobs and revenue for the state. (Note: the Minister of Finance was referring to continuation of projects already under way - construction of a new smelter for U.S. company Century Aluminum and expansion of the Swiss-Canadian Alcan smelter. End note.) Justification for Tax Increase -------------- ¶4. (C) The Minister of Economic Affairs, Gylfi Magnusson, told CDA that increasing tax revenue is essential to close the fiscal gap and stimulate the economy. He noted that the tax base has eroded in the last year, especially in the corporate sector. Aluminum companies argue that the proposed energy tax of ONE ISK per kWh (0.8 cents) targets the industry unfairly and will force the businesses to cut back on operations. (Note: this tax would apply to all consumers of electricity, not just the aluminum industry. Aluminum companies, however, would shoulder the majority of the tax burden since they utilize about 80% of the nation's electricity. End note.) Minister of Industry Juliusdottir, however, asserted that the GOI will not allow taxes to suffocate industries. She and other Ministers told CDA that the ONE ISK per kWh (0.8 cents) mentioned in the first draft of the budget had merely been an example, but was too high. As of November 9, the GOI is proposing a tax of 12 aurar (0.1 cents) per kWh. (Note: Reykjavik households pay about seven to eight ISK (about six cents) per kWh for electricity, and the aluminum companies pay undisclosed lower amounts. Energy prices for aluminum firms differ based on agreements signed with the government. End note.) Finance Minister Sigfusson reiterated that all must share the burden of rebuilding the economy, and while aluminum companies may not be happy about it the GOI hopes the final solution will be considered fair. Foreign Minister Skarphedinsson assured CDA that he was working to broker a compromise that would enable the firms to continue to operate in Iceland and not close off potential future investment into the country. Future Direction -------------- ¶5. (C) The GOI recognizes the importance of creating a more comprehensive, standardized environment to attract FDI. Minister of Industry Juliusdottir told CDA that she intends to create a clearer, more general framework for FDI rather than negotiating with companies on a case-by-case basis. Investors should know what to expect, she said, regarding the legal environment, financial environment and taxation. Simultaneously, Minister of Finance Sigfusson is working on creating a long-term vision for the country's future development. He acknowledged the need to harmonize incentives and the duration of investment agreements, and is considering introducing possible deductions for new investment and incentives for start-up periods. Last week, Sigfusson introduced two bills to parliament providing incentives for Icelandic high tech and research and development companies. Comment -------------- ¶6. (C) GOI officials understand the importance of FDI in rebuilding the nation's economy. Though the government has been slow to implement changes to create an attractive investment climate, it recognizes that steps need to be taken to attract, or keep, investment. Plans to create a clearer, comprehensive framework for FDI and to introduce incentives are two examples. In addition, as CDA stressed in meetings with the Ministers, it is important that key industry players be included in process. The government appears to have accepted the notion as several aluminum representatives, who earlier approached the Embassy in frustration after being kept out of the discussions, recently thanked the Embassy for getting them a seat at the table and nudging the government away from the initial tax proposal. The reduction of the proposed energy tax from ONE ISK (0.8 cents) to 12 aurar (0.1 cents) resulted from consultative talks between the GOI and the Association of Icelandic Employers, of which the aluminum companies are the largest members. While current plans and proposals are still subject to change, the ideas under consideration and initiation of dialogue are steps in the right direction for U.S. firms. End comment. WATSON