The Role of the Tax Systems of Ukraine, Russia and Kazakhstan in Attracting Foreign Investments: Comparative Aaalysis

by

VKTOR HOHOTS

A thesis submitted to the Faculty of Law in conformity with the requirements

for the degree of Master of Laws

Queen's University Kingston, Ontario, Canada

August, 2000

O Viktor Serhey Hohots, 2000

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Abstract

It is hard to undervalue the impact of foreign investments in a progressive

movement of transitional economies towards a fkee market economy. For this purpose, a

modernized and balanced tax system plays a central role in the improvement of the

general investrnent climate and attract more foreign investments.

Governmental monetary and fiscal policy and, particuiarly, tax policy can have a

major impact on the process of economic recovery of Russia, Kazakhstan and Ukraine. in

the market type economy, taxes play an important role in the distribution of income and

the allocation of resources, as well as have a decisive influence on the general economic

stabilization. The forms of taxation and the amount of tax burden make a direct impact on

the amount and structure of consumption and saving and, subsequently, on the arnount

and structure of foreign investments.

Of al1 the countries reviewed in this analysis, Kazakhstan has achieved the highest

success in improving its generai environment, prirnarily through the improvernent of its

t a system. Ukraine and Russia were not able to bring their tax systems to the Ievel of

simplicity, clarity and effectiveness of Kazakhstan, which has negatively affected their

cornpetitiveness in world capital markets. This study also provides for an analysis of

other factors influencing the general invrstrnent environment in these countries, including

the regulatory fiarnework, political and economic stability, currency regime, banking

system, labor resources, crime and infrastructure.

This study indicates that, in order for Russia and Ukraine to become more

cornpetitive in international capital markets and attract more investments into their

economies, it is increasingly important for these countries to M e r pursue the course of

improvement, stabilization and clarification of their respective tax systems. This task is

even more important for Ukraine, as far as it has to compete with the counbies possessing

enormous arnounts of natural resources, giving them an additional advantage in attracting

foreign investors.

Acknowledgments

First of all, 1 would like to express my most sincere gratitude to a distinguished professor

and expert in the Canadian and international taxation, my supervisor, professor Alex

Easson for his unconditional assistance, encouragement, continuous support and guidance

throughout the process of execution of this thesis.

1 also owe my special gratitude to the professor and coordinator of the graduate program

Sheila McIntryre, as well as professors Phil Goldman, Catherine Lahey and David

Mullan for their constant support and help with my work and studies. My special thanks

to the graduate assistant, Phyllis Reid, who was always there for me when 1 needed any

help.

While 1 feel deeply privileged and honored to be able to work and leam fiom these

wonderhl people, 1 alone, bear the responsibility for any shortcomings that this work

might have.

Table of Contents

Abstract

Acknowledgment

Table of Contents

1. Introduction

II. Detenninants of Investments C h a t e

A. Regdatory Framework Effecting

General Investment Environment

B. Political Stability

C. Economic Stability

D. Currency Regime

E. Commercial infiastructure and Banking System

F. Labor Resources

G. Crime and Corruption

H. Infrastructure

1. Tax system

III. Investment Climate in Russia

1. General Outlook

2. The System of Taxation in the Russian Federation

A. Interrelationship Between the Federal and Regional Budgets

B. Broadening the Tax Base

C. Federal Taxes

i) Profits Tax ii) Persona1 Income Tax

iii) Payroll Taxes

iv) Value Added Tax

v ) Excise Tax vi) Royalties

vii) Customs duties

viii) Replenishrnent and Environmental taxes

ix) Securities issuance tax and royalties

X) Road Fund taxes

xi) Stamp Duties

xii) Federal License Fees

D. Regional and Local Taxes

i ) Tax on the Property of Enterprise

ii) Sales Tax

iii) RoadUsersTax

iv) Educational Levy

V) Advertising Tax

vi) Tax on the Maintenance of Housing

Facilities and Land Duty

vii) Tax on Maintenance of Police Force

E. Double Taxation Treaties

3. Regulation of the Energy Sector

1. General Outlook

2. Taxation of the Energy Sector

IV. The General Investment Environment in Kazakhstan

1. General Outlook

2. System of Taxation in Kazakhstan

A. hrational Taxes

i) Corporate Incorne Tax

ii) Persona1 Income Tax

iii) Value Added Tax

iv) Registration Fee for Issue of Securities

v Customs and Excise Duties

vi) Minerai Resources Tax

vii) Payrolt Taxes

B. Local Taxes

i ) Land Tax

ii) Property Tax

iii) Vehicle Tax

iv) Business Registration Tax and the Fee to

Conduct Certain Businesses

V) Road Tax and Fee on Auction SaIes

C. Double Taxation Treaties

3. Energy Sector

A. General Outlook

B. Taxation of the Energy Sector

V. General Investment Environment in Ukraine

A. General Outlook

1. System of Taxation in Ukraine

A. National Taxes

i)

i i)

iii)

i v)

v

vi)

vi i)

viii)

ix)

x

xi)

xii)

xiii)

Corporate Incorne Tax

Persona1 Income Tax

Value Added Tax

Excise and Customs Duties

State Duty and Stamp Duty

Payroll Taxes

State Innovation Fund

Road Tax and Vehicle Tax

Land Tax

Natural Resowce Tax and Environmental Tax

Foreign Vehicle Transit Duty

Rent Tax and Tax for a Sale of FueVIubricants

Trade License

B. Local Taxes and Duties

C. Double Taxation Treaties

2. Energy Sector

A. General Outlook

B. Taxation of the Energy Sector

VI. Possible Lmprovements

1. Russia

2. Kazakhstan

3. h a i n e

VII. Conclusion

Bibliograpby

VITAE

vii

1. Introduction

For the economies of Russia, Kazakhstan and Ukraine the way out of the

economic crisis is directly comected to the reform of their tax systems, which would

ensure a stable inflow of budget revenues necessary for the state to filfil1 its functions.

AIso, a modernized and balanced tax system plays a central role in the improvement of

the general investrnent climate and heips to attract more foreign direct investments

drastically needed for modemizing and restructuring the econornies of those countries.

Foreign presence has a long history of existence in Russia, Ukraine and

Kazakstan, but active promotion of foreign investments by their governrnents has only

begun after the collapse of the Soviet Union. It has become obvious that neither country

has enough national savings at the current stage of its development to promote

sustainable growth. Al1 the countries equally need maximal inflow of foreign capital and

technology to be able to overcome the consequences of economic failure lefi by the

system of central planning and to facilitate transformation to a fiee-market economy.

Extemal resources must be attracted in the form of foreign investments, including direct

investment, portfolio investments or loans.'

Foreign direct investments (FDI) seem to be the most attractive form as they

would not only help to improve the balance of payments and the development of export

capabilities of different spheres of industry, but would also provide an infusion of outside

capital, technology, and expertise, and create jobs for domestic suppliers and

subcontractors. FDI is very attractive as a non-debt creating source of current account

finance, and more broadly as an indicator of growing international confidence in a

country's sustainability of the entire process of economic reform. A steady flow of FDI

would improve confidence of investors since al1 of the world's major credit rating

agencies include it among their indicators of international creditworthiness.

It will be argued in chapter II that the current share of accumulated FDI by

Kazakhstan, Russia and Ukraine was largely due to the early and successfûl introduction

of !he econornic and tax refonn by the respective countries. FDI volumes of Russia,

Ukraine and Kazakhstan will be compared with other foxmer Soviet Union Republics and

Eastern European countries. It will be argued that the countries that have accumulated the

greatest share of FDIs invested into the region were able to do so because they had started

reforming their tax systems earlier and more broadly.

Governmental loans should also be attracted because they have their positive

input in economic development. However, as a regular borrowing, govemmental loans

have their pnce and limits. Investors' attitude can also become negative especially when

emerging economies experience economic decline or crisis, which will make borrowing

more difficult and e ~ ~ e n s i v e . ~ Portfolio investments should be equally attracted, but they

can bring a high volatility to the market by bringing prices to extremely high levels when

the market is on a rise, and abandoning the market altogether, liquidating their shares at

any cost, what can be devastating especially in case of emerging markets like in Russia,

Ukraine and ~azaks t an .~

Business Information Service for the Newly Independent States (BISNIS),"Commercial Overview of Kazakstan". Ch. 2, December 1999, on-line (BISMS Main) ~hnp:iiwufw.bisnis.doc.gov~bisnis/country/kazakStan.hmi~ ' Emerging markets Group, "Commenrs" , Introduction, on-line: (Kazakhstan I-ferald Main) < h t r p : / / w w w . h e r a l d . a s d c . k z / p u b l i c / r e s e ~ ~

hid .

The markets of these countries attract foreign investors with their immense wealth

of mineral resources, expansive consumer market, and cheap though highly educated

labor forcea4 Even though there are various secton pnoritized by the governments of each

specific country, including infrastructure, riianufacturing, social sector projects, and

agriculture, investments in minera1 resources accounts for a major part of the overall

volume of capital inflow received by Russia and Kazakhstan for the last decadeS5

The state of the investment climate in Ukraine is in need of major improvements

and is currently rated as being far behind the one in Kazakhstan. Also, there are a great

number of similar problems that both Ukraine and Russia have to overcome in the near

fùture in order to improve their competitiveness on the market of foreign investments.

Unlike the Russian and Kazakhstani economies, that are strongly backed up by vast base

of natural resources, the Ukrainian economy is largely dependable on the supply of

energy resources fiom outside (mostly fiom Russia), which drastically increases its

foreign debts and cnpples its budget spending capabilities.

Ukraine has also inherited a small and weak private sector, a burdensome

industrial sector with the emphasis on heavy industries, including industrial metallurgy,

machinery-building and the agricultural sector crippled with the inefficient and dragging

process of privatization. Currently, Ukraine does not possess any particularly strong

sectors that would give it any cornpetitive advantage over Russia and Kazakhstan, which

are also actively involved in the campaign of attracting foreign investments.

-

See "Commercial Overview ofKazakhsran", Business idormation Service for the Newly Independent States, October 1999, on-line: (BISNIS Main) http://wv/w.bisnis.doc.gov/bisnis/co~ kazakhstan.htm> See also Frenkel W. and Sukhrnan M . "New Foreign Investment Regimes o/Russia and Orher Republics of rhe Fornier USSR: A Legislutive Analysis and Historical Perspective", Boston College of International and Comparative Law Review, Swnmer 1993, no. 16, p. 400 on-line: WL(BC1CLR)

In Russia and Kazakhstan the developing oil and gas sector has emerged as the

most capable one of integrating into the global economy. The share of the oil and gas

sector in overall exports of the Russian Federation constitutes about 45 %, an3 accounts

for about 60 % of foreign currency flow and 20 % of GD P.^ The same importance of

energy and mineral sector plays in the economy of K d s t a n , where even during the

time of a drop in world oil pnces, the export volumes were increased by Kazakhstan to

the point that revenue fiom export of oil and mineral products reached S7.854 billion.' It

accounted for 47% of al1 cumulative investment into the repubiic for the period from

1993 to 1998, and 82% in the first quarter of 1999.'

However, the system of taxation of the sector has not been properly refined and

even today it uses obsolete fiscal methods that do not consider financial results of the

companies. and imposes heavy taxation rates.9 According to a number of tax analysts, the

current tax systern of the Russian Federation, which was laid in 1991 is dramatically

confusing, and what in conjunction with other factors, such as political instability, scale

of bureaucracy and crime, and high levels of capital flight, makes the investment climate

extremely unfavorab~e.'~ Since the tax reform in Russia started, the initial package of tax

laws, necessary to support economic reforms and establish the market economy in the

country, was repeatedly changed and modified by various branches of the state power,

' See "The hvesrmenr Ciintore in Russia", Expert Institute, Ernst & Young, 1999, see Summary and Ch. 2.13. See also Gialdini L., "Kazakrtan Lisrs Prioriry Secrors for /nvesrment", International Taxation. lufy 15, 1997, on-line: WL (WTD)NEW See "The fnverrntent Climare in Russia", E x p e ~ hstitute, Ernst & Young, 1999, Summary. See "Commercial Overview of Kazakhstan", Business Information Service for the Newly Independent

States, October 1999, Ch. 2, on-line: (BISNIS Main) ~http://www.bisnis.doc.gov/bisnis/counay/ kazakhstan.htm>

Ibid. Sarnoyieniio V., "Tax Reform in Russia: Yesterday. Today and in the Near Furure" International Tax and

Investment Center, on-line: (ITIC-CIS Main) ~http:f/inicnet.org/publications/Defaul?.htm~ ' O See "The /nvesrment Climate in Russia", Expert Lnstitute, Ernst & Young, 1999, Sununary.

Such fiequent changes created a situation of confusion for both tax inspecton and

<axpayen."

Both Russia and Kazakhstan are considered to be major players capable of

attracting most of the foreign investments flowing into the region.I2 Both countries have

suffered an economic downtum after the cnsis that took place in most of the Asian

economies, inc!uding Russia. However, the economic downtum in Kazakhstan for the

lasr few years was less severe than in ~ussia." Nevertheless, three quarters of the Kazak

exports go to Russia, and a severe devaluation of the Russian cuiiency dunng the crisis

senously hurt Kaz& economy as well as economies of al1 the other newly-independent

states in the region, including ~kraine. '~ This paper will argue the relative success of

Kazakhstan can be explained by a more favorable tax treatment that creates a better

i nvestment,

This paper wiII pursue two objectives. First, it will highlight the unique character

of the reform process of foreign investment laws in each of the states under review. It

will provide a general overview of the legal fiarnework created by the states envisaged to

attract foreign investments, focusing in particular on an analysis of tax regimes of the

respective countries in order to determine the extent to which each particular system

encourages foreign investments. It will be argued that on a basis of analysis of al1 the

foreign investment climate deteminants, and tax regimes in particular, Kazakhstan

appears to have achieved the best resuIts in providing foreign investors with the most

I I Samoylenko V., "Tm Reform in Russia: Yesterday. Today and in the Near Future" International Tax and Invesanent Center, on-line: (ITIC-CIS Main) <http://inicnet.org/pubIications/Defauit~ " Collins S., "Narural Resources and Investment Potenrial Lure US Firms to Kanakhstan", Central Asian Hot Spot Senes, Aspen Law and Business, November 1995, on-Iine: (ITIC-CIS Main) ~http://inicnet.org/publications/Default.htrn~ '' See "Central Asia, Caucasus Performed Better in 1998 than Russia. Ukraine", on-line: (Kazakhstan Herald Main) ~hnp://~w.herald.asdc.kz~pubIic/researccomen 1 O . h d >

stable general foreign investrnent climate. Based on the results of the study, it will be

demonstrated that both the Russian Federation and Ukraine have to deal with numerous

obstacles, such as burdensome and ambivalent tax systems, political instability, lack of

modem infiastructure, weak banking systems, bureaucracy and crime. However, the

Russian Federation has been able to attract more foreign direct investments, not because

it has been able to provide a better overall investrnent climate, or because of its size, but

because of the major inflow of investments in the energy and minera1 sectors. l5

From the other side, Ukraine, does not possess such a rich natural resources base

as does the Russian Federation, and it will be argued that the only way for Ukraine ta

strengthen its position on the international capital markets is to achieve significant

improvements in al1 the problematic areas. Such first steps have already been taken by

the main ian Parliament through the introduction of the new Tax Code of Ukraine on

June 20,2000.

Second, on the basis of findings, recommendations will be given on what

rneasures should be taken to improve the taxation regime with the purpose of

improvement of the overall investing environment. Third, there will be mentioned

international obligations of al1 three countries in the area of avoidance of double taxation,

and specifically examining taxation of Canadian legal and physical persons conducting

business on their temtory under the appropnate double taxation treatie~.'~

IJ %id. " Sec "The lnverrment Ciirnate in Rurzia". Expert Institute, Ernst & Young, 1999, Ch. 2.13 16 International obligations of Russia, Kazakhstan, and Ukraine regarding taxation of Canadian enterprises and persons located and conducting business on their temtory wilI be only mentioned in general ternis

II. Determinants of the investment climate

1. Determinants of FDI

investors might decide to invest abroad for a variety of reasons, but the general

feature is a strive for maximization of their profits. They may also chose to invest in other

countnes for a purpose of diversification and minimization of their nsks, or if they need

to expend their market that became too tight for a specific business. Another reason for

decision to invest abroad would be availability of technology or know-how that gives

them an advantage over local enterprises in the foreign counties.

There are again a lot of reasons favoring investing abroad instead of exporting to,

or importing fiorn, other countries, or licensing their technology to firms in other

countries. An investor rnay choose to invest abroad as opposed to export its products

because it cm be more efficient, considering possible tariff barriers or transportation

costs. Another reason can be the nature of the product: it is not practicable to export

pastry, because it can be baked and sold having established a net of bakeries and shops

abroad. It can be more secure for investor to invest into production of a product abroad as

opposed to importing, because it might provide the investor with a better security of the

product's supply.

No matter what the real motives of the investor are, it appears that in addition to

the over-riding profit motive the principal objectives of most FDIs is either to gain:

- and extend the market for the product or service abroad; or

because of their individual nature and because they do not reflect the general national tax regime that is being the major focus of this comparative analysis.

- access to the natural or human resources located abroad, considering the higher level

of efficiency of investing abroad instead of their importation.

The final decision of the investor as to which country to invest in is generally based on

the overall assessrnent of the general investment ctimate of the country targeted for a

future investment.

FDI contributes to the transition and economic performance across the region in

three major ways. First, FDI rnay directly increase capital accumulation (even through

acquisition investments, capital accumulation tends to take place as part of modernization

and restructuring strategies. Second, it raises the productivity of the enterprise sector and

benefits export performance. Third, it generates technological and organizational benefits

for domestic suppliers and cornpetitors. In general, in the context of transition, FDI tends

to have a set of attributes that can contribute to forming market-onented institutions and

behavion. It does so through upstream and downsîrearn linkages and demonstration

effects. FDI pIays an important roIe in addressing the capital shortage related to low

dornestic savings and limited financial inter-mediation. For instance, in Kazakstan the

FDI into the energy sector contributed 27 % to gross fixed capital formation in 1997."

FDI can serve as the best indicator of a level of favourability of the general

investment environment. The concept o f 'investment climate' is related to the level of

'favorability' of conditions that rnay be made in the country (region, industry) in order to

attract investment~.'~ The investment climate can be evaluated on a b a i s of analysis of

17 "Easrent and Central European FDi Levels Up", news brief, East European Banker, Lafferty Publications Limited, June 1999, p. 2. 18 See "The Invesnnent CIimare in Russia", Expert Institute, Ernst & Young, 1999, Ch. 2.1.

the determining factors that facilitate investment climate and boost economic growth. The

overall assessrnent of investment climate is based on the following facto^'^:

a) the quality of legislation that regulates economic life and the level and effectiveness

of protection of foreign investrnent under the Iegislation;

b) stability of the political system, its predictability and ability to suppon an economic

transformation process;

C ) macroeconomics indicators, such as the condition of the budget, the balance of

payrnents, and state debt compared to GDP;

d) the general currency regirne and possibility of repatriation of investment profits;

e) the effectiveness and quality of the commercial infiastructure, banking system and

accessibili ty of borrowing;

f) a well-educated, technology-oriented labor pool;

g) crime and corruption

h) the state of transportation and cornunication infrastructure; and

i) the quality of the system of taxation and extent of the tax burden

Early and successful introduction of the economic and tax reforrn is directly

related to the increase of FDI inflow into the country. Table 1 demonstrates the

l 9 See "Comnrercial Overview of Ka=alrhsranV, Business information Service for the Newly independent States. October 1999, Ch. 2, on-iine: (BISNIS Main) ~http://www.bisnis.doc.gov/bisnis/cou~ kazakhstan.htrn> See also "The Intvsîment Climare in Russia", Expert Institute, Ernst & Young, 1999, Ch. 2.1.

countries of Eastern and Cennl Europa

! Czech Repubi~c Macedonia 1-

1 Poland

- Sources: EE

Table 1 Accurnulated Net Foreign Direct Invesmients for the period of 1989 to 1999

(In millions of U.S. dollars) -

Cumul Cumula- FDI FDI Former Cumul Cumula- FDI FD1 a-tive tive FDt inflow inflow Soviet a-tive rive FDI inflow inflow FDI inflow per Fer Union FDI inflow per F r inflow per capita capita Republics inflow per capita capita 1989- capita 1998 1 999 1989- capita 1998 1999 99 1989-99 99 1989-99 434 130 13 15 Russia 10.334 71 12 5 2.265 273 6 5 - 89 Ukraine 2.751 1 5 5 _ 15 1 O

I I I 1 1

1D (1 999) and World Bank ( 1999). !998 FDI Data estimated by EBRD."

indicators are projected in dollars per capita. This way the real input of investments is

reflected according to the size of the population of the respective country. Kazakhstan

was able to attract the highest per capita rate of FDI as compared to Russia and Ukraine.

This inference c m also be supported by the additional data in the table illustrating the

performance of a majority of the Central European countries (Hungary, Po!and and

Czech Republic) as well as Baltic States (Estonia, Lithuania and Latvia). Al1 the

mentioned countries started early in the transition and introduced comprehensive tax

reforms. Serious tax policy reforms in the Russian Federation and Ukraine did not take

pIace until the last half of the decade and the process was not completed until today.

'O European Bank of Reconstruction and DeveIopment "Transition Reporr Update". Economic transition in Central and Eastern Europe, the Baltic States and the CIS, May 2000, p. 15.

The focus of this work is on tax systems of the countries under review, but a brief

analysis of the non-tax factors mentioned in this chapter will be given.

A. Regulatory Framework Affecting the General Investment Environment

The importance of the clarity and effectiveness of the legal h e w o r k regulating

foreign investments as well as the overall economic activity within a country is hard to

underestimate. Since the moment al1 three countries started a process of economic and

legal reforms, the problems of vagueness of law, contradictory legal provisions and poor

implernentation remain the countries' key concerns.

Al1 specific problems and shortcomings of the legal systems of each of the

countries will be discussed in the following subchapters. However, for the purpose of a

better understanding of the major barriers to investments, this study will also rely on the

statistical ranking of the major factors-baniers of the legal systems of each respective

country. In al1 three cases the transparency of laws is perceived as the major legal barrier

Table 2. Legal System

(1 = most difficult aspect; 4 = least difficult)

to investment. The Pace of legal change is also a concern for investors, particularly in

Factors-barriers/ Countries Trmsparency of laws Technical temqarpon Pace of Icpl change

Russia and Ukraine. This difficulty in processing of changes in the legal systems also

-

'' Special Report of the international Tax and investment Center ([TIC), Moscow, June 1999.

RussiP

Sources: International Tax and investment Center (1999)"

1.73 3 1.82

hbrkhsran

1.92 2.92 2.33

Ukraine

1-83 2.93 1.83

implies a lack of development in the legal infiastruciure and may also be the problems of

bureaucracy and corruption existing in al1 three countries.

The fint significant achievement of the Russian govemment in attracting general

foreign investments was the adoption, in 1991, of the law on foreign investment~.'~ The

law included a number of important guarantees and privileges for foreign investors, such

as:

National treatment for foreign investors, except where specifically provided by law;

Guarantees against unlawfùl expropriation without proper compensation;

Simplified procedures of registration for foreign entities intending to conduct

business activities on the temtory of the Russian Federation;

Liberalized customs procedure for imports of equipment required for operation of the

business and expons of the produced products; and

The right to transfer abroad protits fiom the business activity.

The law became a clear indication of the intention of the Russian government to

prornote a liberalization of foreign investments, even though numerous decrees and

regulations have repeatedly modified it.

i i ) Kazakhstan

7 7 -- Law "On Foreign Investmencs in rhe RSFSR". Sovetskaya Rossiya, July25, 199 1.

Kazakhstan was the first of the three countries that was able to start fundamental

economic reforms directed towards the creation of the new regulatory system that would

help attract foreign investments to the country. These refoms include demonopolization,

privatization, debt resmicturing, banking reform, lifting profitability controls, trade

liberalization, setting an adequate govemment procurement process, tax and customs

reforms, etc.

Together with the significant progress that the Kazakhstan's Government has

made in implementation of the market refoms, there are some shortcomings and

deficiencies in the system. As it is in the case of Russia, although not to the sarne exient,

the laws and regulations in Kazakhstan are also subject to fiequent changes and

modification^.^^ There have been indications that attracting foreign investments is a

higher priority than supporting their presence in the country.24 The Government has also

been making promises that were not ultimately implemented. For instance, it promised

that the tendenng process would be conducted in an open and fair manner, though there

were a number of cases when tenders were issued just a week before the application

deadline, thereby limiting the cornpetition?

i i i ) Ukraine

Afier the collapse of the Soviet Union, Ukraine was the second largest republic in

terms of population and economic significance. Based on the analysis of its skilled work

23 BISNIS, "Commercial Overview of KmaWisran". December 1999, on-line: (BISNIS Main)

force, highly educated population and significant resources, a 1990 research done by

Deutsche Bank ranked Ukraine to have the best chances in successfiilly transfonning

itself into a modem market-onented ~ o c i e t y ~ ~

However, a very senous problem still lies with the tension between an

institutionalized bureaucracy still widely present in administrative echelons of the former

system, and a skeptical and impatient population awaiting credible and efficient

economic refoms and a legal environment that would secure and faciiitate domestic and

foreign investments. Thus, a market-oriented legal infiastructure is still at the early stage

of development in Ukraine. Fundamental regulatory mechanisms need funher

development in the areas of banking, corporations, securities reguiation and property

nghts in order to facilitate capital accumulation and financing techniques - two essential

elernmts for the development of a healthy and growing pnvate sector.

It has become increasingly obvious to intemal and extemal investmeni analysts

that the success in the transition of Ukraine to the market econorny will greatly depend on

the ability of the domestic legislator to provide an adequate legal infrastructure to create

and support an attractive and rewarding investment environment. The economy has

significantly suffered fiom huge deficits, inefficient state-run enterpnses, and high rates

of inflation, and it critically needs large inflows of foreign investrnents. To fil1 out the

conceptual and practical gaps created by an underdeveloped legal infrastructure and

discouraging investment climate, some fundamental legislation affecting the activities of

enterprises, business associations and foreign investments has been passed.

- -- -

'' BISNIS , "Investmenr Climate in Kazakhsran", December 1999, on-line: (BISNIS Main) <http://www.bisnis.doc.gov/bisnis/coun~/9808K07.han~ '' "The Soviet Union ar the Crossroaàs", Facts and Figures on the Soviet Republics, Deutsche Bank AG. 1990.

For the last decade, Ukraine has produced a substantial legislative body of

commercial, contractual and investment regulations. Many of the first laws in the

mentioned areas have gradually lost their contemporary importance and need to be

updated in order to cope with the developing business environment. The Ukrainian

legislative infrastructure also needs new civil and tax codes. The Russian and

Kazakhstani experiences have proven that a modem Civil Code would help to

significantly improve the overail legislative environment, especially in the areas of

contractual and commercial relations."

One of the first legal specialized reguiations targeting the establishment and

improvement of a favorable investment regime was the Decree No. 55-93 of the Cabinet

of Ministers of Ukraine "On the Regime of Foreign Investrnent", which came into effect

in June 1993. The decree originally provided for a 5-year tax holiday on profits for

enterprises with qualiQing foreign investments. However, the decree was consequently

repealed after the Ukrainian Parliament passed the new Law of Ukraine, " On the Regime

of Foreign Invesunent," in March 1996. The new law has established a variety of forms

and mechanisms for carrying out foreign investments in Ukraine, including the

mechanism of acquiring an interest in already existing companies in Ukraine or

establishg a new Company with a Ukrainian partner. The mechanism has also

estabIished rules and procedures for subsidiaries and branches wholly-owned by foreign

investors; the acquisitions of the rights to use land and/or concessions for the use of

" Paliashvili I., Presentation for the Country Focus Workshop on Ukraine and the 1998 International Conference on Contracnial Law and Agreements in Russia and the CIS, December 1998 on-line: (Russian ljkrainian Legal Group Main) chnp://www.rulg.com~

natural resources in Ukraine by foreign investors, independently or jointly with Ukrainian

legai entities or physical penons etc.28

However, one of the major cornplaints of the foreign investors regarding the

legislative system in Ukraine are its instability and constant modification. This instability

directly affects the investors' confiidence in b i n e ' s cornmitment to market reforms and

attract foreign investment. A good example of this destructive practice by the Ukrainian

Government is the recent change of the tegislation providing for tax holidays for foreign

investors. A 5-year tax holiday provided by the Decree "On the Regime of Foreign

Investments" of June 1993, was blatantly repealed by the Law "On the Taxation of the

Profits of Enterprises" of January 1, 1995. Such a practice bnngs considerable harm to

the trustworthiness of the Ukrainian general investment environment, and ultimatel y, to

the process of economic reform.

A. Political StabiIity

The existence of a stable political environment can also not be overlooked. War is

certainly very bad for development, what can be supported by the fact that 11 of the 28

econornies in EasterdCentral Europe and CentralEastern Asia have had amed conflicts

on their soi1 at some point of time during the last 10 years.29 Armed conflict between

Chechnia and Russia had a very detrimental effect on decision-making process of

foreign investors conceming fùrther investments in the country.

-- -

'' The Law of h i n e " On the Regime of Foreign Investment", of March 19, 1996, art. 3 09 "Cenrral and Eastern Europe: Conclusions", Janet Matthews Information Services, Quest Economic Database, June 1 1 , 1999, p. 24.

Another important factor was an ability of the national governments to obtain a

majority for successful launching of market and legal reforms. This problem has been

most apparent in Ukraine and Russia, where policy-makers have failed to take a

consistent line on the reforms. In Ukraine's Case Privatization is the obvious example,

with the presidential administration drafting various pnvatization prograrns, only to have

these stalled or thrown out by parliament, which had different objectives. In a case of

Russia, stability of market reforrns have been fatally disrupted by z constant tug-of-war

between the president, government, parliament and the economically powerful

'oligarchs'.

Among the three countries, Kazakhstan appeared as the only one capable of

attaining a political stability that allowed the President of the republic to obtain the

necessary political power to move the reforms ahead, even despite serious inter-ethnic

problems existing today in the country.

Opinion of foreign investors is also transparent in this regard. Foreign investors

were asked to comment on the question of the aspects of the political environment, which

constitute major barriers to the investing. The results produced proved that even though

Table 3. PoliticaI Environment

Sources: International Tax and ïnvesment Center (1999)~'

(1 = most difficult aspect; 4 = l e s t difficult)

- - - -- - - --

30 Special Repon of the international Tax and Investment Center (ITIC), Moscow, iune 1999.

Factors-bamers/countries Political environment

Russia 1 Ka=~khsîan 1 Ukraine 2.17 1 3.57 1 2-5

political stability is not the major obstacle to the investments, political uncertainly in

Russia and to the lesser extent in Ukraine has had an adverse effect investrnent potential

in both countries.

j) Russia

There are strong elements in Russian political circles supporting protectionism

which has aisen in response to a belief that free trade and foreign business activity in the

post-Soviet years has been a major cause of the industrial decline in the country. This

allowed some politicians to support policies of limiting foreign share holdings or property

ownership as well as increasing the tax burden on foreign bus in esse^.^' Also, there are

strong decentralizing tendencies among the republics of the Russian Federation for

political power and independence in carrying out economic and market ref~rms.~ '

The nationalization of foreign investments is prohibited by the Russian

investment regulations, except for nationalization following Iegislative action and where

deemed to be in the national interest. By law, such nationalization may be appealed to

the courts of the Russian Federation, and are to be paid with prompt, adequate and

effective ~orn~ensation. '~

i i ) Kazakhstan

j1 "Counrn? Cornniercial Guide: Russia", Fiscal Year 2000, Show Case Europe, U. S. Commercial Service, Ch. VIII. j7 This tendencies will be discussed in details in Ch. III.3.A. "Interrelationship Between the Federal and Resional Budgets".

The political situation in Kazakhstan continues to be the most stable of the

countnes under review? This can be explained that Kazakhstan is a constitutionai

republic with very strong presidency and the remainder of power divided among

executive, legislative and judicial branches of power. The president N. Nazarbayev is

considered to be a reform-oriented politician with far-sighted political vision and

pragmatic implementation. Political stability in Kazakhstan is usually considered to be a

result of his firrn grasp on power and ability to keep the opposition f?agmented. It is hard

to say whether Kazakhstan would remain as politically stable as it currently is without the

present market reform-oriented strong presidency.

Political factors, specifically questions of political stability and its influence on

the legislative consistency, deserve separate attention as they are important factors

influencing the decision-making process of potential foreign investors. Since Ukraine

became an independent state, it had suffered penods of political instability caused by

clashes between various political forces defined along the ethnic l i n e ~ . ~ ~

The population of the westem part of Ukraine has been actively supporting a

policy of doser integration with the westem economic and political organizations,

including EU and NATO. It also ardently supports the use of the Ukrainian language as

the only state language in the country, which has caused a wide and serious outcry in the

- -

'' "Countn. Commercial Guide: Russia", Fiscal Year 2000, Show Case Europe, U. S. Commercial Service, Ch. VILE. 34 Deerman A., "Kazakhsran: How a New Petroleurn Law Cm Fuel Economic Developrnent", Tulsa Journal of Comparative and international Law, Fall, 1993, Ch. 1, on-line: (WL)TLSJCIL

Eastern Russian-speaking part of the country. The language dispute has becorne a

fundarnent for a lot of other political and national priorities, including the dilemma closer

cooperation with Russia and the former CIS corntries, joining political and economic

organizations, including customs unions with the Russian Federation and the CIS

countries.

Al1 the above-mentioned political and linguistic disputes have had a senous

effect resulting in the split in the Ukrainian Parliament along the ethnicllinguistic and

political lines, and deprived the Parliament of a coherent consensus needed for adoption

of cornmencing of coherent economic and tax refoms.

In addition there still exists a strong communist opposition in the Ukrainian

Parliament, which strongly opposes any progress in economic reforms and closer

cooperation of Ukraine with the Western financial and political organizations. Policy-

making is still unpredictable, highl y complex, bureaucratic, and confiised, so there are

chances that any advances made would be reversed.

C . Ecorroniic Stabifiiy

The Russian crisis in 1998 not only threatened the output recovery across the

region, but also put renewed pressure on the stabilization policies of most countries. The

breadth and Pace of economic restructuring and stabilization has varied significantly

arnong the three countries. The available evidence suggests that the scope, speed, and

35 "Business Report on Ukraine", Business Euro, 1998 on-line: (Business -Europa Main) <hrtp://\w.business-europa.co.uk>

stability of economic policy reforms significantly influenced the ability of the countries

to re-establish economic growth (or limit the economic decline) during the transition.

Table 4 demonstrates the current state of the general govenunent balances in the

three countries. Significant declines in the current account deficit in 1999 in al1 three

countries largely reflect a decline in irnports brought into the countries. The dollar value

Table 4. General govenunent balances.

Sources: EBRD ( 1999) and World Bank ( 1999). !998 FDI Data estimated by EBRD."

of imports fell in al1 of the three countries between 1998 and 1999. Russia has been the

major market of Ukrainian and Kazakhstani products, and appreciation of Ukrainian and

Kazakhstani currencies vis-a vis the rouble (devaIued by the Russian cnsis) did not allow

the two countries to be able to recover the previous volumes of their exports to Russia.

On the other side, Russia has been able to take advantage of the rising world oil pnces

and recorded a large curent account surplus in 1999.

i ) Russia

Russia's balance-of-payrnents has increased since 1998 (see table 4). Russian

exports fell from $18.5 billion in the first quarter of 1998 to S15.6 billion in the first

quarter of 1999, and imports dropped caused by devaluation, from $18.3 billion in the

j6 European Bank of Reconstruction and Development "Transirzon Reporr Updare", Economic transition in Central and Eastern Europe, the Baltic States and the CIS, May 2000. p. 1 1.

first quarter of 1998 to 59.4 billion in the fint quarter of 1999." Exports are expected to

grow in the second quarter of 2000, due to stronger pnces for energy, greater

competitiveness of other C X ~ O ~ S . ~ ~ Low real income levels and the increased

competitiveness of lower-priced, domestically-produced import substitutes will be able to

constrain the inflow of imports.

The 1998 crisis has had a very negative impact on the inflow of investments.

Annual foreis direct investment into Russia fell fiom 54 billion in 1997 to $2.2 billion

in 1998 with portfolio investment falling even more sharply, from 9 17.3 billion in 1997

to S8 billion in 1 9 W 9 However, recent estimates predict that investments will nse in the

second quarter of 2000.~' Russia's officiai extemal debt is currently $152.4 billion, and

the Government has announced that it cannot meet its 1999 extemal debt payments of

S 17.2 billion and was able to pay only $9 bil~ion.'~ Russia missed scheduled payrnents in

19% to several international financial institutions, including London and Paris clubs."

i i) Kazakhstan

Kazakhstan has been ninning a trade deficit from 1992, which amounted in 1996

to S 752 million ( U S ) constituting roughly 3.5 % of GD P.'^ Government had to cut social

- - -

3 7 "Counfn Commercial Guide: Russia", Fiscal Year 2000, Show Case Europe, U. S. CommerciaI Service, Ch. IV. 38 Ibid. 39 Ibid. 4 0 "NIKoil Sees Major Inflow of Western /nvesfments ro Russia", Alexander's Gas and Oil Connections, VoI. 5. issue No. 7, A p d 27, 2000, on-line: <http://www.gasandoiI.com> 4 I "Counrp Commercial Guide: Russia", Fiscal Year 2000, Show Case Europe. U. S. Commercial Service, Ch. IV. " Ibid- 43 "Coun y Commercial Guide: Kazakhstan", FiscaI Year 1 999, Show Case Europe, U. S. Commercial Service, Ch. II.D., on-line: (SCE Main) <http://www.sce.doc.gov.>

spending during the Russian financial crisis, which seriously affected the Kazakhstani

economy. In 1999 the deficit was about 3.6 % of the country's GDP." The budget for the

year 2000 indicated inflation growth equal to 10 %. Recently, the balance of payments

was improved pnncipally due to the increase in world oil prices.45

Ukraine was able to renew its foreign reserves since the second half of 1999,

following a substantial drap in foreign reserves in 1998 that also caused an increase in

budget deficit and made obtaining of foreign financing more d i f f i c ~ l t . ~ ~ Ukraine's almost

complete reliance on imports of oil and gas was continuously pushing the trade and

current accounts into deficit since the country's independence." Ukrainian external debt

service obligations will constitute about $ 3.2 billion (US) in 2000, and the larger part of

it will be paid for oil and gas imports.

The budget deficit in 1997 was % 1.5 (US) billion, and was expected to increase as

a result of the financial cnsis in Russia, which negatively affected almost al1 the former

Soviet republics.48

U "Comntercial Overview of Kazukkrun" of December 1999, Business Information Service for the Newly- Independent States (BISMS), on-line: (BISNIS Main) <http://www.bisnis.com> " "Counq- Commercial Guide: Kazakhstan", Fiscal Year 1999, Show Case Europe, U. S. Commercial Service, Ch. 11-D., on-Iine: (SCE Main) <httpY///www.sce.doc.gov.> 56 "Counrty Commercial Guide: Ukraine", Fiscal Year 2000, Show Case Europe, U. S. Commercial Senrice, Ch. 11-D., on-line: (SCE Main) <http://www.sce.doc.gov.~ 47 "A Guide ro Doing B u i n a s in Ukraine" Department of Foreign Affairs and International Trade, Ch. 1.3. on-Iine: (DFAIT Main) <http://www.dfait-maeci.gc.ca>

ibid.

D. Currency Regime

The Russian crisis in 1998 not only dismpted the output recovery of its major

trading partners Ukraine and Kazakhstan, but also renewed pressure on their currency

stabilization policies. Table 5 demonstrates the end-year annual inflation rates for the

three countnes fiom 1992 to 1999 and a projection for 2000. Almost al1 countries in CIS

Table 5. Inflation

including Kazakhstan recorded an increase in inflation in 1999, which can be explained

by a lagged spill-over effect on prices from the currency depreciations that followed the

Russian crisis. In contrast, both Ukraine and Russia were able to bring their inflation rates

down. Russia was able to rapidly decrease the inflation fiom 84.5% in 1998 to 36.8% at

the end of 1999. ükraine decreased the rate only slightly fiom 20% in 1998 to 19.2 at the

end of 1999.

Although present inflation rates are not of any immediate problem for most

transition economies, al1 three countries face serious fiscal and curent account

imbaiances. Table 6 demonstrates that Russia and Kazakhstan were more successful in

bringins down the cument fiscal balances than Ukraine. In Kazakhstan the improvement

is

(change in year-end retaiWconsumer price level, in per cent)

t 9 European Bank of Reconstxuction and Development "Transition Report Update", Economic transition in Central and Eastern Europe, the Baltic States and the CIS, May 2000, p. 9.

Sources: EBRD ( 1 999) and Worid Bank ( 1999). !998 FDI Data estimated by EBRD."

1997 10.9 1 1.3 10.1

1 Counny/ycar Russia Kazakhstan Ukraine

ZOO0 projec-tion 20.0 8.8 20.0

1998 84.5 1.9 20.0

1999estirnau 36.8 18-1 19.2

1992 2.506 2.984 2-730

1993 840 2.169 10.155

1994 204.4 1.158

1995 128.6 60.4

1996 21.8 28.6

401.0 ] 181.7 39.7

Table 6. General Government Balances

due mainly to cutbacks in expenditure rather then enhanced revenues.51 Low revenue

collection remains pervasive in al1 three countries. Russia was able to improve its fiscal

balance mostly because of higher output and profits that led to revenue collection that

was 40% higher than expected. The improvement of the Russia's fiscal balance (on a

cash basis) was also due to non-payrnent of the government to some Wcstem creditors.

Table 7 demonstrates the attitudes of foreign investors towards the currency

policies of the Russian Federation, Kazakhstan and Ukraine. The investors were asked

Table 7. Fiscal regime

(1 = most difficult aspect; 5 = l e s t difficult) [ Factors-barriers/countries 1 Russia ] Kaskhsîan 1 Ukraine ! Cürrcncy control 1 3.18 1 4 1 4.4

Sources: International Tax and Investment Center (1999)5'

where the fiscal regime constituted the most formidable bamier to investing. Instability of

the currency rates seems to be most troubling in Russia, what can also be explained by

the general detrimental effects caused by the 1998 Russian cnsis. In general, currency

control factor does not seem to be the major impediment to investments.

50 European Bank of Reconstruction and Development "Trattsition Report Updaie", Economic transition in Central and Eastern Europe, the Baltic States and the CIS, May 2000, p. 1 1. 5 1 Ibid., p. 10.

The mbie is the only legal tender in Russia. Russian law provides for two major

types of operations with foreign currency: a) current operations, including importlexport

contracts and loans that do not exceed 180 days; and b) capital operations, including

investments, financiaI Ioans exceeding 180 days, and deferred import and export

payrnents for more than 90 days. Current operations have no limitations, while capital

operations generally require prior approval of the Central Bank of Russia (cBR).'~ The

New Tax Code of Russia also provides for ab les as the only tender that can be used on

the territory of the Russian Federation. It also requires that non-resident foreign

organizations and non-resident physical perrons may fiilfil1 their tax payment obligations

through the use of foreign currency se t t l emen t~ .~ Tax resident organizations are still

required to remit their taxes in r~bles . '~

Capital flight of hard currency out of the country is currently the major enemy in

the stabilization of the Russian currency. The CBR has substantially altered its exchange

rate policy and tightened its currency controls since the August 1998 financial cnsis.

Tighter controls have helped reduce capital outflows, thereby supporting the ruble? The

portion of the currency fiom export sale proceeds that is subject to mandatory conversion

52 Special Report of the International Tax and Investment Center (ITIC), Moscow, June 1999. 53 **Country Commercial Guide: Russia", Fiscal Year 2000, Show Case Europe. U. S. CommerciaI Service. Ch. II-D., on-line: (SCE Main) <http://www.sce.doc.gov.> 54 Tax Code of the Russian Federation of January 1 , 1999, General Part, Chapter 8, an. 45.3. 55 Ibid. 56 "Counfry Commercial Guide: Russia", Fiscal Year 2000, Show Case Europe, U. S. Commercial Service, Ch. IV, on-lie: (SCE Main) <http://www.sce.doc.gov.>

was increased fkom 50 to 75 %." in March 22, 1999, CBR adopted a regulation that

requires residents purchasing foreign currency for prepayment of import contracts to also

deposit a ruble equivalent of the prepayment in a non-interest-bearing account at the

CBR. The real purpose of this regulation is unclear, as it basically makes the subject pay

double price of the contract to import prepaid goods.58 New regulations issued by the

Central Bank also impose limitations on the purchase of foreign exchange using ruble in

correspondent accounts and significantly increase bank reporting requiremerd9

ii) Kazakhstan

The Kazakhst.mi govenunent imposes minimal restrictions on the converting or

transfering funds associated with an investment into a freely usable currency at a legal

market-clearing rate. Due to the national currency (tenge) stability and suficient growth

of currency reserves, the National Bank of Kazakhstan (NBK) has allowed currency

convertibility since February 1996. Consequently, the application of Kazakhstan to adopt

Article 8 of the International Monetary Fund Charter was approved by the [MF in July

1996. Under this agreement, Kazakhstan has a duty not to restrict current account

transactions such as currency conversions or the repatriation of investment profits.

--

5 7 Scott C.. Starygin A., "1999 Russian T u Reform - Srill Waiting", World Tad Daiiy, J a n u q 1 8,2000, on-line: ( W r L ) \ D 5 8 Antel C., "Russia Enacrs Tm. Currency Changes", Tax Notes International, Xews Analysis. May 17, 1999, p. 2006. 59 Ibid. 60 See Repon of the Business information Service for Newly independent States (BISNIS) "Commercial Overvierv ofKaïakhsran", of December 1999.Ch. VI.

The present currency regulation environment allows the transfening of money

associated with the investment in foreign currency inside the country and abroad? That

allows foreign investors to settle their obligations, including the payment of wages to

their resident and non-resident employees, in foreign currency. There is no distinction

made behvcen resident and non-resident when opening bank accounts as well as there are

no restrictions on the type of accounts needed for investment or import/expon a~tivities.~'

hvestors may also convert and repatriate their profits fkom a business in Kazakhstan,

though in practice, conversions of tenge c m be limited due to the undeveloped nature of

Kazakhstan' s currenc y e ~ c h a n ~ e . ~ ~

iii) Ukraine

The Ukrainian currency (hryvnas) is presently the only official currency that can

be used in al1 transactions carried out in Ukraine between residents, as well as between

non-residents and residents, unless a license allowing payments in foreign currency has

first been obtained fiom the National Bank of Ukraine (NBU). Al1 the transactions

outside Ukraine between residents and non-residents must be in foreign currency? As an

exception, al1 commercial transactions between a resident and non-resident in the sphere

of 'trade turnover' must be carried out in foreign convertible currency and only through

authorized Ukrainian banking institution^.^^ Thus, in case a non-resident wants to carry

6' ibid. '' "Countv Commercial Guide: Kazakhsran 1999", Showcase Europe, Ch. V1I.B. on-line: (SCE Main) <hnp:il~vww.sce,doc.gov> '' Ibid. 04 See the Decree of the Cabinet of the Ministers of Ukraine No. 15-93 "On the Sysrem of Currency Regtiiarion and Currenq~ Conrro f ', an. 5. 65 Ibid., art. 7.

out commercial transactions within the scope of 'trade turnover' on the temtory of

Ukraine in the local currency, he/she would need to obtain an individual license h m the

NBU.

For the purpose of carrying out hard-currency transactions, residents must obtain

a license allowing payments in foreign currency ffom the N'BU. There are some

restrictions on the amount of cumncy that individual residents may export or import.

Resident legal entities are also subject to restrictions, although to a lesser degree,

considering that legal entities are permitted to carry on activities with a foreign party such

as the remittance of dividends, interest, fees, and payment for purchased goods. The

Ukrainian currency is presently being converted and is regularly traded at auctions held

by the Ukrainian Interbank Currency Exchange as well as the informa1 inter-bank

currency market?

E. Conmercial Infrasîrucîure and Banking System

It is of utmost importance for al1 three counties to develop and implement a

program for the restnicturing of the banking sector, as well as general market

infrastructure, what would allow the investor to borrow additional resources for financing

business projects. Statistical data based on responses of foreign investors investing in

Russia, Ulcraine and Kazakhstan proves the urgency of this matter. The results from

66 "Legal Framework Agecring Foreign Invesrmenr", Trade Mission of Ukraine, Apnl 1 5, 1 997 on-line (Brama Main) ~http://ww.brama.com>

Table 8. Commercial Infrastructure

(1 = most dif'fïcult aspect; 4 = least difficult) Factors-bamers/counties Currcncy control

Russïa 1 Katpkhsran 1 Ukraine 1.45 1 2 - 7

Sources: International Tax and Investment Center ( 1 999)67

Table 8 demonstrates that the commercial infiastructure is the major barrier for investing.

However, the situation in Russia seems to be worst among the three countries. The state

of development of banking systems also differs. The analysis of the sector is discussed

separately for each particular country.

Similar to the banking sectors in Kazakhstan and Ukraine, the Russian banking

system is relatively yomg and needs fùrther improvements. Considering that it only

started evolving in the late 1980s, there were about 1,500 banks in Russia at the end of

1998.~' In June 1999, eleven large and medium-sized banks lost their licenses after they

were revoked by the CBR.~'

However, commercial Iending remains a small share of Russian banks' business.

Today, long-term lending (over 1 year) comprises about 10 % of credits and many

Russian banks remain in precarious shape?' The development of a program for the

restructuring of the banking sector became essential. It should be recommended that CBR

shouId refrain in future fiom granting licenses to banks controlled by former managers of

67 Special Report of the International Tax and Investment Center (ITIC), Moscow, June 1999. as "Counrr3. Commercial Guide: Russia", Fiscal Year 2000, Show Case Europe, U. S. Commercial Service, Ch. VIII. 69 Ibid. 'O Ibid.

insolvent banks or to banks which are controlled by insolvent banks until those banks

have paid back their debts.'!

i i ) Kazakhstan

The Kazakhstani banking system continues to be one of the strongest among the

republics of the former Soviet union." Similarly to Russian and Iikrainian banking

systems, the Kazakhstani banking system in also in the process of transition due to the

consolidation of the indusny and the movement towards the adoption of international

banking standards under the control of the NBK. The thirty largest banks of the country

are currently able to conduct operations, issue bonds, certificates of deposit, and act as

custodians in the corporate securities markets, as weH as own stock in investment

companies and participate in NBK credit au~tions.'~

In 1998 there were only 76 remaining of the 84 established banks present in 1994

in Kazakhstan, with ten of the largest banks controlling approximately 80 % of banking

as set^.^' There are four main tiers in the system, including seven large domestic banks, 21

banks with foreign participation, four govemment-owned banks and 19 remaining srna11

Almaty-based banks and 25 regional bar~ks .~~ More and more foreign banks are

establishing their subsidiaries in Almaty, including Citibank and Societe Generale, which

established their subsidiaries in 1998.

" See "The Invesmrent Climare in Russia", Expert institute, Ernst & Young, 1999, Ch. 4.2.3. '" Report of the Business information Senvice for Newly independent States (BISNIS) "Commercial Overvieirt -- of Kazakhstan", of December 1999.Ch. VI. " Ibid. 7.1 "Coitnrry Commercial Guide: Kazakhstan 1999", Showcase Europe, Ch. VI1I.A. ' 5 Ibid.

Along with al1 the achievements that the Kazakhstani banking system has

achieved so far, there are aiso problems. Most private resident-owned companies have

limited their borrowing because of high interest rates and uncertainties about the

inflation's impact on costs and revenues. The inability to obtain loans at reasonable rates

also contributes to the overall fnistration of small and medium-sized entrepreneurs. Thus,

problems with obtaining loans, short duration of credit, inexperienced Ioan oficers, and

uncertainty in appiying new banking laws remain the obstacles.

iii) Ukraine

As with a majority of the sectors in the Ukrainian economy, the banking system is

still at its developing stage. It is a three-tiered system with the National Bank of Ukraine

and a major financial institution that regulates and oversees the general banking and

rnonetary system in Ukraine. Currently, there are about 250 commercial banks in

Ukraine, which constitute the ' £ k t tier' of the system and are the former specialized state

banks. They include a savings bank (Oschadbank), three specialized Iending banks

(industrial investment, agricultural and social development) and one Export-Import Bank

of Ukraine. These banks remain dominant in serving government prograrns in their

sectors.

The second tier of banks consists of commercial banks that were founded by

pnvate Ukrainian enterprises and entrepreneurs without involvernent of state money in

their funding capital. The second tier of banks is currently the Iargest of the goups. All

commercial banks face a problem of unstable macro-economic conditions and the

swelling discount rate and the threat that inflation might not be kept under control. Also,

the banking system remains fragmented and undercapitalized, which creates major

problerns with vade and project financing in

The third and the last tier includes banks with foreign capital. The Government

abolished a 15 % limit on foreign investrnents in domestic banks. Curent restrictions on

foreign banks have been eased and general barriers to market entry are considered to be

quite low with the curent regulation allowing banks to established the use of 100 % of

the foreign capital. There is the minimum capitaI requirement of 10 million Euros that

has to be met using the exchange rate at the date of statutory agreement, and shares of

each shareholder should not exceed 3 5 % of the registered capital.77

Also, there have been other significant positive changes taking place in the

system. As of June 1998, reporting and accounting standards in the banking system of

Ukraine were modified according to the Action Plan of the State Program of Transition

towards an International System of Accounting and ~tatistics.~' Also, there has been a

significant increase in confidence of people in the banking system, and particulariy a

progressive increase in time deposits at commercial banks. This has become possible

after the introduction of the Decree No. 996198 by the President o f Ukraine, "On

Measures to Protect Rights of Lndividual Depositors to the Commercial Banks in

Ulcraine". The Decree established an insurance fund for such deposits with the

guaranteed right for compensation for depositor's costs if no access to the deposit would

- --

7b "A Guide lo Doing Business in Ukraine", Department of Foreign Affairs and International Trade, on-line: (DFAIT Main) <http://dfait-maeci.gc.ca> 77 "Banking Sysrertl of Ukraine", Business Analysis, 1 999 on-line: ( W h i c a g o Main) ~htrp://~krchicag~.com~ 78 '*Overview ofrhe Ukrainicrn Banking Secror", U.S. and Foreign Commercial Service and US. Department of State, 1998 on-line: (BISNIS Main) ~htrp://www.bisnis.doc.gov/bisnsdcounûy/ bank9805.hm>

be provided. Such additional fùnds provided by the general population would help

commercial banks to mobilize a potential base to provide credits for investment projects,

which are primarily dedicated to the development of the production capacity of the

economy.

F. Labor Resources

The labor force in al1 three countries is considered as generally highly-educated and

technically competent, even though it sometimes lacks specialized training for the

manufacturing, management and service secton. in general, foreign investon consider

Table 9. Availability of local legal experts

the availability of the skilled labor to be quite satisfactory. It may also be inferred fiom

the table that investors do not generally have any significant problems with availability of

local legal experts.

(1 = most difficult aspect; 4 = least difficult)

Similarly to Ukraine and Kazakhstan, the level of literacy in Russia is

considerably high." RussiaYs labor market is fragmented, and the labor mobility across

Kazakhsran 1 Ukraine i Factors-barriersicountries

79 Spccial Report of the international Tax and Investment Center (ITIC), Moscow, June 1999. 80

1 a Availabili of local le al u rts 3.83 Sources: international Ta and Invesunent Center (1999)~~

Russie

regions is very low, which is consequently reflected in substantial differences in wage

and employment levels. For instance, Moscow has one of the lowest levels of

unemployment, and monthly incomes are up to three times higher than the average level

across the country. According to statistics of the International Labor Organization, the

average national unemployment in May 1999 was 10.4 million, or 14.2 % of the

workforce, with unemployment rates in various depressed regions of 40 %.''

However, with regard to the quality of the work force, the Swiss Beri Institute has

established that arnong 49 countries with low labor prices, Russia was characterized as

not a very favorable option for locating a manufacturing business.82 It indicated that,

contrary to the popular opinion conceming the low cost of Russian labor, the correlation

between salary and output of Russian workers are at 20 % of the maximum level. Also,

the labor force has a very limited number of workers with adequate qualifications and

work culture necessary for modem computerized rnanufa~turin~.~'

ii) Kazakhstan

Kazakhstan's workforce is considered as generally highly-educated and

technically competent, but it lacks trained labor in the manufacturing, management and

service sectors.&< However, during the last five years a great arnount of specialists with

secondary education and vocational training emigrated fiom the country. Labor force

- - - -

'' "Counrn Commercial Guide: Russia", Fiscal Year 2000, Show Case Europe, U. S. CornrnerciaI Service. Ch. VIII. '' See "The hvestment Chnaze in Russia", Expert Institue, Ernst & Young, 1999, Ch. 2.1. 83 Ibid. 84 See Repon of the Business Information Service for Newly independent States (BISNIS) "Commercial Overview of Kazakhsran", of December 1999.Ch. MI. on-line: (BISNIS Main) ~http://ww.bisnis.doc.gov>

participation rate in 1998 in Kazakhstan was at about 64% and the structure of the labor

force has been changing for the iast decade effected by the process of transition to the

market e c o n ~ r n ~ . ~ ~

Kazakhstan uses the Labor Code of 1973 (with arnendments of 1997) as the major

instrument regulating the relationship between employers and employees. The 1993 Law

of Kazakhstan on Professional Labor Unions has provided legal guarantees against

limitations of personai rights, including labor, social, economic, political or persona1

rights and freedoms as a result of a membership in a union, and prohibits the denial of

employment, the denial of promotion or the release Erom employment on the basis of

such rnember~hi~. '~ Recently, there was a distinct tendency by the Kazakhstani

govemrnent to put greater ernphasis on foreign firms to hire Kazakhstani nationals

instead of foreign workers. The new labor Iaw requires expatriates to obtain work permits

in order to be able to work in ~azakhstan."

&aine has a highly educated labor force with a very high literacy rate? After

the coIlapse of the Soviet Union the military-industrial complex in Ukraine made

available a great number of excellent specialists, engineers, and prograrnmers. According

to official Ukrainian sources, unemployment rates in the country for 1998 were as high as

- - - --

8 5 "Doing Business in Kazakhsran", Ernst & Young, August 15 1999, Ch. E. 1 on-line: (Taxcasr Main) chnp://www. taxcast.com> 86 Report of the Business Information Service for Newly Indepeadent States (BISNIS) "Commercial 0i.enierv ofKazakhsran", of December 1999.Ch. VI1.D.

Ibid. 88 "Commercial Guide of Ukraine", Country Commercial Guide, U.S. Department of State, fuiancial year 2000, Ch. VI1 (G), on-line: (U.S. Department o f State Main) <http://www.state.gov>

23 %." Apparently, such numbers seem to unrealistic, considering al1 the current

problems that the Ukrainian transitional economy has to deal. The International Labor

Organization has reported that the unemployment figures for the year of 1999 were as

high as 34 % when you include workers on unpaidhvoluntary leave and unreported

separations? Also, most experts agree that the reported unemployrnent figures are

senously understated, as underemployment of state enterprises increases and employment

in unofficial sector increases, attracting a great share labor force.9'

Even though the labor force is generally highly qualified, many Ukrainians are

not prepared to meet the demands of a new dynarnic, information-based commerce. The

former Soviet comrnand-administrative system discouraged creativity and entrepreneunal

spirit, which had a destructive effect on the growth of businesses in Ukraine. Companies

wishing to do business rnight need to invest additional time and resources in training of

personnel.

Wages in Ukraine are very low in comparison to those in Canada, and they are to

remain very low. The nominal average wage is in a range of about S 140 per month as of

May 1998." As a result of a faster growth in consumer prices as compared to the nominal

average wage, the real wages in 1998 were in fact 12.9 % lower than in 1997, and real

wages in 1997 were 2.4 % less than in 1996." Furthemore, there are some significant

differences in salaries between various categories of ernployees, where the average wage

of an unskilled worker is approximately $140; bilingual secretary or ofice manager

g9 "Country Commercial Guide: Ukraine", Fiscal Year 2000, Show Case Europe, U. S. Commercial Service on-lie: (SCE Main) <http://www.sce.doc.gov.> 90 Conitnercial Guide of Ukraine*', Country Commercial Guide, U.S. Deparunent of State, financial year 1999, Ch. VI1 (J), on-l&: (U.S. Depanment of State Main) <htrp://~&,state.~ov> 9' Ibid.

(English and Ukrainian) - fiom SSOO/month; and financial managers and chief

accountants, English-speaking, with a working knowledge of western accounting systems

- h m S 1000/month.~

G. Crime and Corruplion

The problem of crime also seems to be a factor of utmost importance, especially

in Russia. Foreign businessmen have been repeatedly blaming this social evil to be a

serious penl in doing business. These fears are based on several instances of physical

violence against foreign businessmen with fatal outcomes.

Other senous problems that have also been addressed by the investors are the

problems of corruption and bureaucracy. Table 10 illustrates a degree of difficulty that

Table 10. Corruption

(1 = most dificult aspect; 4 = l e s t difficult) Factors-barrierdcounmes 1 Russk 1 Kazakhsion 1 Ukraine Corruption 1 1.67 - 9 1 1.33 :

Sources: International Tax and investment Center ( 1999)~~

corruption causes to investors in each of the countries under review. Table 10 illustrates

that the problem has gained the most serious effect in Ukraine, followed by Russia and

Kazakhstan.

The level of difficulty that bureaucracy causes to investors is illustrated in Table

1 1. This factor is evaluated based on consistent parts of bureaucracy, including

93 " C o u n r ~ Commercial Guide: Ukraine", Fiscal Year 2000, Show Case Europe, U. S. Commercial Service on-line: (SCE Main) <http://www.sce.doc.gov~ 94 "A Guide ro Doing Business in Ukraine" Department o f Foreign Affairs and International Trade, Ch. 2.4 on-line: (DFAIT Main) <http://www.dfait-maeci.gc.ca>

Table 1 1.

regulatory requirements; Pace of processing different govemmental applications/forms;

Bureaucracy (1 = most difficuIt aspect; 4 = least difficult)

availability of information; relationships/communications; and market infrastructure.

The high level of crime in Russia not only scares away foreign businessmen from

investing in the Russian economy, but also significantty increases secunty costs of

businesses. It basically becomes another hidden tax on businesses including the need for

reaching an agreement with organized criminal groups, paying of bribes etc.97 The crime

rates in Russia are considered to be the highest among al1 the republics of the former

Soviet nio on.^'

Another significant obstacle to the activity of foreign businesses in Russia is a

widespread problem of corruption among the officers of al1 the Ievels of state power in

the Russian Federation. Corruption continues to spread with the fùrther liberalization of

Ukraine

1.29 2.71

3.29 3.33 1.5

- - - - ppp --

95 Special Report of the International Tax and Icvestment Center (ITIC), Moscow, June 1999. 9" Ibid. " See "The lnvesrment Climate in Russia", Expert institute, Ernst & Young, 1999, Ch. 1.2. 98 See in general Syfert S., "Capitalism or Corruprion? Corpotare Srmcrure, Western Investmenr and Contmercial Crime in the Russian Federation", New York Law School Journal of International and Comparative Law, No. 18, 1999 on-line: WL(hWSnCL)

Sources: International Tax and invesment Center ( 1999)%

Kazaûhstan

2-14 2.47

2.93 2.38 4

Factors-barriers/ Countries Repulatory Requirements Pace of processing different govemmental applications/forms AvailabiIity of information Relationships/communications Marker infrastructure

Russia

1.82 2.55

2.82 2.33 3.25

economy. The possible measures of elimination of this social crime include the further

reduction of Iicensed activities, enforcement of legal remedies in the prosecution of the

involved penons, support of the media in publicizing corruption case etc?

ii) Kazakhstan

Crime rates in Kazakhstan are considered to be iower than in Ukraine and

significantly lower than the rates in the Russian ~ederation."' However, there remain

serious problems in this area, including primarily corruption. In 1997, in order to fight

comption arnong public official, a Higher Disciplinary Council was created under the

President and the Law on Fighting Corruption was passed the Parliament in the spnng of

1 9 9 8 . ~ ~ ' However, al1 these measures have not been able to achieve any significant

success in combating of corruption and there had been no major prosecution and

dismissal of senior govemment of fi ci al^.'^^ A new Cnminal Code adopted in 1997 also

contains provisions regarding penalties for giving and receiving bribes and other

econornic crimes that spread with the liberalization of the market econorny.

iii) Ukraine

Since the break-up of the Soviet Union there has been a proliferation of crime, but

not just cornrnon crime, economic crime throughout most of the newly independent

- - - -

99 See "The invatment Climate in Russia", Expert institute, Ernst & Young, 1999, Ch. 4.2.8. 100 Report of the Business Information Service for Newly Independent States (BISNIS) "Commercial Overview of Kazakhstan", of December 1999.Ch. IV.

countries. Increasing crime and comption, while not being as senous a problem in

Ukraine as in ~ u s s i a , ' ~ ' is a significant factor inhibiting legitimate business activity and

foreign investment in Ukraine. Economic types of crime have included bribery, black

market activities, and extortion. Also, it was repeatediy reported by national and foreign

economists that the unofficiai economy in Ukraine is thriving and currently is one of the

biggest in Europe. According to western estimates, the unofficial economy in Ukraine

constitutes up to 20-30 % of the total national GDP, even though national experts indicate

that this figure might reach up to 50-60 %.

Another very serious problem that foreign businessrnen have been repeatedly

compIaining about is the problem of corruption of state officials. In an attempt to deal

with the problem, President Kuchma estabiished a national problem against corruption,

but there have been no significant changes (taking place) since the program's

introdu~tion. '~~ The Ukrainian civil service and regulatory systern has also been affected

by comption. The concept of a conflict of interest is still poorly construed, and many

officials and bureaucrats retain their commercial interests while in power. 'O6

Among the possible factors that have contributed to the rise of crime and

comption are the disappearances of the centralized control system of the old soviet

regime, the creation of novel property arrangements and the almost unlimited and

- - - - -- - - - - -- . - - - - - --p.- --

101 Report of the Business Information Service for Newly independent States (BISNIS) "Commercial Olvn*iertp of Kazafrhsran", of December 1999.Ch. IILB. 'O1 Ibid., Ch. VILA. 1 1. 1 O3 "Commercial Guide of Ukraine", Country Commercial Guide, U.S. Deparment of State, frnancial year 2000, Ch. III (B), on-line: (U.S. Department of State Main) <http://www.state.gov> 104 1 s haq .M.. "Foreign Direct Invesrmenrs in Ukraine Since Independence", CERT discussion paper, Herion-Watt University, Economic Department, May 1997, on-line: (CERT Main) <http://www.hw.ac.uk> 10s "Ovenlieu* of the Ukrainian Bunking Secfor", US. and Foreign Commercial Service and U S . Deparunent of State, 1998 on-line: (BiSNIS Main) ~http://www.bisnis.doc.gov/bisnis/counny/ bank9805.hm> IO6 "Counrr)l Commercial Guide: Ukraine", Fiscal Year 2000, Show Case Europe, U. S. Commercial Senxe on-iine: (SCE Main) <h~://www.sce.doc.gov>

umeguiated access to retail markets.lo7 While there is an active cnminal legislation with

severe potential sanctions, some compt acts have been criminally prosecuted, but the

majority of those that were exposed encountered little or no action. Foreign observers

have raised the question of "selective justice" having its place in the Ukrainian judicial

~ ~ s t e r n . ' ~ ~ Al1 of the mentioned factors contribute to the general instability of the

investment environment and inhibit foreign confidence in the progress of the economy.

Market infiastructure is another very important element influencing the

investment decision-making. Table 12 illustrates the assessrnent of a difficuity related to

market infiastructure in each of the countries under review. The table demorxtrates that

commercial infrastructure and availability of distribution channels are mostly accessible

in Ukraine and to a lesser extent in Kazakhstan. It should be noted that availability of the

Table 12. Market Infrastructure

(1 = most dificult aspect; 4 = least difficult) 1 Factors-barriers' 1 Russia 1 Kazakhsran 1 Ukraine I

- - - -

I Oi 1s haq M ., "Foreign Direct investments in Ukraine Since independence", CERT discussion paper, Heriott-Watt University, Economic Department, May 1997, Ch. 4.6, on-line: (CERT Main) <http:/l~ww.hw.ac.uk> I os "Overvieiv of the Ubainian Banking Sector", US. and Foreign Commercial Service and U .S. Department of State, 1998, Ch. VI1 (F), on-line: (BISMS Main) <htrp:/l~~w.bisnis.doc.gov/bisnis/co~n~/ bank9805.htm> la9 Special Report of the Intemationat Tax and Invesûnent Center (ITIC), Moscow, June 1999.

Countries O Commercial Infrastructure

Lack of privarizarion proprams Lack of distribution channels Availability of local market Sources: International Tax and Investient Center ( 1 9 9 9 ) ' ~

1 -45 3 2.55 3 -09

- 7

3.08 2.3 1 2.77

7

1.8 2.8 3

market infrastructure is a common problem to al1 three countries, but Russia and to a

lesser extent Kazakhstan are additionally influenced by a factor of their extensive

geographic parameters. The last factor makes building of a new infiastructure (especially

automobile roads and rail roads) extremely diffkult and costly.

i) Rrissia

Infrastructure is seen as another clear weakness. Immensely extensive territories

mean huge transportation costs. This reduces the general attractiveness of the regions,

which are located far away Fom the sources of raw materials and sales markets.

Transportation services are outdated, and communication systems are both ineffective

and e ~ ~ e n s i v e . " ~ The absence of modem infrasûucture leads to a significant increase in

the start-up costs of a business.

i i ) Kazakhstan

The geopolitical situation of Kazakhstan in the center of EuroAsia makes it

dependent on the neighboring countries' transport links to get its goods to world markets.

Kazakhstan is largely dependent mostly on a pipeline system of Russia and sometimes on

Ukraine for transportation of oil and gas for export. There has been a lot of research done

on mapping a route for Kazakhstani pipeline in order to relieve the country's dependence

on the Russian pipeline system. A lot of work has been done to build

110 Dean R. " Considering Business Opportuniries in the Soviet Union in the 1990 's", Transnational Law, No. 24, 1991, p. 325.

the pipeline which

Vand. Journal of

would connect production fkom the Caspian Sea and the Tengiz field (currently, one of

the nchest oil deveiopment sites in Kazakhstan) to the Russian port of Novorossiysk on

the Black Sea,

Kazakhstan also has a railroad system that connects the country with Europe via

Russia, to Persian Gulf via Iran, and to the Pacific Rim via China. Currently, Kazakhstan

has signed cooperation agreement with China, Pakistan and Kirgyz Republic to upgrade

the road network."' A paved road network connecrs al1 major cities. However, the lack

of funds has lefi most routes poorly maintained.

iii) Crkraine

Most of the Ukrainian infiastructure was built back in the post-World War II years.

General slow-downs in the economy, investrnent cutbacks, and insufficient rates for

services have led to the general detenoration of this infiastructure. A particular problem

is the poor quality of roads. Even though the whole network of roads is large - 273.000

km of highway, the maintenance is the major concem, caused by bad workmanship and

low quali ty materials used for their construction. l l 2 Additionally, the communication

system, especially the telephone system, needs major investments. This system is

inadequate for both business and persona1 use, as there are only 8 million existing

-- -.

I I I "Counrv Commercial Guide: Ukraine", Fiscal Year 2000, Show Case Europe, U. S. Commercial Service Ch. 1I.E. on-line: (SCE Main) <http://www.sce.doc.gov> ' '' Ishaq M ., "Foreign Direct Investments in Ukraine Since Independence", CERT discussion paper, Henott-Wan University, Econornic Department, May 1997, Ch. 4.7, on-line: (CERT Main) <http://www. hw.ac.uk>

telephone circuits serving about 52 million people, with the telephone density of 15 1.4

telephone circuits per 1 O00 persans. ' l 3

n i e poor state of Ukraine's telecommunications, energy systems, transportation,

and roadhighway infrastructure will need investments of up to $40 (US) billion dollars

over several decades.Il4 There have been continued attempts undertaken by the

international financial organizations to influx additional resources into the infrastructure.

Separate attention is going to be paid to energy conversion, projects that prornote

improved nuclear safety, and projects promoting private sector initiative in infiastructure

development and improvement. ' l5

1) T u systems

Economic refonns in al1 three countries affected almost al1 sectors of the

economy, with varying degrees of success. Tax reform has a special place in the general

reform process, and was recognized as crucial to the success of the countries' economic

transition."" a market-type economy, governmental tax policy can significantly

influence economic recovery in the countries through the distribution of income and

allocation of resources. The form and structure of the tax system and the amount of tax

burden can make a direct impact on the amount and structure of consumption and saving,

"j Ibid. IL1 "0r.ervierv ofthe Ukrainian Banking Sector", U.S. and Foreign Commercial Service and U.S. Department of Stace, 1998, Ch. II (E), on-line: (BISNIS Main) ~http://www.bisnis.doc.gov/bisnis/country~ barik9805 .hm> I I 5 Ibid. t l6 M. Maninez-Vazques and R. Mch'ab, "The Tax Refonn Experiment in Transitional Economies", National Tax Journal, Vol. LIII, No. 2, p. 273.

on the amount and structure of domestic and foreign investments.'" The overall level of

regulation and taxation in ail the three countries act as a deterrent for foreign investors,

because these factors reduce returns on investments. Levels of regulation and taxation

that reduce the afier-tax investment retum below that required to compensate the investor

for the inherent nsks undertaken act as an artificial bamier to investrnent in al1 three

countries.

Apart fiom modemization of the states' respective tax structure, al1 three

countries have been continuously experiencing problems with the tax administration and

enforcement inhented from the former socialist planned economy. Persona1 incorne tax

was not paid by individuals, but by their employers. The relatively small number of

taxpayers (employers) had basically resolved the question of compliance for the former

cornmunist regimes, allowing the states to audit any organization each year to enswe

such cornpliance. Tax administration and enforcement were aiso significantly facilitated

by the ability to track payments through the state banking system and by administratively

set pr ies and wages.

With diversification and expansion of the types of taxpayers and the overall

modemization of the tax system countnes had to concurrently resolve the problem of

restructuring of the mechanism of compliance and enforcement. Al1 the countries that

undertook tax reforms, generaIly focused their efforts on tax policy and ignored the

advice of western experts, gave low pnority to modernizing tax administration and

introducing modern accounting rules. The case of Russia is the best exarnple where the

recent 1998 crisis highlighted the risk that progress in macro-economic stabilization cm

II7 See Luzik P., "International merience of Tax Reform and Lessons for Ukraine", Discussion paper No. 99/03, Center of Economic Reform and Transformation, February 1999, p. 33.

be quickly reversed when underlying stnictural weaknesses are not addressed. Arnong the

three countnes, Kazakstan was the first one to introduce a comprehensive and modem tax

code in 1995. However, the country neglected the importance of reforming its tax

administration systems, which resulted in significant losses of revenue for the 1 s t decade.

Thus, it is crucial that the overall modernization of the tax systerns in the region should

be accompanied with the structural one.

Table 13 illustrates the responses of the foreign investors as to what aspects of the

tax regime they find most difficult. In Russia the availability of tax incentives, and tax

Table 13. Tax Regime

(1 = most difficult aspect; 5 = least difficult) 1 Factors-barrierd 1 Russh 1 Kaz~Winan 1 Ukraine 1

complexity seem to be most problematic, cornparing with Ukraine and Kazakhstan. On

Counnies Levels of tau rates

I Avaiiability of tax and invernent incentives 1 Tm administration 1 Tm regime cornplexity (averaee)

the other hand, tax administration is the major impediment in Kazakhstan. The tax

collection record in Ukraine and the levels of tax rates seem to be connected as high tax

Sources: International Tax and Invesment Center (1999)"'

rates might make businesses to go underground. The following three chapters will

2.8 3-8 2.3 3.33

I

examine each country in detail.

3.18 3.55 2.55

_ 2.33

3.33 3.83 1.85 2.38

III. Iavestrnent Climate in Russia

1 . General Outlook

During the last few years, Russian Govemmental oficials have been repeatedly

reassuring both foreign investors and the federal public that it is the officia1 policy of the

Russian Federatiou to support and encourage foreign investments. The Govemment has

been making attempts to attract investments in various sectors of the economy, though

rnostly relying on investments in the energy and resource sectors, based on the

presumption that it was the most attractive sector for foreign investors in the last decade.

The decline of world oil pices forced the government to take senous rneasures directed

on reforming the legal fiamework governing the country's oil industry. A widely spread

belief among the members of the Russian government that the oil and gas industry is

'unsinkable' has been a serious irnpediment to the creation of the investment-friendly

Iegal environment.'

2. The System of Taxation in the Russian Federation

If a venture with foreign investments is successfÙ1 in its business in Russia, it wilt

have to pay a variety of taxes. Taxation of business operations of foreign investors, and

118 Special Report of the International Tax and Investment Center (ITIC), Moscow, June 1999. Il9 Samoylenko V. , "The Fare of the Russian Tax Code: A Look from Inside rhe Srare Duma Walls", International Tax and Investment Center, on-line: (ITIC-CIS Main) <htrp://inicnet.org/publications/DefauIt.htm~

their earned profits and dividends, is clearly one of the most important factors in

assessing the attractiveness of the host country. The legal regime regulating taxation in

Russia recently underwent major changes and remains one of the most volatile areas of

Russian law. This chapter will concentrate on the genera; analysis of the system of

taxation of foreign legal entities conducting business on the temtory of the Russian

Federation.

The performance of the Russian tax system since its creation in 1991 can be

charactenzed as very poor.120 In fact, foreign investors have repeatedly stated that the tax

regime in Russia remains one of the major obstacles to foreign investments.12' There are

a number of reasons accounting for this.

First, political instability in Russia and inability of consolidation of the political

will to move reforms foward. The President of the Russian Federation and the Russian

Duma have been constantly fighting over the direction of reforms, what resulted into the

lost time advantage, which was used by countries like Kazakhstan.

The Russian tax system is extremely cumbersome, as there were about 30

separate federal taxes and 170 local and regional taxes.12' The tax-collecting system has

grown to 89 regional tax offices and 2,639 local tax offices with about 180,000

employees.'z' The size of the tax-collecting mechanism was not very helpful in

improving the tax coIlection, and annual losses to the Russian budget, c m be estimated

120 See "The Invesrment C h a t e in Russia", Expen hstitute, Ernst & Young, 1999, Ch. 2.1 1. '" Durinç the meeting of the President of the Russian Federation B. Yeltsen with American businessmen in Washington, the tax system was cited as one of the major factors for their hesitance to invest in Russia. See newspaper Rabochaya Tribuna, no. 170 ( 1 069) October 1, 1994, p. 1 . l x Hamson S., "Two Special T a Regimes: An Opporruniry for Foreign Investors?", International Bureau of Fiscal Documentation, European Taxation, October 1, 1996, vol. 36 - 1996, no. 10. '?j Himes S., "Russia S Tax Re/onnW, Observer, no. 215, January 1999, p. 26.

up to 25 trillion nibles (US S5 billion).124 The exaemely burdensome tax system

significantiy increases the chances of the already high-risk investments to be less

profitable.

Second, a great number of enterprises suffer fkom arbitrary actions of the Russian

tax and customs authorities, because of the incomplete nature of the tax legislation on

both federal and regionaVloca1 levels, which O ften creates areas of legislative

unce~tainty."~ Tax guidelines of the Regional State Tax Service (STS) authorities

frequently contradict the instructions issued by the central authorities, leading to

autonomous actions of the local tax authorities and unequal treatrnent of taxpayers.Iz6

Obtaining the necessaty information about the interpretation of changes in fiscal

regulations and fiequent modifications of the regdatory noms often constitute

significant difficulties by increasing the costs of monitoring legislation.12' It also

increases fiscal nsks that contribute to a negative assessrnent of the Russian investment

environment. 12'

Third, the modem Russian tax system still heavily relies on payroll, gross income

or expenditures, disregarding the determinants of the actual profitability.'29 The

accounting rules and principles used by the tax service in the former Soviet Union, which

were pnmarily designed to keep a record of the volume of the actually produced product

instead of concentrating on the profit that the producer made. 130

"" Freeland M , "Crackdown Planfir R W a n Companieî'Access ro Cash", Financial Times, March 22, 1996, p.2. "' See "The lnvesment Climate in Russia", Expert institute, Ernst & Young, 1999, Ch. 2. I 1 . '" Himes S., "Russia 's T a Reform", Observer, no. 215, January 1999, p. 26. "' See "The lnvesrmenr Climate in Russiu", Expert institute, Ernst & Young, 1999, Ch. 2.1 1 .

1bid. 129 Black, D., "Su You Wanr ro Invest In Russia? A Leghlarive AnalysCs of the Foreign lnvesrmenr Climate in Russia", Minnesota Journal of Global Trade, no. 5, Winter 1996, p. 142 on-line: WL 130 Himes S. , "Russiu 's T m Reform", Observer, no. 215, January 1999, p. 27.

Arnong the other factors, reiiance on high penalties and numerous exceptions for

a wide range of favorably treated taxpayen can be narned.'" One of the most significant

provisions of Part 1 of the newly adopted f a x Code of the Russian Federation is the

removal of the former extremely hi& 100 % tax penalties and replaced them with a fine

of 20 % for any tax deficiency, and 40 % if a criminal intention was f 0 ~ n d . l ~ ~

A. Interrelationship Betweeo the Federal, Republican and Regional Budgets

The inter-relationships between the federai and regional govemments have also

added to the complexity of the tax structure. The central govemment in Moscow has

granted a considerable amount of freedom to the Russian regional and local authorities.

Such a decentralization of the fiscal and budgetary regulation was primarily caused by

the emerging centrifuga1 political forces in the regions and republics of the federation, as

well as caused by the general inability of the central government to effectively regulate

and manage the regional economies. Economically powerful republics, such as Tatarstan,

Bashkortostan and Sakha (Yakutiya) have been able to bargain for exceptional powers in

econornic and budgetary areas as well as in the area of international relations.

During the period fkom 1991-1993, the budgetary system in Russia could be

characterized as one combining the features intrinsic to both the budgetary unitarism and

1 3 ' ibld., p- 26- 13' Tax Code of the Russian Federation of January 1, 1999, General Part, Chapter 16, an. 122. General pan of the Tau Code established general taxation principles, defmitions, penalties, and administrative procedural provisions. The Second Part establishing specific rates of the taxes was severely criticized by the previous Duma (Lower House of the Russian Parliament) members, and most probably be adopted by the end of 200 1.

budgetary federali~rn. '~~ There still is a continuing practice of non-payment fiom the

regional leaders to the Federal budget. This alarming practice imposed a task on both

federal and regional govemments to create a mechanism of inter-budgetas. relationship.

The Federal Government concluded power-sharing treaties with almost every Subject of

the Federation and signed separate supplemental treaties regulating budgetary

r e l a t i on~h i~s . ' ~~ In the context of these treaties, there were three major innovations

introduced. First, the Subjects could independently establish rates for the federal tax on

profits (on the portion paid into their budget)?' Second, a single n o m was introduced

for distribution of federal taxes between the federal budget and the budgets of the

Subjects. Lastly, a fùnd of financial support was introduced for economically weaker

regions.

The present supplemental treaties were a first attempt of the govermnent in

Moscow to reconcile the budgetary systems of the Federation and the regions; therefore,

they had as many glitches as the positive things that they had achieved. First, al1 the

supplemental treaties on budget regulation contain sirnilar provisions stressing supremacy

133 See Lavrov A., "Federalizing Russra S Budget System: A Thorny Parh", Current Digest of the Post- Soviet Press, Jury 5, 1995, vol. XLViT, no. 23, online: WL (TM) mereinafter, Federalizing Budget]. 134 This chapter included analysis of P o w e r - S h a ~ g Treaties and Supplemental Treaties signed between the state organs of the Russian Federation and the state organs of the following Subjects of the Russian Federation: republics - Tatarstan, Sakha (Yakutia), Bashkortostan, Kabardino-Balkar, Northern Osetiya- Alaniya, Buryatiya, Komi, Chuvash; krais - Krasnodarsk, Aitai, Khabarovsk; oblasts - Nizhni Novgorod, Irkutsk, Rostov, Sakhalin, Leningrad, Kaliningrad, Kaliningrad, Orenburg, Tver, Omsk, Sverdlovsk, Perm, Vologda, Bryansk, Chelyabinsk, Ulyanovsk, Saratov, Magadan; federal cities - St. Petersburg; autonomow o h g s - List'-Ordinsk, Buryat, Komi-Permyat. See also Mikhail Guboglo, "FederaIiPn Vlasti i Vlast' Federalizma", in Federalini Viasti i Vlast' Federalizma, Moscow, 1997. ' j5 Sre an. 2 of the Decree of the President of the Russian Federation No. 2270 of December 22, 1993 "On Cerrairi Changes irz Taxation and Inrerrelationship of Budgets of Diflerenr Levels", with additions and rirnendments as of December 24, 1993. online: WL (TST) Foreign Taxation. [hereinafter, Creating Federalism]. 134 Fromrneyer T. A., "Power-Sharing Treaties in Russia 's Federal System", Loyola of Los Angeles International and Comparative Law Journal, March 1999, p. 1, online: WL (KR) LYLAICU. [hereinafter Power-Sharing Treaties].

of the governmental control in certain areas."' uitroductory provisions provide that "'the

formation of the regionai budget and budgetary relationship between the regional and

9. 138 federal budgets are regulated according to the legislation of the Russian Federation .

Another common provision stipulates the procedure of formation of the federal

hnd for financial support of the Subjects of the Federation. It is created within the federal

budget, with subsequent distribution of the fund's assets to "needy" and "especially

needy" regions, on a basis of objective criteria and special formula^."^ The assets are

usually transferred for financial support of federal social welfare programs in individual

regions.'"O Before the supplemental agreements were signed, inter-budgetary relations

were rnostly camed out on the basis of "secret bargaining"' between the Subjects and the

central govemment in ~ o s c o w . '" The signing of supplemental agreements on the regulation of the budget and tax

relationships between the Center and the Subjects has also had several negative

consequences. One of them was an artificially created discnminatory environment in the

budgetary and tax system within the Federation. Four economically and politically

powerful republics, narnely Kareliya, Bashkiri ya, Tatarstan and Sakha (Y akuti ya), were

137 Ibid., p. 33. 138 See " The Supplemenral Treaty Berween the Russian Federation and the Adnlinisrration of lrh-utsk Oblasr Nt .4ma of Budger and T a Policies ," an. 1 , of May 27, 1996, See on-line: http://blac k.inforis.nnov.su/infobase/~.exei a/90.new/?doc= 14 149 139 See "The Supplemenral Treay Benveen the Organs of Srare Power of the Russian Federation and rhe ..ldtninistration of the Republic of Komi in Area of Budget and Tar Policies ," art.3, of March 20, 1996, See on-line: h~://black.infons.~ov.su/infobase/ wwwr.exe/a/90.new/?doc=35 1 19; See "The Supplemenral Treary Benveen the Organs of Srate Power of rhe Russian Federation and rhe Admin fsrrarion of Rostov Oblasr in Area of Budger and Tax Policies," art.3, of M a y 29, 1996, on-line: http://black. i n f o r i s . ~ o v . s u ~ i n f o b a s e / ~ a/90.new/?doc= 1 5483 ; See also "The Supplemenral Treay Benveen the Organs of State Power of the Russian Federarion and the Administration of Khabarovsk Krai iri Area oJBudger and Tax Policies ," art.2, of July 24, 1996, See on-line: ~i~:l/black.infori~~nnov.sulinfobase /wwu.r.exe/ a/90.new/?doc=34669 1.10 See Khabarovsk Krai, Budget and Tax Policies, art. 4, ibid; See also Power-Sharing Treaties, p. 33, supra note 43. 1.11 See Federalizing Budget, p. 1, supra note 40.

able to keep the special tax and budgetary conditions that they were able to get fiom the

central govemment in 1991-1993, using the political weakness of the enter.'" This

situation caused signifiant discord among the rest of the Subjects of the Federation, and

considerably complicated any possibility of persuading the rest of the regions to observe

the proposed uniform budgetary r ~ 1 e s . l ~ ~ The reluctance of the economically powerful

republics to comply with the uniform rules was primarily caused by the mechanism of

contribution to the "federal fund for financial support of the regions" into which a few of

the economically powerfùl republics were usually making the largest contributions.'"

The inability of the central government to align the payments of taxes by the

Subjects with the unifonn budgetary rules produced a series of adverse effects. Right

after the signing of the supplemental treaties with Kareliya and Yakutiya republics, the

federal budget received less than 5% of the total arnount of taxes due from Kareliya,

which was granted by the federal authorities to the republic in the form of tax credit~."~

Another serious problem emerged afier the introduction by the federal

govemment of the law "On the Tax System of the Russian Federation". The law provided

for supplemental taxes in addition to those already existing, which couid be enacted at the

federal level, stipulating that the Subjects could also set the rates of these taxes within

their j ~ r i sd i c t i ons .~~~ Local govemments, however, interpreted the provision in a much

broader sense which, eventually, turned out in a situation where the nurnber of types of

taxes rose to about 200.'" The federal govemment has reacted with the introduction of an

14' ibid. 14' Ibid. 144 See Power-Sharïng Treaties, p. 34, supra note 45. 145 See Federalizing Budget, p. 1, supra note 42. 146 Harrison S., "Two Special T m Regimes: An Oppormniry for Foreign fnvestors?", International Bureau of Fiscal Documentation, European Taxation, October 1 , 1996, vol. 36 - 1996, no. 10. 14' ibid.

arnendment to the law, prohibiting local authonties fkom introducing of their own

raxes.lJ8 The Constitutional Court of Russia rejected a petition filed by some of the

republics challenging the constitutionality of the law. The Court noted that the regions

have the right to impose only those taxes, which are specifically allowed by the federal

governrnent."g It also confirmed the legitimacy of the new Tax Code of the Russian

Federation, which cuts the number of taxes to thirty.lSO

B. Broadening of the tax base

The taxable base for the taxes imposed on the territory of the Russian Federation

was f in t defined in the law ''Conceming the Fundamental Principles of the Taxation

System in the Russian Federation" of December 27, 1991. The taxable base included

"income (profit), the value of specified goods, specified types of taxpayers' activities,

securities transactions, the use of natural resources, the property of legal entities and

physicai persons, the transfer of property, the added value of goods, work and services

rr 151 and other objects established by legislative acts .

There were numerous attempts undertaken by the government to broaden the tax

base through the reduction and revision of tax exemptions, arguably with the purpose of

fighting tau e v a ~ i 0 n . l ~ ~ Such measures were first implemented through a senes of

'" ibid. 149 Gurushina N., "Russian Consriturional Coun Says Regions ' Taxing Power Limites', Press Watch international, OMRI, March 25, 1997, on-line: W L (WTD) PWI.

ibid. 15' Ibid., art. 5. lZ2 Markina O., "Some Problems of Company Taxation", Bulletin for International Fiscal Documentation, April 1995, p. 163.

presidential decrees, which have abolished various exemptions previously granted to

taxpayers. '"

C. Federal Taxes

Federal taxes constitute the major share of collected revenue from activities of

investon. The following taxes are enacted by the federal govemment and are collected on

the whole temtory of the Russian ~ederation'":

1 ) Profits Tax

2) Persona1 income tax

3) Payroll taxes

3) Value Added Tax

5) Excises

6) Royalties

7) Customs duties

8) Secunties issuance tax

9) Replenishrnent tax

1 0) Environmental taxes

1 1 ) Road Fund taxes

12) Stamp duties

1 3) Federal license fees

' 53 See in general the Decree of the President of the Russian Federation No. 1004, "Concerning Some Quesrions of T a Policy" o f M a y 23, 1994. 154 See Law of the Russian Federation "Concerning the Fundamental PrincïpIes of the Taxation Sys~ern in ~ h e Russian Federarion" of December 27, 199 I , no. 2 1 18-1, an. 19.

i) Profits Tax

Thc main income tax applied to enterprises with foreign investments is profits tax.

Under the law of the Russian Federation "On the Taxation of the Profits of Enterprises

and Organizations", corporate enterprises with foreign investrnent, established on the

temtoiy of the Russian Federation, and international associations and organizations

engaged in business, have to pay tax on their profits.'" The tax is levied on the

permanent representative offices of foreign legal entities including "subsidiary, bureaus,

offices, agencies or any other business facilities prospecting or developing natural

resources or engaged in the construction, installation, assernbly, adjustment and

maintenance of equipment as defined in contracts, providing services and periorming

other works, as well as organizations and individuals authorized by foreign legal entities

i t 156 to represent them in the Russian Federation .

The taxable base is the gross profit of the enterprise fiom the "realization of the

products (works, services), of the fixed assets (including the land plots) and of the other

property of the enterprise, and also fiom the incomes fiom the extra-realization

i i 157 transactions . The total amount is reduced by the amount of material production costs,

amortization (at statutory rates), salaries, social contributions and administrative

espenses. Enterprises engaged in foreign economic activity would have to exclude the

155 Law of the Russian Federation No. 2 1 16-1 "On the Taxation of the Profîrs ofEnrerprises and Orgariizations", of December 27, 199 1 , an. 1. 15' Ibid., art. 1.4. 157 Ibid., art. 2.2.

paid export duties fkom the earnings fiom the products (works, services) rea~ization."~

The taxable base also does not include h d s received fiom foreign investors for the

purposes of financing production-purpose capital investments on condition that they will

be used up within one year afier the date of receipt. Otherwise, if the f h d s were not used

within one year afier receipt, they will be subject to taxation as part of non-sales incornes

"in the accounting period in which they were used otherwise than emarked or in which

II 159 the tetm for their being used as earmarked expired .

For assessrnent of the profits of foreign legal entities, The law provides special

particulars providing that:

a) The tax is to be levied only on that part of the entity's profits fiom its transactions in the Russian Federation. Profits derived by a foreign legal entity fiom foreign trade transactions conducted exclusively on behalf of the foreign legal entity and involving the purchase of products (works, services) in the Russian Federation shall be tax deductible, as shall be the exchange of goods and exports to the Russian Federation of products (works, services), whereby the legal entity becomes the proprietor of such products (works, services) under Russian Law until the latter crosses the state border of the Russian Federation, with the exception of profits received fiom the sale of products fiom warehouses owned or leased by the foreign legal entity in the Russian Federation;

b) If a foreign legal entity operates both in the Russian Federation and outside its borders, and does not keep separate accounts of profits which would help to identiQ the profits derived fiom the transactions conducted via a permanent representative office, the amount of profits may be calculated according to an agreement between the taxpayer and the tax authority controlling the former's remittances to the budget; c) Should it prove impossible to identify the profits received by a foreign legal entity fiom its transactions in the Russian Federation, the tax authority in charge shall have the right to calculate such profits on the basis of the gross income and production expenses involved, proceeding fiom a profit rate of 25 %.

Iss bid . , an. 2.3. IS9 ibid., art. 2.6.

If the Governent of the Russian Federation has an agreement with the other State

for avoidance of double taxation, as in case of Russia and Canada, the profits of the legal

person should be taxable only in a state of the permanent residence of the specified legal

person.'60 Although, if the business has a permanent establishment in both countries -

signatories to the agreement, the business profits may be taxed in the other State to the

extent as attributable to that permanent e~tab1ishrnent.l~~ Under the Bill-37, Russian tax

authorities must ailow for deductible expenses incurred for the purposes of the permanent

establishment of the legal entity including executive and general administrative expenses,

no matter if they were incurred in the State in which the permanent establishment is

situated or elswhere. 162

Income received by an enterprise in a foreign currency are taxed conjointly with

ruble earnings, provided that the foreign cwrency proceeds would be recalculated in

tubles at the exchange rate of the Central effective on the date when the enterprise had

identified the eamings fkom realization of the products (works, s e r~ i ce s ) . ' ~~ The tax paid

is split between the federal budget and the subjects of the Russian Federation, having

total profits tax not exceeding 30 %. The rate that the entity, including foreign legal

entities, has to pay to the federal budget is 11 %.lG The rates of profits tax set by the

subjects of the Russian Federation can be up to 19 %.16' The tax levied on the profit

received fiom mediation transactions and deals, insurers, markets, broker offices, banks

'& Canada's Bill (2-37 Relating to Agreements Between Canada and Numerous Countries for Avoidance of Double Taxation and Fiscal Evasion With Respect to Taxes on Income of May 17, 1996, Worid Tax Daily. October 9, 1996, art. 7.1 on-line: WL(WTD)ïTB 16' Ibid- '" Ibid., art. 7.2 163 Ibid., art. 2.7. '65 Law of the Russian Federation No. 2 1 16- 1 "On the Taration of the P r o m of Enterprises and Organizarions", of December 27, 199 1, art. 5. ' 6 5 Ibid.

and other credit organizations is set at rate that may not exceed 27 %? The rates were

recently reduced f?om a total of 35 % to the cunent 30 %, the federal tax rate was

reduced fiom 13 % to 11 % and the local share of the tax was reduced fiom 22 % to a

maximum of 19

The law provides that some foreign and Russian legal entities are exempt from

payment of profits tax. To qualim for exemption, the entity's income has to be received

from the performance of specid-purpose socioeconomic programs or from gratuitous

financial assistance, granted by international organizations and govemments of foreign

States, by foreign juridical and natural persons in accordance with intergovernmental and

interstate agreements.

However, the profits tax rates do not constitute the major problem in the sense of

financial burden for both Russian and foreign legal entities. The nominal rate of the tax is

low, but the effective rate is relatively high because of restrictions on deductions. 169

Persona1 income tax is levied on al1 individuals with Russian income, including

Russian and foreign citizens, and stateless persons.'70 The worldwide income of Russian

residents is also subject to the tax.I7' The rate of income tax is set at a maximum of 45 %

'& ibid. 16' Federal Law No . 62-FZ "On Amending rhe Law of rhe Russian Federarion on the T m on the Profi of Enterprises and Organizarions", of March 12, 1999, art. 5. l o g Law of the Russian Fedention No. 2 1 16-1 "On the Tararion of rhe Projks of Enterprises and Organizations", o f December 27. 1991, art. 6. 169 Set Antel S, . Starygin A., "1999 Russian Tar Reform - Stiïl Wairing", on-line: WL(WTD) "O The Law of the Russian Federaaon "On Incorne Tax on /ndividuals" of Decernber 7 , 1991, art. 1. I f 1 ibid., art. 2.

on individuals withmWhigh earnings". In Russia, one is considered rich if he/she eams

300,000 nibles annua1ly."' The rates are listed in article 6 of the Income Tax ~aw." '

Even though, the tax rate hike was approved by the International Monetary Fund,

some tax analysts consider the rate as a hindering factor in the govemmental policy of

increasing taxpayer discipline. Higher rates would force professionals that fit into the

"high earning" category to plan the remuneration of their payment in order to avoid

paying the tax.17' The tax on income of individuals is also regulated through international

agreements on avoidance of double taxation, as the one between the Russian Federation

and Canada, and provides for the rules of enumerating of tax on income and capital

received by persons conducting business on the State-signatory's t e m t ~ r ~ . " ~

Organizations including enterprises with foreign investrnents must pay payroll

taxes on employees' gross salaries. Payroll taxes are made to the following fùnds:

- The Pension Fund. The employer's contribution is set at a rate of 28 % of the arnount of

the employee's gross salary.'" An additional 1 % of pretax deduction is taken from the

employee's salary. '77

- -

"' It is approxirnately 51 8,000 (CAN). See also Antel C. "Russia Enacrr Tu. Currency Changes", Tax Notes international. May 17, 1999, p. 2006. l Ï 3 The Law of the Russian Federation "On Incorne T u on Individuals" of Decernber 7 , 1991, art. 6. 174 See also Antel C. "Russia Enacrs Ta. Currenq Changes", Tax Notes International. May 17, 1999, p. 2007.

Canada's Bill C-37 Relating to Agreements Between Canada and Numerous Couniries for Avoidance of Double Taxation and Fiscal Evasion With Respect to Taxes on hcome of May 17, 1996, WorId Tax Daily, October 9, 1996, art. 7.1 on-line: WL(WTD)'TTB

Procedure for Collecting Insurance Prerniums and Temporary Target Fee for the Benefit of the Pension Fund of the Russian Federation (Approved by the No, 800 of July 2 1, 1 WS), para. 9.1 177 ibid., para. 9.3.

- The Social Security Fund. Employer organizations and individuals (natural persons)

who employ individuals under labor contracts have to make a 5.4 per cent payments in

cash andlor in kind accrued for the benefit of the workers to the Social Insurance Fund of

the Russian ~ederation."~

- The Ernployment Fund. Employers also have to pay insurance prerniums to the State

Ernployment Fund of the Russian Federation at the rate of 1.5 per cent "of payments in

cash and/or in kind accrued for the benefit of workers on al1 grounds, whatever sources of

hnding are involved, including rewards under civil-legal contracts which subject is the

SV 179 performance of works and provision of services .

- The Medical insurance Fund. Employers must make payments of the accrual of

insurance prerniums at the tariff 3.6 % (of which 0.2 % is payable to the Federal Fund of

the Mandatory MedicaI insurance) for payments to the mandatory medical insurance

funds.

The totaI amount of payroll expenses charged upon employers is about 38.5 % of the

gross salary of each employee.

iv) Value Added T a

In December 199 1, the Russian Parliament passed the law " Concerning the Value

Added Tax", which provided that any organization which has a status of legal entity,

178 Federal Law No. 1-FZ "On Tarifs ofInsurance Premiurns Payable to the Pension Fund of the Russian Federarion, the Social Insurance Fund of the Russian Federation. rhe Srare Employmenr Fund of the Russian Federarion, and the Mandatory Medical Insurance Fundsfor 1999" (with the Amendments and Additions of October 25, 1999), of January 4, 1999. art. 2.

conducts business operations and is located on the territory of the Russian Federation is a

subject to the value added tax (VAT)?' The rates imposed were initially set at 28 % for

sales at unregulated prices and at 21.88 % for most ~ o o d s . ~ ~ ' The current rate for al1

goods (work and services) is 20 %.la' The previous amendment to the law reduced the

rates for certain foods and children's goods to IO%, but it was canceled by one of the

govemmental decrees, setting the universal tax rate of 20%.

Currently, VAT accounts for over 40% of the Eederal budget revenue, and Russian

econornic analysts argued that its removal would "not guarantee that the business activity

,r 183 and the revenues fiom other taxes would significantly increase . The M F also

supported sustaining the higher rate arguing that "the tax is one of the most easily

collected taxes", which maintains significant importance in a situation of Russia's very

low level of collected taxes.lU AAer proposals to cut VAT were made by the Russian

Governrnent last year, the Constitutional Court of the Russian Federation struck down the

govemment's decision to impose a modified f o m of accrual taxation for VAT as

unconstitutional. lg5

The VAT is aIso applied to barter transactions and to cash sales and, similar to

Western European VATs, it is not applied to exports (sales of goods outside of the

179 Ibid., an. 3. 180 See the Law- of the Russian Federation "Conceming Value Added Tax" of December 6, 1991, No. 1992- 1. an. 2. I Y 1 Lieberman E., "Russia Modernkes Ifs Tax Sysrem. Bur Ghosrs ofrhe CESR Srill Haunr", Commercial Law and Practice Course Handbook Senes, Practicing Law Institue, March 22-23, 1993, p. 567, on-line: WL. ln' See the Law of the Russian Federation "Conceming Value Added T a " of December 6. 1991, No. 1992- 1, art. 6. '" SamoyIenko V., "The Fare of the Russian T m Code: A Lookfiom Inside the Srare Duma Walk", International Tax and Investment Center, on-lule: (ITiC-CIS Main) ~http://inicnet.org/publications/Default.htm> 184 "Russian Govenirnenr Says VAT Should Be 20 % in 1999", Reuters, Apr. 26, 1999 on-line: (CNN Main) < ~ ~ ~ ~ : / / c u s ~ o I ~ I L ~ ~ w s . c L I I ~ . ~ ~ ~ ~ 185 Himes S., "Russia 3 T a Reform", Observer, no. 215, January 1999, p. 28.

Commonwealth of Independent States (cIs))?~ VAT can also be applied to certain

services, depending on their VAT coven a significant portion of transactions,

but there are some major exemptions, including banking operations, operations with

securities, export of goods and services, insurance etc.'88 The taxable base for goods and

services provided within Russia and separate goods and services imported into Russia

consists of the invoice cost of the goods or services provided.'89 The VAT taxable base

on the imports is comprised of the customs value, the customs duty, and the excise duty

of goods and services imported into ~ u s s i a . ' ~

v) Excise Tau

The rates and procedure for payment of excise taxes in the Russian Federation is

regulated by the law of the Russian Federation "On Excise", No. 23-FZ of February 1,

1 996.19' The excise tax is instituted on the sale of ceriain products within the Russian

Federation. In fact, excise tax has replaced the sales tax that existed in the USSR, and

was mostiy imposed on luxury products.

The law imposes the rates of tax that Vary depending on the type of product.

Excises are levied on most of the lwury and 'vice' type goods, including alcohol,

- -

1 'ab L ieberman E., "Russia Modernizes ILS T a System. But Ghosrs ofrhe USSR Srill Haunr", Commercial Law and Practke Course Handbook Series, Practicing Law Institute, March 22-23, 1993. p. 567 on-line: WL. 187 See the Law of the Russian Federation "Concerning Value Added Tm" of December 6, 199 1. No. 1992- 1, an. 6. 1 SS Ibid., art. 5 . LW Ibid., art. 3. '90 Ibid., an. 4.4. 19' Law of the Russian Federation "On ficise" of February 1 , 1996, No. 93-FZ on-line: (IST Main) <http:/!www.ist.ni >

tobacco products, automobiles, jewelry, including also gasoline, gas and The rates

of excise tax on oil and gas are currently at 18 % of the value of production, unless they

are specifically subjected to a different rate or exempted by the govemmental decree.lg3

Excise duty c m also be imposed on imports e n t e ~ g the temtory of the Russian

Federation. The rate of the duty varies depending on the type of the imported product.

The tax base includes the customs value of the goods subject to the excise duty. These

goods include cigarettes, cars, alcoholic bwerages etc.Iw

Excise duty is also payable on oil, including gas condensate, extracted and

produced fkom deposits with relatively better mining, economic and geographical

charactensti~s.'~~ The rates of the excise duty, are set up specifically for particular

enterprises and are listed in a Resolution No. 1 1 lof the Government of Russia Federation

of November 1, 1 Y92 and No. 847 of Novernber 1,1992.'" For other enterprises and

economic entities, including foreign legal entities, which are not envisaged by the

mentioned resolution, the rates of excise duty would equal 18 %.19' Payers of the excise

duty on oil, including gas condensate, are "oil and gas producing enterprises and

associations of al1 organizational and juridical forms, including enterpnses with foreign

equity .. . and citizens effecting the extraction of oil, including gas condensate, on the

rr 198 tenitory of Russian Federation, its continental shelf and economic zone .

192 Ibid., an. 4. 193 Ibid., the rate was lastly modified by the Law No. 192-FZ of Eecember 29 1998. 194 See the Law of the Russian Federation "On the Cusroms Duries" of Febmary 5, 1997, No. 25-FZ. 195 See the Finance Ministry of the Russian Federation instruction No. 1 1 1 "On Procedure ofPaymenr for E-rcise Tar on Oil inciuding Gas Condensare", para 1 , Ruslegisline, News of December 1 , 1992, on-line: Lexis (Ruslegisline) News 1% Resolution of the Government of Russian Federation of November 1, 1992 No. 847 "Excive Dufy on Oil E-rcrracreci on RF Territory" on-line: Lexis (Ruslegisline) 19' See the Finance Minisay of the Russian Federation Instmction No. 1 1 1 "On Procedure ofPayment for ficise T u on Oïl including Gas Condensare", para 1, Ruslegisline, News of December 1, 1992, on-line: Lexis (Ruslegisline) News 198 Ibid., para. 4.

The decree by the Govemment of Russia Federation of July 27, 1992 No. 1375-r

provides for exemption for enterprises and organizations formed with the participation of

foreign capital, which supply oil and gas condensate of their own production for

export.'99 In accordance with the resolution, enterprises, which were registered before

January 1, 1992, contain no less than 30 % of the foreign equity and are "engaged in the

mining andor processing of oil and gas and effecting works (senices) towards irnproving

the output of the main products of the oil, gas and petrochemical industries, shall be

exempt from excise duty on the export of oil and gas condensate which they mine and

9 9 200 take out of the territory of Russia Federation .

vi ) Royalries

The Law of the Russian Federation "On Subsurface" and subsequently issued

related regulations require al1 the subsurface users to pay a fee for the use of the

subsurface, except in the instances stipulated in the 1aw.*O1 The fees imposed on the usen

of natural resources includeto2:

a) payments for the right to explore and apprise deposits. The payments are made

throughout the duration of the exploration work. The tax base will include the agreed

ISY Ibid. '* Ibid.. Annex 1. notes, para. 1 . The term of exemption with regard to each enterprise is established by the interdepanmental cornmission o f the Finance Ministry's Committee for Foreign Investments. the Econornics Ministry of Russia, the Fuel and Energy Ministxy of Russia, the Comrninee on Geology of Russia and the State Customs Committee of Russia. ' O ' Law of the Russian Federation "On Subsu$ace" of February 2 1 1992, No. 2396- 1 , an. 39.

Ibid., art. 42.

or estimated cost of work performed. The tax rate is set at 1-2 % of the cost of the

performed work;

b) payments for the right to prospect deposits of oil or mineral resources. Payments are

made by the prospector for the duration of exploration works. The tax base is ageed

or estimated by the sides to the agreement and include the cost of al1 the work

performed. The rates imposed on the user of resources Vary fiom 3 to 5 % of the

performed work cost;

c) payments for the right to extract commercial minerals c m be made on the b a i s of

one-time payments and regular payments by the user. If the payments are made

regularly, the total tax paid varies fiom 6-16 % of the total value of produced

resources. The regular payment rate is applied to the projected average of the annual

output. If the user makes a one-time payment, it wilI amount to no less than 10 % of

the value of the produced resources;

d) payments for the right of underground construction work. The tax base estimated

equals to the total cost of the work performed. The rate imposed varies fiom 1 to 3 %

of the totaI cost of the construction.

Royalties are also paid under the production sharing agreements.203

\ri i ) Custurtts Duties

The Russian Federation also imposes an export tax on certain types of goods that

are exported from the The tax is assessed in European currency (ECUs) either

'O' See discussion in Ch. 111.3.2 "Taxation of the Energy Sector" on p. 73.

as a percentage of the customs value of the good or a flat rate per ton of the exported

product. The tax payrnent ranges fiom 5 to 70 % or f h m 1 to 80,000 ECUs in cash

value.'05 The export regirne of the Russian Federation is based on a two-colurnn system,

which includes a base rate and a 50 % higher barter rate, which compensates for the loss

of mandatory hard currency

The Russian Govemment dso imposes hi& duties on exports of oil and gas and

on the export of certain other commodities. The duties levied on exports of oil have been

ranging from 21 ECU to 45 ECU per ton; and duties on other commodities range from

1.5 ECUs per ton to 150 ECUs per ton, making it considerably expensive for e ~ ~ o r t e r s . ~ ~ '

To make things wone, under the influence of certain powerful republics - Subjects to the

federation, the Central Govemment took the position that it can grant exemptions to

exporters conducting business in particular republics. Such an approach created a certain

degree of inequality in treating and broadening the discretion of state bureaucracy. For

instance, the Russian President ruled by his decree that in the Karelia region the tax can

be elirninated where the production is sold to pay for certain goods, including food and

equipment.'08 Ln some cases the tax was also eliminated for certain investments in oil

until the investor had recouped his initial e ~ ~ e n s e s . ~ ~

- -- - -

'@ See the Governmental Resolution of the Russian Federation on introduction of Expon Tariff on Goods Exponed from the Russian Federation, Decree No. 91 of December 3 1 , 1991, r e p ~ t e d in Econornicheskaya Gazeta, February 15, 1992, at 15 ' O 5 Ibid. =O6 Ibid. 'O7 Pollack R., Bernstein A. and Minakova L., "Foreign Invesrmenr in Russia: The Perspecrive of the Russian Governmenr and Problems Faced by Western Invertors", Commercial Law and Practice Course Handbook Series, no. A4-4420, March 22-23, 1993, p. 523. 'Os Lieberman E., "Russia Modemizes ILS Tay Sysrem, But Ghosrs of the USSR Still Haunr", Commercial Law and Practice Course Handbook Series, Practicing Law Instinite, March 22-23, 1993, p. 568 on-iine: W L '* Ibid.

The foreign investor would also have to pay import duties when importing

products on the tenitory of the Russian Federation. The tax is levied on the customs value

of the goods irnported and the tax rate ranges within 0-30 %ile of the value of irnported

goods, depending on the item. On certain imported products, the importing entity must

also pay customs clearance fee that equals 15 % o f the value of imported goods. The

legislation regulating imports provides that some imports are contributions to the charter

capital for entities with foreign investment and, in some instances, temporary irnports are

also exempt.

vi i i) Replenishment and Environmental Taxes

The law on subsoiI establishes the following types of payrnents that should be

levied on users of underground reso~rces~ '~ :

1) tender (auction) participation fee and a fee for the issuance of a license;

2) payments for the use of underground resources;

3) charges for replacement of the minera1 raw materials base;

3) excise tax.

The payrnents for the use of the minera1 resources are made by any natural and

legal persons of the Russian Federation, including "natural and the legal persons of

foreign states, regardioss of their fonn of o ~ n e r s h i ~ " . ~ ' ~ The rates of deductions for the

''O The Law of the Russian Federation No. 2395- 1 "On Underground Resources" of February 2 1 , 1992. an. 39. "' See Federal Law of the Russian Federation No. 187-FZ "On the Continental Shelfofthe Russian Federarion", of November 30, 1995, art. 40.

use of natural resources depends on the type and quality of the resource used, amounts of

production, etc.*12

The govemment also exempts certain categories of users of natural resources

from paying the deductions, including: a) the owners of the land plots who use the

resources to meet their direct needs without selling them; b) the subsoil users carrying on

regional geological and geophysical works, geological s w e y , other geological works

associated with the general geological investigation; and c) the subsoil users which have

received areas for the formation of specially protected geological facilities of scientific,

cultural, aesthetic, sanitary and health-protective importance.2 l 3

Al1 companies in the oil industry have to pay a tax for the restoration of the

pnmary resources (RPR). Pursuant to Article 60 of the Federal Law on the Federai

Budget for the Year 1997 the govemment has established a Fund for the Reproduction of

Mineral Raw Materials ~ a s e . ~ " The resources of the Fund are supposed to be used for

the reproduction of the minera1 raw material sources, including the geological

investigation of the subsoil of the Russian Federation and to compensate for the costs of

management of the State Subsoil Stock of the Russian ~ede ra t i on .~ '~ The rate of the

reproduction deductions for oil and gas condensate equals 10 % and is levied on the value

of mineral resources s o ~ d . ~ ' ~

"' Federal Law No. 224-FZ "On the Rares of the AlIocarions for the Reproducrion of the Mineral Ra~v-Marerial Base", of December 30, 1995, art. 1.

' 1 3 Instruction of the State Tax Service of the Russian Federation No. 44 "Dn rhe Order of rhe Calcularion and Paymenr IO rhe Budget and rhe Target-oriented Use of Deducrions for rhe Reproducrion of the Mineral- Ratr, Marerial Resources" of December 3 1, 1996, para. 9. "' Federal Law No. 29-FZ "On the Federal Budgerfor 1997" o f February 26, 1997, art. 1 . ''' Ibid., art. 60. "' Federal Law No. 224-FZ "On the Rares ofrhe Allocationsfir the Reproductio~ ofthe Mineral Raw- Marerial Base", of Decembcr 30, 1995, art. 1 .; See also Decision of the Govemment of the Russian Federation No. 986 "On rhe Approval of the Regdations on the Fundfor the Reproducrion of Mineral Raw Materials Base", o f August 2, 1997, available on-line: Lexis(Ruslegisline)

i x) Securities Issuance Tax

The Secunties law of the Russian Federation provides that every legal entity has

to pay securities issuance tax on the nominal value of newly issued securities."' The Law

defines securities transactions as "actions or intentions by the taxpayer designed to

acquire property rights to shares, savings certificates, and bonds regardless of their fom,

circulation tems and par value and bills of exchange by concluding contract and

VI 218 registering a prospect of capital issue .

The tax base includes the contract price and the registration of the prospectus of

capital i s~ue."~ The rate of a tax on every security transaction is at 0.5 % of the nominal

cost of the shares issued by the legal person or any other type of s e c u r i t i e ~ . ~ ~ In such

case, the issuer executing the primary issue of securities shall pay the tax in the form of

payment for registration of the issued prospectus.22'

The law exempts the following categories of taxpayers fiom payment of tax on

securi ties transactions2":

- legal and natural persons purchasing shares initially issued by a joint-stock Company

from the date of its registration by a govermental body;

- issuers executing the primary issue of securities; and

"' See the Law of the Russian Federation "On the T m Levied on Operarions wirh Securizies" of March 23 1998, No. 36-FZ, an. 1. "s 1bid. 219 Ibid., art. 2. "O Ibid., art. 3. '" Ibid. 171

"' Ibid., art. 4.

- legal persons executing in the established order, intermediary securities operations, on

the account and on behalf of a customer.

Taxpayers calculate the amount of tax independently, based on the contract value

or the par value of the arnount of issued securities and the corresponding tax rate. The

calculation of the tax on securities transactions executed in foreign currency is calcuiated

in rubles based at the exchange rate established by the Central Bank of the RSFSR and

enacted as of the date of registration of this transaction.223

x) Road Fund Taxes

Alf legal persons, including the enterprises with foreign investment, international

associations and organizations, conducting their business through "permanent

representative offices, foreign legal persons, branches and other similar subdivisions of

the enterprises, organizations and institutions that have their own balance-sheets and

settlement accounts, set up in the territory of the Russian Federation have to pay a road

taxe^".'^" The foreign legal entities - owners of transport facilities pay the following

taxes! which are directed to the Road Fund of the Russian ~edera t ion :~~ '

- the Fuel and Lubncant Sales Tax;

- the Motor Road User; and

- the Vehicle Owner Tax.

"' ibid., an. 5. "' Law of the Russian Federation No. 1759-1 of October 18, 1991 on the Highway Funds, an. 5 . '" See the Letter of the State Tax Service o f the Russian Federation No. ShS-6-07/6 1 1 "On Methodological Direcrions for the Conducr of Documenrary Inspections ofthe Taxpayers Paying Taxes for the Benejir of the Road Funds ro Be Used in Practical Operation" of September 14, 1998, see Methodological Directions for the Conduct of Documentq Inspections of the Taxpayers Paying Taxes for the Benefit of the Road Funds.

Legal entities, including foreign legal entities as well as the natural persons, pay

the fuel and lubncant sales tax on such commodities as automobile petroleum, diesel fuel,

diesel oils, carburetor engine oils, carburetor and diesel engine oils, cornpressed and

liquefied gas used as engine fÙe1."6 The tax, however, will not be levied if fbels and

lubricants are sold by one structural unit to another structural unit within one legôl

entity.12' The taxable base would include the revenue fiom the sale, or markup on resale,

or gasoline, diesel fuel, diesel and tractor oils, and compressed and liquefied gases used

as engine hiel.22s The tax is payable at a rate of 25 % of the total revenue re~eived."~

Al1 legal entities established under the legislation of the Russian Federation

including enterprises with foreign investment, international associations and

organizations pursuing entrepreneurial activities through permanent establishment,

foreign legal entities; branches and other similar units of enterprises, organizations and

institutions pay the motor road user ta^.'^' The taxable base includes the "proceeds

received from the sale of products (works, services) and the sum of the difference

between the selling and purchasing prices of the goods sold as a result of procurement,

supply and sale as well as trade activities".'"

During the computation of the tax base for the road user tax, organizations

pursuing the resale of fùels and lubricants compute the fuel and lubricant sales tax based

on the arnount of the difference between the s e l h g and purchasing pnces of these

materials. It is deducted fiom the arnount of the difference between the selling and

'" Ibid., para. 1. -,*- -- ' ibid. '" Ibid., pan. 2. x9 Ibid., para. 6. 230 fbid., para. 15. '3' Ibid., para. 16.

purchasing pnces of these materials"."* The tax rate equals 2.5 % of the proceeds from

the sale of products (works, services); and 2.5 % of the sum of the difference between the

selling and purchasing prices of the goods sold as a result of procurement, supply and

sale as well as trade a ~ t i v i t i e s . ~ ~ And the last, vehicle owner tax is payable on an annual

bais by the legal entities, the citizens punuing entrepreneurial ac tivities wi thout setting

up a legal entiw, foreign legal entities and citizens, who own vehicles at the fixed rates

(per h o r ~ e ~ o w e r ) . ~ ~ ~

The regulations provide for the exception fkom the motor road user and vehicle

owner taxes for foreign and Russian legal entities invited for the period of the

imp lementation of target social and economic prograrns (projects). They may be "related

to housing construction, creation, construction and maintenance of the vocational

retraining of military personnel, . . . credits and grants provided by international

organizations and the govements of foreign States, foreign legal entities and natural

persons under inter-governmental and inter-state treaties as well as the agreements signed

on the authorization of the Govemment of the Russian Federation by the bodies of state

t r 235 administration .

The related federal regulations define the stamp duty as "an obligatory payment,

est ab lis hed and operating across the entire temtory of the Russian Federation, collected

'32 Ibid., pan . 18. '33 Ibid,. para. 19. 234 ibid., para. 29. See the rates listed in the paragraph. 35 Ibid.. para. 23.4.

for the performance of legally valid actions or for the issue of documents by the bodies or

by the official persons, authonzed for t h i ~ " . ' ~ ~ The payers of the duties are the citizens of

the Russian Federation, foreign citizens and legal persons, applying for the performance

of legally valid actions or for the issue of docwnent~.'~'

Article 3 of the Stamp Duty Law provides the Stamp Duty is levied for:

- the statements of claim and other kinds of applications and complaints, filed with the general jurisdiction courts, with the arbitration courts and with the Constitutional Court of the Russian Federation;

- the performance of notary actions by the notaries of the state notary's offices, or by the authorized official persons of the executive power bodies, the bodies of local self-government and of the consular institutions of the Russian Federation;

- the state registration of the civil status acts and for other kinds of legally valid actions, performed by the bodies for the state registration of the civil status acts; and

- the issue of documents by the said courts, institutions and bodies; for the examination and the issue of documents, related to acquiring the citizenship of the Russian Federation or to forfeiting the citizenship of the Russian Federation, and also for the performance of other legally valid actions, defined by the present Law.

Amounts of Stamp Duties are listed in article 4 of the law depending on the object

that the duty is paid for.238 In order to certifi the deal, which is calculated in foreign

currency, and also if the foreign cwrency is the object of succession, the amount of the

stamp duty is transferred into rubles based on the exchange rate at the day of payrnent of

the stamp duty, quoted by the Central Bank of the Russian ~edera t ion.~ '~

'36 Law of the Russian Federation "On the Smte Revenue Duty" of December 9, 1991 arnended by the Fedenl Law No. 226-FZ "On Introducing the Amendmenu and Addenda to the law ofthe Rwsian Federcztion on the S n p e Dury" of ~ e c e i b e r 3 1. 1995, art. 1. "' Ibid., art. 2.

Ibid.. art. 4. '39 ibid.. art 4.4.26.

xi) Federal License Fees

The federal law on licensing of certain types of activities provides that legal

entities or individual businessmen have to obtain special permission (right) for the

carrying out of a licensable type of activity and observe the Iicense requirernents and

conditions imposed by the licensing body.2* The law provides that the licensee has to

pay license fees for carrying out a licensed a ~ t i v i t ~ . ~ ~ ' If a license has been issued by the

federal bodies of the state power, the activity may be carried out on the whole tenitory of

the Russian ~ederation.~'~

The effective period of a license is established by related regulations on the

licensing of a concrete type of activity, provided that it cannot be less than three years.2"

The federal laws and regulations on licensing of concrete types of activity may also issue

a license with unlimited time restriction, even though it can be cancelled in case if the

licensee does not comply with the noms regulating the license-related activity2& The

rate of the fee for the consideration of an application for a license is established by the

Russian Govemment for every concrete type of a c t i ~ i t ~ . ~ " The areas of activity requiring

licensing are listed in article 17 of the law and include certain types of manufacturing,

creation of design, operation and repair of oil and gas equipment etc.

'"O Federal Law No. 158-FZ "On the Liceming oflenain Types ofAcriviries" of September 25. 1998 (with the Amendrnents and Additions of November 26,1998, December 22, 1999), art. 2. 24 1 Ibid., an. 7.1. '" ibid., art. 7.2. Note that payment of license fees to a republican/regional governrnental authonties would enritle the payer ro conduct the business only on the temtory of that particular republic or region. As it was discussed above, some republics and regions have been able to bargain special tax privileges from the federal govenunent. Thus, for some businesses, especially those involved into energy and minera1 sector, it could be more beneficial to consult the regionailiocal legislation regulatïng taxation of foreign entities before registering the business federally. 245 ibid.. an. 8. '" Ibid. 24 S Ibid., an. 10.2.

D) Regional and Local Taxes

There are also a nurnber of regional and local taxes, which are set and collected

by regional and local authonties. Local authorities are entitled to a share of a split profits

tau, which may amount up to 19 % of the tax paid by enterprises located on the temtory

of the l o c a ~ i t y * ~ ~ It should be noted that, with minor exceptions, local taxes in al1 the

countrîes under are so-called "nuisance taxes", as they tend to bear mostly administrative

burden on foreign investors, rather than financial. Legislation of the Russian Federation

provides for taxes to be paid by foreign legal entities to the regional and local budgets."'

These are the following regional and local taxes to be paid by Russian and foreign legal

entities:

1) Tax on the property of enterprise (Assets t a )

2) Sales Tax

3) Road Users Tax

4) Educational Levy

5) Advertising Tax

6) Tax on the Maintenance of Housing Facilities

7) Tax on Maintenance of Police Force

8) Land Duty

'""aw of the Russian Federation "On the Taxarion ofthe Profits of Enrerprises and Organizarions" o f December 27, 1991, no. 21 16-1, art. 5. '"' Law of the Russian Federation "Concerning the Fundarnenral Principles of the Taxation Sysrem in rhe Russian Federation" of December 27, 199 1, no. 2 1 18-1, art. 20.

i) T a on îhe Property of Enterprise

The sum of the tax payrnents is charged in equal parts to the republican budget of

a republic within the Russian Federation, to the budgets of territories and regions, the

budget of the autonomous region, the budgets of autonomous areas and the budgets of

districts, cities and towns in the place of location of a t a ~ ~ a ~ e r . ~ ~ ' The tax is charged on

the annual average balance sheet value of fixed and intangible assets (less depreciation),

inventory, and certain defined expenditures on the entity's balance sheet. For foreign

legal entities or ventures with foreign investments, as subscnbed by lawZ4', depreciation

is calculated using the rates of the home country, but maximum limits are set by Russian

~aw.'~'

The maximum rate allowed by federal law should not exceed 2 % of the taxable

base?' Legislative (representative) bodies of the entities of the Russian Federation

establish the specific tax rates on the property of enterprises, determined depending on

the types of the activity of the enterprises. If the tax is not specifically set, then it is

presumed to be 2 %, as stipulated by the federal Law on the Property Tax of Enterprises.

i i ) Sales T u

Local sales tax must be paid by al1 foreign legal entities, companies and other

corporate entities having civil competence, set up under the legislation of foreign

248 Ibid., art. 20.1 .a. '49 There should be not less ttian 30 % of foreign investment in the total amount of assets of the entity.

countries, international organizations, branches and representative offices thereof set up

on the territory of the Russian ~ederat ion.~ '~ Sales tax payments shall be entered into the

budgets of the subjects of the Russian Federation, and into the local budgets, in the

amount of 40 and 60 % respectively, and is presumed to be used for the social needs of

poor groups in the population.2s3

The tax is levied on the value of the goods (work, services) being sold, retail or

wholesale, for cash payment, etc? The sales tax rate is set at up to 4 % and the sum of

the tax is established as the percentage share of the pnce of the good that corresponds to

the tax rate, without counting the sales tax, and has to be in the price of the good.2'5 The

higher limit of tax rate was raised in January 1,2000 from 2 % to a maximum of 5 %.

The federal budget for the year of 1998 initially proposed to allow regional taxes

of up to 5 % with the purpose of replacing a planned 5 % reductiori in the VAT rate for

1999."~ The change, however, was not passed by the Parliament and the VAT remained

the same and is assessed on the pnce of the goods in addition to VAT, which resulted in

an increased indirect tax burden.

250 Law of the Russian Federation No. 2030- 1 "On the Property Tax of Enterprises" of December 1 3. 199 1 (with the Arnendments and Additions of July 16, December 22, 1992, March 6, June 3, 1993, November 1 1, 1993, April25, June 23, August 22, 1995, January 8, 1998, February 10, May 4, 1999). arts. 3 and 5. 25' Ibid., an. 6. '" Law of the Russian Fedeation "Concerntng the Fundamenral Principles of the T w r i o n Sysrem in the Russian Federarzon" of December 27, 199 1, no. 2 1 18- 1, an. 2 "j Ibid., an. 20.e.

ibid.. an. 20.3. =55 Ibid.

iii) Road Users T a

The rnotor road user tax must be paid by entities under the legislation of the

Russian Federation including the enterprises with foreign investment, international

associations and organizations purçuing entrepreneurial activities through permanent

e~tablishrnent.~~' The tax rate is ranging fiom 1.25 % and to a maximum of 3.75 %. If

otherwise provided by the local authorities, the tax rate can be set at 2.5 %.258 The tax is

Ievied on proceeds received fiom the sale of products (works, services) and the sum of

the difference between the selling and purchasing pnces of the sold goods.259

iv) Educationaf Levy

A special fee is collected from legal persons to meet the needs of educational

establishments. The maximum rate allowed by the federal law is 1 % of the total

employment income paid to full-tirne and part-tirne employees. The rate, may also be

varied by every individual subject of the federation within the stipulated range.'"

' 5 6 See Antel S.. Starygin A., "1999 Russian T a Reform - S M Waiting", on-line: W L ( W ) '" Letter of the State Tax Service of the Russian Federation No. ShS-6-07/611 "On Merhodofogicof Directions for the Conducr of Documenrary fnspecrions ofrhe Taxpayers Paying Taxes for the Benefir of rite Road F u n k ro Be Used in Pracrical Operurion " of September 14, 1998, para. 15. "' Ibid., para. 19. 1'9 Ibid., pan. 16.

Advertising tax is levied on the cost of reimbursable services associated with

advertising a good or service. The maximum rate allowed by federal law is 5 %, but it

rnay be varied regionally.26'

vi) Tax on the Maintenance of Housing Faciïities and the Land Duty

The amount of the housing facilities tax is detennined on the basis of the

applicable rate and cost of sold goods (works, services) minus the sales. The tax is levied

at the maximum rate allowed by federal law that equals 1.5 %, and may be varied

ïegionally.26' Land duty is paid for the total amount of square meters used by the

Company.

vi i) Tax on Maintenance of Police Force

Maintenance of police force duty is levied on citizens and enterprises, institutions

and organizations, irrespective of their organizational legal forms, in order to maintain

the militia, improve temtories, fulfill the needs of educaion and for other purposes.263

The arnount of duties per annum may not exceed 1 % of the amount of 12 times of the

- - - - - - - - -

"O Law of the Russian Federation "Concerning the Fundamental Principles ofrlre Taxarion Sysrem in rhe Russian Federarion" of December 27, 199 1. no. 2 1 18- 1, art. 20.1 .d. "'~bid., art. 21.1 .h. "' Letter of the Moscow Department of the Ministry of Taxes and Fees No. 11-14/1739 1 "On rhe Order of the /nrroduction of rhe Sales T a on rhe Temioty of the City of Moscow" of June 23, :999, para 2. 263 Law of the Russian Federation "Concerning the FundamenraI PrincQles of the Taration Sysrem in the Russiari Federation" of December 27, 199 1, no. 21 18- 1, art. 20.1 .g

minimal monthly wage established by law? For natural and judicial persons the

regulation establishes a duty set at a 3 % of the annual wages h d calculated on the basis

of the minimal rate of rern~neration.~~'

E . Double Tawation Treaties

In the 1 s t decade, Russia has become a signatory to several agreements on the

avoidance of double taxation, inciuding the Tax Treaty with Canada signed in May

1 9 9 6 . ~ ~ In the case of Russia, the Treaty is applied to the taxes on income and on capital,

irrespective of the manner in which they are levied, i n ~ l u d i n ~ ~ ~ ' :

- tax on profits of enterprises and organizations;

- income tax on individuals;

- tax on capital of enterprises; and

- tax on capital of individuals

The treaty is applied to residents of both countries-signatones to the treaty,

provided that the terni 'resident', under the treaty, includes any person or legal entity that

is liable to a tax by reason of domicile, residence, place of management or any other

criterion.'" Generally speaking, this double taxation treaty provides for a procedure of

tau relief in the case of taxation of Canadian investor in Russia. It provides a deduction

for tax on income or capital paid to the source country against residence-based taxation in

'M Ibid. 2b5 Minimum rate of the remuneration of labour as kom April 1, 1996 is in the amount of 75.900 roubles a month. The exchange rate as o f March 2000, was 25 rubles = % 1.00, per dollar. '* See Bill C-37 "Agreemenr Berneen the Governmenr of Canada and the Government of the Russian Federarion for the Avoidance of Double Tararion and the Prevenrion ofFiscal Evasion With Respect to Tares on Incorne and on Capitar', of May 17, 1996, on-line: (WL)'ITR 'b7 Ibid.. an. 2.

anad da.^^^ A Canadian resident Company can make a deduction in computing its taxable

income of any dividend received by it out of the exempt surplus of a foreign affiliate

which is a resident of the Russian ~ederation.~'' According to the Treaty, profits, income

or gains of a Canadian resident, which are taxed in Russia are considered to arise fiom

sources in ~ u s s i a . ~ "

3. Regulation of the Energy Sector

A. General Outlook

Oil and natural gas can be found in many of the republics of the former Soviet

Union. However, Russia rernains the dominant force in oi1 and gas production. There are

some disagreements among the experts on the quantity of the oil and natural gas in the

country. However, a general agreement was achieved that despite some decline in oil and

gas reserves and the complexity of oil fields, Russia still has one of the nchest

hydrocarbon resource bases in the world.

The oil and gas sector accounts for approximately 45 % of Russian exports, 60 %

of foreign currency revenues and 20 % of GD P.^'^ Russia's hie1 and energy sector

controls approximately 5 % of world oil reserves and 34 % of world gas reserves, and is a

"' ibid., art. 4. 269 Ibid., art. 23. '70 - ïbid., art. 23.b. "' Ibid., art. 23.d. '" See "The Invesrment Climare in Russia", Expert institute, Ernst & Young, 1999, Ch. 2.13.

key sector of the e c ~ n o r n ~ . ~ ' ~ However, since 1985 Russia has been expenencing senous

probiems related to the deciine in the output of oil and gas exports from 550 million

tonnes in 1989 to 300 million tonnes in 1998.'7J Russia needs a substantial influx of

foreign investments to reverse the process of decline and prevent the continuing

shrinkage of the foreign currency reserves of the country.

Russian Duma has adopted several legislative acts regulating the energy and

mineral sector, including Subsurface Law, Law on Production Sharing Agreements (PSA

Law), and Law on Concessions. These legislative acts have been awaited by a lot of

potential foreign investors for almost a de~ade.'~' The delay was cause for several

reasons, including political and b~reaucratic.~"

B. Taxation of the Energy Sector

In the area of exploration of energy and minera1 resources, the government has

taken severai steps to encourage participation of foreign investments. Major progress was

achieved with the adoption of the Law "On the ~ubsurface".'~' The law govems the

relationship between parties in a process of the study, use and preservation of the

subsurface, waste products of mining industries and related processing The

law stipulated that the use of the subsurface might only be granted on the basis of

273 ~b id . '74 b j d -

"' PoIlack R., Bernstein A., Minakova L., "Foreign Investmenr in Russia: the Perspecrive of the Russian Governnienr and ProbIems Foced by Wesfern ~ n ~ s m r s " , Commercial Law and ~ G c t i c e c o k e Handbook Series, PLI Order No. A4-4420, March 22-23, 1993, p. 527, on-line:WL(LJR) 2'6 See in general. Ibid. "' Law of the Russian Federation "On the Subsurface", of October 28, 1992, on-line: <http://www.ist.rn> 278 Ibid., Prearnble.

licenses, which c m be granted by means of cornpetitive bidding or auct ion~.~ '~ The

regulation establishes nghts and duties of subsurface user^'^' as well as it provides main

guidelines on the use and replenishment of the minera1 resources. Subsurface usen are

required to pay a fee for the use of the resources, which i n ~ l u d e ~ ~ ' :

- payment for the right to use the subsoil;

- contributions for the replenishment of the minera1 and raw material resource base;

- licensing fees;

- excise tax; and

- rent payments for the use of water areas and areas of the sea floor.

In addition to the mentioned fees, subsurface users have to pay "taxes and other

charges and payments required by law, including payments for the land use and

geological information", though the user may be granted an allowance for depletion of

the subsurface under this la^.^'' The amount of fees for the right to conduct operations of

prospecting and exploration are detemined according to "economic and geographical

conditions, size of the subsurface area, type of mineral, the duration of operations, the

>r 283 extent to which the territory has already been explored and the degree of risk .

Under the Law on Production Sharing Agreements (PSA) Law, the Russian

governrnental authorities and the investor can conclude a production sharing agreement,

providing that the investor explores and produces natural resources and shares a part of

the produced matter wit3 the Russian govemment.284 The major advantage that PSA

'j9 Ibid, an. 13. Ibid., art. 22.

18' Ibid., art. 39. 282 hid.

'83 Ibid., art. 4 1. '& The Federal Law of the Russian Federation "On Production Shoring Agreernena" of Decernber 30, 1995, No. 225-FZ, art. 2.

agreement offers for the investor is that the investor will be able to initially recover al1 the

costs spent on the project, and it is only aAer the hl1 recovery of expenses that the

investor will be sharing a part of the product.

The Law provides for the following taxes and payments to be paid by investor -

Party to PSA agreementzg5:

Profits Tax;

Value Added

Payroll Taxes

Payment for the Use of Subsoil;

one-time payments (bonuses);

annual payments for conducting exploration (rentals);

royalties;

Annual payments for conducting an exploration are established per unit of subsoil

area used, depending to economic and geographical conditions, the size of the subsoil

area, the type of minera1 resources, the duration of the said works, the degree of

geological study of the subsoil area and the degree of risk invo~ved.~~ ' One-time

payments (bonuses) are established in accordance with the terms and conditions of the

PSA at the conclusion of the agreement, andior upon the achievement of a certain

r e s u ~ t . ' ~ ~ Royalties are established as a percentage of the production volume of raw

2 s s Ibid., art. 13. 2s6 VAT is only paid on the product sold within the territory of the Russian Federation. '" The Federal Law of the Russian Federation "On Production Sharing Agreements" of December 30, 1995, No. 225-FZ, art. 13.4. 286 Ibid.

minera1 matenals or of the value of the produced output and payable by the investor in

cash or in the form of a portion of produced mineral raw r n a t e r i a l ~ . ~ ~ ~

The profits tax is levied on the value of a portion of the profit defined as provided

for in the PSA and owned by the investor under the PSA. Such value has to be reduced

by2i".

- the arnount o f the investor's payments for the use o f borrowed funds;

- one-time payments by investor during the use of subsoil;

- other unrecoverable costs incwred by the investor

The PSA must also speciQ the other costs incurred by the investor under the

agreement, including the specific items and the accounting procedure for the purpose of

profits tax. Then, in the future, the profits tax base can be reduced by the amount of the

arising difference until it is fd ly re~overed.~ '~

Investor pays the VAT for the sale of the share of produced resource owned by

him under the terms and conditions of the PSA. Al1 the amounts of the VAT paid by the

investor over an appropriate penod for the inventory, as well as for the works and

services acquired by him for the purpose of PSA operations, can be deducted fkom the

arnount of VAT payable to the budget over that period.292 The operators (carriers and

other persons) involved in the PSA operations under separate agreements (contracts) with

the investor are exempt fiom the VAT and excise duties on imports of goods and services

to the temtorj of the Russian ~ederat ion.~ '~ However, the exemption can only be applied

to the imported goods intended for conducting the said operations in accordance with the

289 Ibid. Ibid., art. 13.2.

29' Ibid. 292 ibid., art. 13.3.

project documentation. Also, the PSA operaton are exempt fiom the VAT on exports of

raw mineral materials and products of their processing outside the customs temtory of

the Russian Federation to which the investor is entitled under the tenns and conditions of

the agreement. 29"

Foreign companies have been encouraged to participate in various projects on oil

and gas exploration, and the govenunent of the Russian Federation has tried to negotiate

urnbrella credits with various institutional investors. including the IMF and the major

ex port-irnport b a n k ~ . ~ ~ '

IV. The General Investment Environment in Kazakhstan

1. General Outlook

Simila. to Russia, the Kazakh economy is currently in a state of transition, and

Kazakhstan was one of the first post-Soviet states initializing a pnvatization program and

liberalking its national legislation in order to attract foreign investments. Because of its

exceptionally rich oil and mineral resources and its relatively stable political situation, it

is wideiy considered by the international business cornrnunity as one of the most

attractive of al1 the Soviet successor States for foreign invest~nents.~"

'93 ibid. 294 ibid. '9 5 Pollack R., Bernstein A. and Minakova L., "Foreign Investment in Russia: The Perspective ofrhe Russian Government and Problem Faced by Western Investors", Commercial Law and Practice Course Handbook Series, no. A4-4420, March 22-23, 1993, p. 5 15. 296 Ernst & Young, "Doing Business in Kazakhstan", International Taxation, October 1, 1994, on-line: WL(WTD)

Kazakhstan's nch resource base and highly-educated labor force together with its

geo-economicai location in the center of Euroasia, linking the fast growing Asian

industries and Western Europe, are important factors, that combined with effective

econornic reform, enhance the country's future ability to join the world's progressive

market economies.'" The laws regulating foreign investment activities in Kazakhstan

provide for a number of incentives, which include: a) up to 100 % tax relief on the first

five yem of the investment; b) up to 50 % tax relief on the second five years of the

investment; and c) partial customs duty exemptions on equipment and raw matenals

needed for the in~es tment .~ '~

Together with the significant progress that the Kazakhstan's Govemment has

made in irnpiementation of the market refonns, there are some shortcomings and

deficiencies in the system. As it is in the case of Russia, although not to the same extent,

the laws and regulations in Kazakhstan aïe also a subject to fkequent changes and

modification^.'^^ There have been indications that attraction of foreign investments is a

higher priority than supporting their presence in the country.'" One of the major

cornplaints that foreign investon have been continuously mentioning is tliat the principles

and rules incorporated in Kazakhstanis legislation suffer fiom their inadequate

irnplementation, mostfy because of corruption in govemmental circles. The Government

has also been making promises that were not ultimately implemented, for instance, that

tendering process would be conducted in an open and fair manner, though there was a

-- - -

"' BISNIS, "Commercial Overview of KazaWisran", December 1999. on-line: (BISNIS Main) ~http:llwuw.bisnis.doc.gov> '98 See in general the Law "On Srate Support for Direct /nvestment1* of February 1997.

BISNIS, "Commercial Overview o/Kazakhsranw, December 1999, on-line: (BISNIS Main) <http:lluww.bisnis.doc.gov>

Ibid.

number of cases when tenders were issued just a week before the application deadline,

thereby limiting the c ~ m ~ e t i t i o n . ~ ~ '

2. The System of Taxation in Kazakhstan

Kazakhstan was the first of the countries under review th2t started the reform of

its legal and tax systems in cooperation with IMF advisors, and was able to introduce a

new comprehensive tax code by 1995. This coliaboration proved to be very productive

and effective, and the timing of the adoption of the new code has proved to be great, and

gave the country a substantial cornpetitive advantage in attracting foreign investments as

compared with Russia and Kazakhstan. The Code's simplicity has also proved to be up to

international standards and requireinents of international inves tor~ .~~ ' Table 1 in chapter

II, demonstrates that the early and successful introduction of the economic and tax reform

is directly related to the increase of FDI inflow into the country. The indicators are

projected in dollars per capita, what reflects the real input of investments according to the

size of the population of the respective country. Kazakhstan was able to attract the

highest per capita rate of FDI as compared to Russia and ükraine.

Conipanies that are formed in Kazakhstan under its national law are taxed on their

world-wide income. Income that the foreign companies or persons have made through

their representatives permanently established in the country is taxed in Kazakhstan.

'O' BISNIS, "lnvestment CIimate in Kazakhstan", Decernber 1999, on-line: (BISNIS Main) ~http:/~www.bisnis.doc.gov/bisnis/country/9808K07.htm~ 'O' J. Maninez-Vazquez and R. McNab, "The Tar Reform Experimenr in Transirional Counrries", National Tas Journal, Vol. LIII. no. 2, p. 277.

Unlike in Russia, branches of foreign entities are taxed on Kazakhstani source in~ome'~',

e.g. taxed where services were performed, not where the payrnent for the service was

made. Incorne from the source located in Kazakhstan to a non-resident and not related to

a permanent establishment, is taxed at the source of the payrnent, and fbrther, on the total

income without deductions, excluding labor that is taxed as personal i n c ~ r n e . ' ~

The double taxation problem is avoided in the Canada-Kazakhstan Income and

Capital Tax Convention of September 25, 1996.305 The Convention, in particular, applies

to the incorne tax of corporations and individuals, and the tax on the property of legaI

persons and individ~als.~"

Recently, the Kazakhstani government has adopted a set of new laws, which have

brought some significant changes to the generaI tax climate. In April 1995, the

govemment had enacted the Tax Code of the Republic of Kazakhstan, which was later

arnended by the law o f July 16, 1999, and became effective in August 3, 1999."' The

Ministry of Finance has aiso issued tax instructions clarieing the determination and

payrnent of taxes.

The code applies international taxation principles of equity, economic neutrality

and simplicity, establishing that residents are liable tu both direct and indirect income in

Kazakhstan if they have been physically present on the temtory of the republic for 183

303 Edict No. 2235 Having the Force of Law of the President of the Republic of Kazakhstan "Concerning Tares and Ozher Obligaroty Payments ro the Budget", of April24, 1995, art. 35 pereinafter Law on Taxes to the Budget]. See also Repon of the Business Information Service for Newly Lndependent States (BISNIS) "Commercial Overview of Kazakhstan", of December I999.Ch. N. 3 M Law on Taxes to the Budget, ibid. 305 Ibid., see in general Ch. 7. job Canada-Kazakhstan Income and Capital Tax Convention and Protocol, signed on September 25, 1996, Tax Anaiysts, on-line: WL(WTD)ïTR, art. 2.3. Ln the case of Canada, the Convention applies to the taxes imposed by the Government of Canada under the Incorne Tax Act- 307 BISNIS, "Tar & Accounting**, Country report, on-line: (BISMS Main) <http://www.bisnis.doc.gov>

days in any consecutive 12-month period.308 Taxes on economic activity are less

contradictory and complex than the ones in Russia. The new Tax Code, however,

provides for significantly severe penalties for late or non-payment of taxes to the central

or regional budgets. For instance, recently, changes to the tax law provided that the

faiIure to remit and withhold VAT on transaction with a foreign legal entity that has not

registered as a Kazakh taxpayer is subject to a penalty in the amount of 100 % of the tax

Although it is not provided in the Tax Code, the Law of the Republic of

Kazakhstan "Concerning State Support to Direct Investments" of February 28, 1997,

provides for the tax holidays that can be granted in some cases as incentives for foreign

legal entities. The law, in particular, provides fo?lo:

- reduction in income tax, land tax, and property tax rates of up to 100 % for a penod of up to five years, and a reduction in the tax rates of up to 50 % for the following five years;

- full or partial exemption fiom customs duties on the import of equipment, raw matenals, and consumables required for implementation of the investment project; and

- natural gants, defined as non-monetary property or propnetary rights of the Republic of Kazakhstan granted to investors with the right of ownership.

1. National Taxes

According to the Law on the Payments to the Budget, Kazakhstani and foreign

legal entities have to pay the following taxes to the national republican budget:

308 See Repon of the Business Information Semice for Newly Independent States (BISNIS) "Commercial Overcliew of Katakhsran", of December 1 999.Ch. IV. jo9 Reese Jenkins, "Kazakhstan Amen& Tax Code. Including Transfer Pricing Provisions", Tax Notes International, Febmary 8, 1999, p. 562.

i) Income tax fiom legal entities

ii) Income tax Erom physical persons

iii) Value Added Tax

iv) Customs and Excise

v ) Tax on securities transactions

vi) Special-purpose payments and taxes of users of the subsurface

vii) Payroll Taxes

i) Corporate Income TQX

Article 30 of the Law on Taxes to the Budget provides for a similar tax base to

that of western countries, upon which the general tax rate for legal entities is 30 %."' The

entity will pay 10 % of corporate tax if it was exclusively derived fiom agriculture, as the

major mean of If the legal entity is registered in a special economic zone,

the corporate income tax rate is set at 20 %.313

Dividends and interest on shares, debentures and other securities belonging to

enterprises are taxed at the rate of 15 %.314 The rate also applies to payments remitted

overseas. The extent of income or withholding tax levied on amounts remitted abroad

may Vary if a double tax treaty applies. According to the Canada-Kazakhstan Income and

Capital Tax Convention, the business profits of a Canadian 'resident' will be taxable only

in Canada unless the Company carries on business in Kazakhstan through a permanent

-- - - -- - - - - - - -

3 I O See in general the Law of the Republic of Kazakhstan "Concerning State Support to Direcr lnvestmenxs" of Febmary 28, 1997. 51 1 Law on Taxes to the Budget, art. 30.1 ., supra note 267. 317 Ibid.. art. 30.2.

establishment situated tl~erein.~" In the case that the Canadian 'resident' carries on or has

carried on business in Kazakhstan, the business profits of the 'resident' may be taxed in

the other State, but only so much of them as is attributable to the a) permanent

establishment; b) sales in Kazakhstan of goods or merchandise of the same kind as those

sold though that permanent establishment; and c) other business activities carried on in

that other State of the same kind as those effected though that permanent

e~tabl ishment .~ '~ The Convention also provides for exemptions of expenses incurred by a

Canadian or a Kazakhstani resident for the purposes of the permanent establishment in

the other country, including executive and general administrative expenses incurred

Kazakhstani law provides for items that may be deducted in determining taxable

Lease payrnents are also deductible up to the amount of amortisation available

for the asses as stipulated in the lease c ~ n t r a c t . ~ ' ~ Interests on non-bank loans are not

deductib~e.~'~

313 ibid.. art. 30.3. 314 Ibid., art. 32. 315 Canada-A'azakhslan Incorne and Capirai T a Convention and Protocol, signed on September 25, 1996, Tas Analysts, on-line: WL(WTD)TTR, art. 7.1. 510 ibid., an. 7.1 . a b c . 317 Ibid.. an. 7.3. 318 See Law on Taues to the Budget, art. 4 1 , supra note 179. See also Country analysis by Ernst & Young, "Doing Business In Kazakhstan", October 0 1 , 1994, Ch. F.2, j19 See Law on Taxes to the Budget, art. 43, supra note 179. 320 See also Country analysis by Ernst & Young, "Doing Business In Kazakhstan", October O 1 , 1994, Ch. F.2.

ii) Personal Income Tax

The personal income tax rate depends on whether the person is resident of non-

resident of Kazakhstan. Non-residents are taxable on the source of income obtained only

in Kazakhstan, and residents are taxable on world-wide in~orne.~'' To be considered a

resident an entity or person has to spend 183 or more days within any continuous 12-

month penod, that begins or ends in a fiscal year, or represents the Government of

Kazakhstan a b r ~ a d ? ~ ~

There is no minimum period of stay in Kazakhstan in which a non-resident would

be exempted from tax in accordance with the legislation. A business trip in Kazakhstan of

one day could, under the current legislation, give a nse to Kazakhstani iiability, unless a

tax treaty appiies.3u

Article 29 provides the rates of persona1 income tax for individuals-residents. The

tau base for the individual's income is the difference between the total annual income of

the person as well as certain deductions stipulated by the law. Recently, legislation

regulating the persona1 income tax was amended providing for a rate increase from 15 to

20 % for taxpayen with monthly incornes exceeding the minimal wage3z4 and frorn 20 to

j" See Law on Taxes to the Budget, art. 30, supra note 179. See also Canada-Kazakhstan Incorne and Capifal T u Convenfion and Protocol, signed on September 25, 1996, Tax Analysts, on-Iine: WL(WTD)TTR, art. 7.1. 3'f Law on Taxes to the Budget, art. 5-22., supra note 179. 323 '* Tararion in Karakhsran", Coopers &: Limbrand Country Report, September 7, 1995, on-line: (Mondaq .Main) <http://www.mon&q.com~ 3'' Minimal wage in Kazakhstan is 21,000 tengelmonth (Kazakhstani cuncncy), what equals about ($350 (CAN)).

30 % for taxpayers in the highest income bracket." Persons eaming less than the

minimal wage would still remain subject to a 10 % income t a d z 6

h o m e of a non-resident fiom a Kazakhstani source, which is not related to a

permanent establishment, is subject to taxation at the source of payment based on the

aggegate income without deductions, at the folIowing rates:

- Dividents and interest - 15 %327

- Insurance payments, payable on insurance agreements - 5 %

- Telecommunication or transportation services - 5 %

- Royalties, services income including management senices, consulting, rent

payments and other income - 20 %

i i i ) Value--4 dded T a

Value-Added Tax is detennined as the difference between 'We amounts of Value-

Added Tax which are accmed on sold goods, work or services, and the amounts of tax

which are subject to payment for purchased goods, perfomed work or services

,9328 rendered . VAT is usually applied at a rate of 20 % on turn-over arising from the sale

of goods, works and services.32g VAT is also applied to the imports of certain types of

goods, works and services at the same 20 % rate330 and is not applied to exPorts."'

j3 ''Kazakhstan Parliamenr Approves Incorne Tax Hikes", Tax Notes International, M a c h 29, 1999, p. 1237. '" Ibid. j2' See also Canada-Kazakhstan Incorne and Capiral Tax Convenrion and Prorocol, signed on September 25, 1996, an. 10.l.b. 32a See Law on Taxes to the Budget, art. 53, supra note 179. 3'9 ibid., art. 54. 330 ibid., art. 66.3. 53 I ibid., 66.2.

iv) Registration Fee for Issue of Securities

The fee is paid by al1 legal entities and physical penons, "which carry out

transactions relating to the transfer of the right to own securities, and also those which

r, 332 carry out their issues, shall be the payers of the tax on securities transactions . The

taxable bases with the tax on securities transactions include the value of original and

additional issues of securities, except for Government securities issued on the temtory of

Kazakhstan; and value of the initial and additional issues of securities launched in the

temtory of the Republic of Kazakhstan, except for issues of shares for the value of

revaluation of joint stock societies' assets, in accordance with current ~ e ~ i s l a t i o n . ~ ~ ~

V) Customs and Excise Duties

Excise duties are imposed on certain types of goods manufactured in the territory

of the Republic of Kazakhstan and imported into the territory of the Republic of

Kazakhstan according to the Iist provided in Article 76 of the Law on Taxes to the

~ u d ~ e t . ' ~ "

Excise duties has to be paid by al1 the legal entities and physical persons, which

manufacture excisable goods in the temtory of Kazakhstan, import excisable goods, or

sel1 excisable goods.335 Rates of excise duties are approved by the Cabinet of Ministers of

j3' Ibid., aR. 87. 3'' Ibid., art. 88-

Ibid-, m. 74- 335 Ibid., art. 75.

the Republic of Kazakhstan in %age of the value of particular goods or of the physical

volume in a natural mea~urement."~ The rates of excise duty charged against certain

goods ranges fiom 20 % to 160 %.337

Even though Kazakhstan does not have discriminatory policies with regard to

imports, goods imported fiom CIS countries on the temtoxy o f Kazakhstan are subject to

preferential treamient. Goods imported from Russia and the Kyrgyz Republic, who are

rnernbers of the customs union are d ~ t ~ - f i e e . ~ ' ~ Importation o f goods is permitted on the

temtory of the republic fiom certain developing or least-developed countries free of duty

or at a reduced rate as part of the Generalized System of Preferences under the W T O . ~ ~ ~

vi) Minerai Resources Tan

Special payments must be made by subsurface users, according to subsurface use

contracts concluded with the Competent Body authorized by the Governent of the

Republic of ~azakhstan." Tax on natural resources includesu' :

- bonuses, which are paid for the right of the subsurface user to explore the resource;

- royalties, that are paid for the pnvilege of exploration; and

- excess profits taxes paid by al1 the subsurface users carrying out mining of minera1

resources that receive additional profits due to better conditions or that sel1 their

336 Ibid., art. 77. 337 See Country analysis by Ernst & Young, "Doing Business In Kazakhsran", October 0 1, 1994, Ch. F.2. 338 "Investmenr C h a r e in Kazakhsran", Counay Report, BISNIS, 1998, on-line (BISNIS Main) <http:ll~ww.bisnis.doc.gov> 339 Ibid. 340 See Law on Taxes to the Budget, an. 94.1, supra note 179. 34 1 Ibid., art. 94.

outpiit at better than expected prices. The tax is paid if its amount and payrnent terms

are stipulated in the exploration andor production agreement.

Tax rates are set for every specific subsurface user by the Cabinet of Ministers and differ

among resource, and are unique to each ~ocation."~

vii) Payroll Taxes

Employers who employ Kazakhstani citizens are required to make contributions

to the Social Security Fund, Pension Fund, and Employrnent Fund. Contributions are

enumerated based on the gross salaries paid to such employees. The contributions' total

to be paid by the employer equals to 3 1.5 % where 1.5 % is paid in social security

payments, 25 % in pension and accumulative Pension Fund contributions, 3 % in medical

insurance payments, and 2 % in employrnent assistance.

2 . Local Taxes

Kazakhstani as well as foreign Iegal entities and physical persons who cany on

business activity on the temtory of the republic have to pay local taxes and levies, which

are set by decisions of local Councils, unless republic law provides otherwise. As it is in

the case with the local Ukrainian and Russian regional and local taxes, the Kazakhstani

local taxes are also predominantly "nuisance taxes". These taxes include the following:

1 ) Land tax

3'" See Report of the Business Information Service for Newly Independent States (BISMS) "Commercial Overview of Kuzukhsran", of December 1999.Ch. IV.

2) Property tax

3) Vehicle tax

4) Business Registration Tax

5) Road Tax

6) Fee on Auction Sales

7) Fee to conduct certain businesses

i) Land Tax

Legal entities and individuals (including lessors at the rates specified for certain

categories of land under lease) are subject to land tax on a plot of land or area of land

granted to them for ownership and use.3u The rates Vary depending on location and

quality of the land and any water supply on the land; the business results or activities of a

land owner or user do not affect the rates.345 The land tax is an annual fixed payment per

unit of land.

i i ) Properi), Tax

Legal entities and physical persons, which have taxable assets under the right to

own, to manage entnisted properties to business authority or operational management,

must pay the property Tax on main productive and non-productive assets of legal

j4' ibid., Part 1. Compare to 38 % of payroll taxes paid by business entities in the Russian Federation. EU See Law on Taxes to the Budget, supra note 179.

Ibid., art. 108.2. ''6 ibid., art. 13 1.

entities and physical persons, which engage in entrepreneurial activities, is paid annually

at a rate of l per cent of the value of the indicated a s ~ e t s . ~ ~ '

Tax on the property of physical persons, which is not used in entrepreneurial

activities, has to be paid annually out of the value of imrnovable property as defined by

the authorized body by the Governrnent of the Republic of Kazakhstan, according to the

rates provided under the law? Budgetary and non-profit making organizations and the

National Bank of Kazakhstan are exempt fiom payment of the ta^.'^^

iii) Vehicle Tax

Legal entities and physical persons which have transport vehicles registered by

the Kazakh state registration organs, no matter if the vehicles are owned or used, have to

pay the tax on transport ~eh ic les .~~ ' The tax base and rates of the tax are indicated in the

Article 128 of the law, and is paid annually on a given vehicle type at the rate from 1 to 8

%, calculated as a %age of the monthly calculation base of kilowatt power of the

~ e h i c l e . ~ ~ '

- p~

jJ7 rbid., 133.1. '" Ibid., art. 133.2. Article 133 provides the rates upon which the property tax must be paid by the payer. 349 Ibid., art. 133.

ibid., art. 126.

iv) Business Registration Tax and the fke to conduct certain businesses

Local municipal organs of state power collect registration fees for the

establishment of legal entities and conduct of individual business activity."' The rates of

the fees Vary from locality to locality, and are stipulated in the regulations of the locality

where the business is to be set up. Businesses also have to pay for licenses to conduct

certain businesses, for instance, in areas of mining, telecommunication, utilities.

v) Road Tax and Fee on Auction Sales

There are four separate taxes that must be paid by the business entities to the

Road und."^ The most significant one among them is the highway users' tax. The tax is

applied at the rate of 1 % of the cost of production in computing the Profits ~ a x . ' ~ Even

though the tax is deductible, the payment of 1 % of the gross receipts c m be a substantial

financial burden for certain smaller bus in esse^.^^^ Al1 business entities participating in

auction sales have to pay a fee set up by the local a u t h ~ n t i e s . ~ ~ ~

- -

35 1 Ibid.. art. 128. 3 5 2 BISNIS, "Commercial Uvervieiv of Kazakhstan", Country report, (page numbers are not available for this document) on-line: (BISNIS Main) <http://www.bisnis.doc.gov> 3 5 3 Law o f the Republic of Kazakhstan "Concerning the Road Fund' of December 19, 199 t . 354 Ibid., art- 4.2. 355 Bedel J., Horowitz D., and Nordberg C. A. Jr. "Stangers in a New Land: U.S. Lawyers Corne ro A'azakhstan", Journal of International Taxation, Vol. 4, No. 7, July 1993, p. 307 on-line: WL(JINLT) 350 BIShTS, "Commercial Overview of lYezaWlstan", Couatry report, on-line: (BISNIS Main) <http://www.bisnis.doc.gov>

C . Double Taxation Treaties

In 1994, Kazakhstan renounced the double taxation treaties negotiated by the

former Soviet Union as of Januay 1, 1995. Currently, Kazakhstan is a Party to a

numerous bilateral tax treaties with United Kingdom, United States, Pakistan, Hungary,

Poland etc. In September 1996, Kazakhstan also signed a double-taxation treaty with

Canada, which was ratified and entered into force on January 1, 1996.)~'

The treaty provides the tax treatment for investors and, in many cases, reduces or

eliminates the tax liability at the sources, thus supporting greater investrnent. Also, it

provides the general definitions of the areas where the double taxation is to be avoided,

and the subjects of taxation to be residents of Canada. For the Canadian resident

investing in Kazakhstan, the treaty provides that the double taxation will be avoided3?

- as a deduction fiom the tax on the income of that resident, an arnount equal to the

income tax paid in Kazakhstan;

- as a deduction from the tax on capital of that resident, an amount equal to the capital

tax paid in Kazakhstan.

I t also provides relief from the double taxation, the assurances of non-discnminatory tax

treatment, the cooperation between Canadian and Kazakhstani officials, and the exchange

of tax information.

The Canada-Kazakhstan Tax Treaty is applied to al1 taxes imposed on the total

income, on the total capital, or on the elements of the income or of the capital as well as

357 "Conwnrion Benveen the Governmenr of the Republic of Kazakhstan and the Governmenr of Canada for the Avoidance of Double Taxation and the Prevenrion of Fiscal Evasion", of Septernber 25. 1996 on-Iine: ( W L ) r n '" ibid., art. 23.

the taxes on gains from the alienation of movable or immovable property, as well as the

taxes on capital appreciation.359 in the case of Kazakhstan, the treaty is applied to the tax

on income and the tax on the property of legal pesons and i n d i v i d u a ~ s . ~ ~ In the case of

Canada, the treaty is applicable to the taxes irnposed under the Income Tax Act.

4. The Energy Sector

A. General Outlook

Kazakhstan is very important to the world energy markets because it contains

significant oil and gas reserves. According to various estimates, Kazakhstan has roughly

16 billion barrels of oil reserves, and may have another 30 billion barrels under its portion

of the Caspian seabedSM' Presently, Kazakhstan is the second largest producer of oil

arnong the countnes of the former Soviet Union after the Russian Federation, producing

about 500 million barrels of oil daily.362 Kazakhstani officia1 sources estimated thai

Kazakhstan could eam S 700 billion in revenues just fiom offshore oil and gas fields over

40 years.363

The major obstacle for Kazakhstan in exploiting its oil and gas resources is the

difficulty of transporting the product to world markets. Kazakhstan uses mostly Russian

network to export oil and gas outside the country.3M Predominantly, oi1 goes through the

359 Ibid., art. 2. ibid. art. 2.3.

361 "Counrr-y Commercial Guide: Kazakhstan", Fiscal Year 1999, Show Case Europe, U. S. Commercial Service, Ch. V.A., on-line: (SCE Main) <http://www.sce.doc.gov.> 361 "Reporr on Energy Sector in Kazakhstan", Energy Information Administration, Aprïl2000, on-line: (LSwest Main) <http://www.users.uswest.net> 363 Ibid. 3& Derman B ., "Kazakhstan: How a New Perroleum Law Con Fuel Economic Developrnenf", Tulsa Journal of Comparative and International Law, Fall, 1993, p. 59 on-line: (WL)TLSJCIL

pipeline system, by rail through Russia to the Black Sea and the Baltic, and by barge

across the Caspian to Baku.

B. Taxation of the Energy Sector

Al1 taxes and additional special payments that are levied on investrnents in natural

resources are listed in the Law on Taxation System in ~azakhstan.'~' The Law provides

for the two major models of taxation for subsurface usen, depending on the main type of

~ o n t r a c t s . ' ~ ~ The fint model prescribes the payment of all types of taxes and other

obligatory payments by subsurface usen as established in the legislation of the Republic

of Kazakhstan. The second model is envisaged only subsurface users of a share to the

Republic of Kazakhstan under the production sharing agreements (PSAs), including:

1) income tax fiom legal entities considering income tax to be withheld at the source of

payment;

2 ) tax on net income of permanent establishments of foreign legal entities;

3) value-added tax;

4) bonuses (surcharge payments);

5) royalties;

6) levy on state registration of legal entities;

7) levy for the right to engage in certain types of activities; and

8) other obligatory payments as established in legislative acts of the Republic of

Kazakhstan and which are not stipulated in this PSA model

365 Law* on Taxes to the Budget, supra note 267. 366 Ibid., art. 94- 1.

The special-purpose payments and taxes include the following:

1) bonuses: subscnption bonus, commercial discovery bonus, and extraction bonus;

2) royalties;

3) tax on windfall profits

Al1 the users of subsurface are payers of the envisaged by the law bon use^.^^'

Subscription bonus is a one-time tixed payment that is made by the subsurface user for

the nght to geological exploration of the subsurface, geological prospecting and

subsequent extraction and/or extraction. It is paid by users of the subsurface on !he

condition of concluding a contract for relevant operations in accordance with the

procedure established by the Kazakhstani legislation. Subsurface users also pay a

commercial discovery bonus, which is a one-time fixed payment and is paid by

subsurface users in the case of a commercial discovery in the contract temtory. The 1s t

one is extraction bonus, which is a fixed payment and it shall be paid by a subsurface user

periodically upon attaining certain stages in developing subsurface or certain levels of

extraction. Starting amounts of subscription bonuses are set by the Cabinet of Ministers

of the Republic of ~azakhstan.~" The procedure, final amounts and any other conditions

for the p a p e n t of bonuses are additionaily established in the contract.

The subsurface uscrs, which cany out extraction of usehl minerals and

processing of technogenic formations, must pay royalties for the nght to use the

subsurface, which are taxed on the volumes of useful minerals extracted by a subsurface

user.369 Additional income that forms with subsurface users from the activities under

cornparably better natural conditions, or under comparably better market conditions and

367 Ibid., art. 95. 368 ibid., art. 98.

which consequently have a higher proportion of profits, is used as the base for taxation

with the tax on windfall profits.370

Al1 types of bonuses and royalties are deducted before calculating taxable income

for income tax and for tax on excess profit.37' The subscnption bonus is not subject to

deduction when determinhg taxable income for income tax and tax on windfall profits of

subsurface üsers. Commercial discovery bonus, extraction bonus and royalties shall be

deductible when determinhg the taxable income for income tax and tax on windfall

profits of subsurface users.

Tax on windfall profits and al1 types of bonuses are payable by subsurface users

in a monetary f o r ~ n . ~ ~ ~ Royalties may be paid both in kind and in the monetaxy fom. It is

allowed to combine the monetary fom of payment with the payment in kind. Ln the case

of paying royalties in kind, the contract must stipulate the destination md conditions for

supply of extracted production.

Exploration and mining companies, including oil and gas companies, were

relieved by the recent arnendrnents to Kazakhstani tax law. Currently, the Iaw provides

that the govemment does not have a right to change the taxation terms written into

subsoil use contracts between the govemment and a subswface user. These terms, which

are determined for each contract after an obligatory state evaluation, are now fixed for the

duration of the subsoii use ~ontrac t .~ '~

369 Ibid., arts. 96. 100-2. ''O Ibid,. art. IOO. 37' Ibid.. art. 94-5.1.2. "' ibid., art. 95- 1.

V. The General Investment Environment in Ukraine

1. General outlook of the economic infrastructure

Ukraine has inherited an unbalanced economy with a tiny pnvate sector, a

dominance of production of industrial goods, colossal amounts of unfinished

consmiction, and a huge stock of unsecured financial liabilities to the population

associated with savings in the former Moscow central banks.'" Similar to Russia and

Kazakhstan, Ukraine has inherited large industrial and agricultural sectors, and relatively

small natural resource sector apart f?om inefficient coal industry. The growth of these

sectors was supported by USSR economic policy, which mostly focused on the

development of heavy industries (with a great share of military related production) at the

expense of other industries in Ukraine. For instance, in 1990 the output of femus metals

and machinery constituted 44.2 % of industrial output production whereas output of food

industry constituted 14 % of industrial production. The ratio between production of

industrial and consumer goods was about 70:30, and it was combined with a deficit of

most consumer goods and products.375

The current Ukrainian economic infrastructure has tied the country to CEE and

f/SU commodity markets and made it extremely dependable on the supply of energy,

machinery and increasingly expensive raw matenals fiom abroad. In 1992, the average

pnce of imported oil increased by 1 13 % compared to 199 1. In 1993, the average price of

imported oil doubled (and reached 76 % of the world market pnce), and the average of

. - -- .. . .

j Ï 3 Polkinghorne M., Tracey A, and York R., "Law and T m Developments" Financial Times Asia Gas Report. August 1998, Issue No 15, on-line: (Coudert Brothers Main) ~http://www.coudert.com>

imported natural gas quadrupled (and reached 52 % of the world market price) compared

to 1992. As a result, in 1994 Ukraine had to pay 15.5 % of its GDP (compared to 2.5 % in

1990) for the impon of energy.376

2. The System of Taxation in Ukraine

Current tax legislation has been under the pro cess of constant revision and

modification, which has not made it much more coherent, but added a factor of instability

to the tax system. During the period of 1997-1998, the govement of Ukraine

cornrnenced a tax reform with the purpose of reducing the number of taxes. President

Kuchma issued several decrees aimed at introducing a single uniform tax system for

small businesses, and a single uniform agricultural tax that is calculated based on the

value of the land. 377 Also inûoduced was a procedure for writing off and restructunng

VAT debts for producers of agricultural products as well as a system of reduction of the

payroll tax to 37.5 % beginning January 1, 1999.378

Like many other tax systems, the Ukrainîan one is also based on value-added tax,

persona1 and corporate income tax. The value-added tax, corporate income tax and

personal incorne tax made up about 43 % of total govemment revenues in the third

3 74 See Luzik P. , "/nternarional Experience of Tax Reform and Lessonsfor Ukraine", Discussion paper No. 99/04, Center of Econornic Reform and Transformation, Febniary 1999, p. 2 on-Iine: (CERT Main) <http:llwww.hw.ac.uk> '" %id. 3 76 ibid., p. 5. 3 75 " C o u n q Commercial Guide: Ukraine", Fiscal Year 2000, Show Case Europe, U. S . Commercial Senrice on-line: (SCE Main) <http://www.sce.doc.gov> 378 Ibid.

quarter of 1998.~" Arnongst the most significant taxes are: a 20 % VAT; corporaie

profits tax that amounts up to 30 %; a persona1 income tax, which is based on an

employee's income, and ranges from 20 to 40 % for the majority of employees in foreign

companies operating in Ukraine. There are also payroll taxes to be paid by employen to

the Social Insurance Fund, Pension Fund, and Employrnent Fund, with total contributions

amounting up to 37.5 % of wages paid by ernployers to their ernployees.380

On December 28, 1994, the ukrainian Parliament passed the lôw "On the

Taxation of the Profits of the Enterprises" (the "Corporate Tax Law"), which is currently

goveming the system of taxation of legal entities in ~ k r a i n e . ~ ~ ' The law abolished the

concept of taxing "dokhod", which was defined as the difference between the value of

products (works, services) sold and their cost of production (not including employee's

salaries and the most recent interest paid on borrowed funds). Since the adoption of the

law, the concept of a tax on profits has replaced the former concept of " d ~ k h o d " . ~ ~ ~ The

laws "On Value Added Tax" and "On Corporate Profits Tax" were passed by Parliament

dunng the first half of 1997. This provided a more favorable VAT and corporate tax and

bnnging some changes to the tax structure that would make it more compatible with

those found internationally. However, the langage of the laws and procedural issues,

together with abundant amendments, often add unnecessary cornplexity to the laws and

create additional problems for corporate taxpayers.

379 See Luzk P. , "lnrernarional Experience of Tar Refonn and Lessons for Ukraine", Discussion paper No. 99/04, Center of Econornic Reform and Transformation, February 1999, p. 2 1 on-line: (CERT Main) <htrp: l l \~~~~.hw.ac .uk> 580 "Commercial Guide of Ukraine", Country Commercial Guide, U.S. Department o f State, financial year 2000, Ch. N (A), on-line: (US Department o f State Main) ~http://www.state.gov> 38 1 The Law of Ukraine "On the Taxarion ofthe ProJts of Enterprises", of December 28, 1993. No. 33994- B P on-line: (Rada .Main) <hrtp://www.ra&.kiev.ua> 382 "Legal Framework Aflecring Foreign Investment", Trade Mission o f Ukraine, Apnl 15, 1997 on-line (Brama Main) <http://ww.brama.com>

The tax system reform has also affected the system of tax administration and

collection. The State Tax Administration responsible for the general implementation of

tax laws was granted broader powers since 1997. It incorporated the Ukrainian State Tax

Police and became accountable directly to the ~ r e s i d e n t . ~ ~ ~

Both ükrainian and foreign entities pay taxes on a quarterly basis. It is very

important for foreign investors to thoroughly examine the regdatory and taxation system

before designing the distribution system, because with the adoption of the laws in 1997,

the Ukrainian tax system grants broader pnvileges to companies that distribute their own

prod~~ts .3m

Prior to the enactment of the Corporate Tax Law-, al1 permanent establishments of

foreign non-resident companies had to be registered with the Ministry of Foreign

Economic Relations and Trade of Ukraine. However, this procedure was changed with

the adoption of the law. The State Tax Administration also issued a separate order

canceling the requuement to register permanent establishments by non-re~idents."~

Recently, the Parliament of Ukraine passed in the first reading a first cirafi of the

comprehensive Tax Code of Ukraine, which will codifL al1 the active tax laws and also

bring some significant rate changes to the major taxes. The new code has reduced the

number of taxes corn 36 to 24, lowered income tax fiom 30 % to 20 %, the VAT rate

from 20 % to 17 %, and would reduce the individual income tax to a ceiling of 20 % fiom

383 "Couttrtl. Commercial Guide: Ukraine", Fiscal Year 2000, Show Case Europe, U. S. Commercial Sem ice, Ch. VI ( A ) on-line: (SCE Main) ~hnp://www.sce.doc.gov> 3s4 "A Guide to Doing Business in Ub-aine" Department of Foreign Affairs and International Trade, Ch. 2.5 on-line: (DFAIT Main) <http://www.dfait-maeci.gc.ca> 385 See the Order of the State Tax Administration "Regulations on the Procedure for Registration of Permanent Esrablishmena of Non-Residents in Ukraine as lncome T a Payers" of January 16, 1998, No. 23; See also The Law of Ukraine "On rhe T i r i o n of the Profirs of Enterprises", o f December 28, 1994. No. 335194-BP, an. 8.

its current 40 %.386 The Ukrainian government has also planned to introduce a five-year

moratorium for changes on tax legislation.

A. National Taxes

The Law of Ukraine "On the System of Taxation" provides for the following

national taxes to be paid by both foreign resident and non-resident companies, which

conduct entrepreneurial activity and have their sources of income on the temtory of

~ k r a i n e : ~ ~ '

1 ) Corporate Income Tax

2) Persona1 Income Tax

3) Value Added Tax (VAT)

4) Excise and Customs Duties

5) Stamp Duty

6) State hovation Fund

7) Road Tax

8) Land Tax

9) Trade License

10) Sale of FueVlubncants Tax

1 1) Vehicle Tax

12) Foreign Vehicle Transit Duty

-

386 "Tar Code Makirrg Irs Way Through VR", Eastern Economist Daily, July 13, 2000 on-line: WL (ALLNEWS)

13) Rent Tax

14) Naturai Resource Tax

15) Environmental Pollution Tax

1 6) Payroli Taxes

17) State Duty

i) Corporate Income T a

The current version of the Corporate Tax Law provides for new tax rates for

entities in Ukraine, and in order to take the Ukrainian tax system closer to the Western

principles of taxation, it has additionally modified their tax bases. The 5-year tax holidays

that were available for Ukrainian enterprises according to the Decree of the Cabinet of

~ i n i s t e r s ~ " was consequently repealed by the Corporate Tax Law. However, al1 the

enterprises that were registered on or prior to December 24, 1993 could stili qualiS for

the tax holiday under the decree.

The Corporate Tax Law defines the object of taxation to be the gross incorne of

the enterpnse, which includes the revenues fiom the sale of products (works, services)

and other material values and property (including basic funds of production). It also

includes al1 other non-matenal assets, broker places (excluding the realization in

387 The Law of Ukraine "On the System of Taxation" o f Jwie 25, 1991, No. 39, art. 14. 388 Decree of the Cabinet of Ministers of h i n e "On rhe Regime of Foreign Investment" of June 5 , 1993, No. 55-93.

exchanges) and profits from non-trading operations deducted from the amount of

expenses for these ~ ~ e r a t i o n s . ' ~ ~

Uniike previous tax legislation, the Corporate Profit Law provides for more

explicit definitions of permitted costs and expenses, residents and non-residents, usual

pnce as opposed to market price, fiee financial aid, bad debts, related persons etc. For

instance, interest payments for loans incurred for working capital needs and for the

acquisition of fixed and intangible assets required for curent production needs may now

be included in the cost of production.3g0 Payments for investment management and

depository senices, expenses connected with the payrnent of dividends and expenditures

for printing and issuing shares and other securities can also be included in the cost of

production.391

The new corporate income tax legislation incorporated the ability for a business

entity to adjust the value of its fixed assets (except for assets that are subject to

accelerated depreciaiion) in line with the inflation rate if the annual inflation rate exceeds

1 O %.39' The business entity must accept that the difference between post-adjustrnent and

pre-adjustment value of fixed assets is also a form of capital income, and a part of it is a

subject to profit tax. Being a product of a capital income and annual depreciation rate, it

usually does not leave a business entity rnuch better off after inde~ation.~"

389 T h e Law of Ukraine "On the Taxation of the Profits ofEnterprises", of December 28, 1994. No. 33994- BP, an. 2. 3 9 0 ibid., arts. 3.1.3 and 3.1.4. 39' ibid., arts. 3.1.8 and 3.2. 392 The Law of h i n e "On Arnendrnents ro the Law of Ukraine On the Thxarion ofthe Profit of Enrerprises" of M a y 22, 1997, No. 283-97-BP, art. 8.3.3. j9' See Luzik P. , "international Ejrper-ience of T a Refinn and Lessons for Ukraine", Discussion paper No. 99/03. Center of Economic Refonn and Transformation, February 1999, p. 36 on-line: (CERT Main) <http://www.hw.ac.uk>

On the other side, Lhe overall structure of the Corporate Tax Law remains too

'schedular', as it separates the rules for assessment and taxation of insurance and re-

insurance and investrnent income. Also, the new legislation creates restraining conditions

for domestic corporations to legally diversi@ their assets, by placing limits for a legal

portfolio abroad because of inability to obtain tax credit for foreign tax on passive income

and capital gains.'w

The Corporate Tax Law has established the basic rate for a corporate tax equal to

30 %.395 The rate of taxation for profits gained from intemediary activities or from

carrying out auctions is 45 %. The auctions that involve securities, ownership interests in

legal entities, currency values and other financial instruments are taxed on a basic rate of

60 %.396 Enterprises involved in the sphere of agricultural production and that use their

own pmduction facilities, or which are engaged in the construction of homes, condos and

other facilities in villages and rural areas, or in certain other types of agricultural

production activities are exempt Corn payrnent of the corporate income ta^.)^'

Pnor to the adoption of the Corporate Tax Law, legislation had set very

conservative depreciation rates. For most types of equipment used for 8 to 10 years,

accelerated depreciation was only pennitted for enterprises with qualiQing foreign

investment, enterprises involved in military conversion m d those operating in the

prioritized branches of the Ukrainian e c ~ n o r n ~ . ' ~ ~ That allowed enterprises to determine

their own accelerated rates of depreciation, but such rates could not be higher than twice

-- -

j9" ibid. 395 The Law of Ukraine "On the Taxation of the Profits of Enterprises", of Decernber 28, 1993. No. 33994- BP, art. 10 396 Ibid. 397 The Law of Ukraine "On Enterprises and Organtkarion Income Tar" of February 2 1, 1 992, No. 2 146- 12, art. 5.1.

that established by the applicable regulations and may not lead to an increase in the prices

of products made by the enterprise.399 The Corporate Tax Law does not contain any

separate provisions reguiating taxation of capital gains, which makes them taxed on at

same basic rate of 30 %.

The Corporate Income Tax Law establishes niles and regulations for taxation of

foreign legal entities carrying out business activities on the temtory of Ukraine through

their "permanent establishments". The Law defines a foreign permanent establishment as:

a) any structure in Ukraine, which is not a legal entity through which a foreign legal

entity either partially or fülly carries out business activities in Ukraine or; b) an individual

who represents and is employed by a foreign legal entity in ~ k r a i n e . ~ In addition to the

national legislation, the question of determination of whether permanent establishment

exists is a subject to the provisions of any applicable tax treaties.lO'

The new Ukrainian legislation on profits tax has a very particular approach to the

issue and redemption of corporate debt instruments, including bonds, annuities,

certificates of deposit etc. The Corporate Tax Law provides that receipts fiom the issue of

corporate bonds, certificates of deposit, and some other corporate securities (except for

stocks) at nominal value constitute a part of gross corporate income, and interest

payments and redernption outlays constitute a part of gross corporate e ~ ~ e n s e s . ' ~ ~ If this

1s the case, an acquisition of corporate debt securities receives the same tax treatment as a

-- ---

398 "Lrgal Framework .4flecring Foreign Investment*', Trade Mission o f Ukraine, Apnl 15, 1997 on-line (Brama Main) ~iinp://www.brarna.com> 399 The Law of Ukraine "On the Taxution of rhe Profits ofEnterprlires", o f December 28, 1994. No. 33994- BP, an. 8. 400 Ibid., arts. 2.1.2. and 2.1.4. 40 1 Ibid., art, 19. 'O2 The Law o f Ukraine "On the Taxation of the Profits of Enterprises", o f December 28, 1994. No. 335194- BP. art. 4.

purchase of raw matenals for production, and an acquisition of corporate ~ecuri t ies~~'

would become a part of gross corporate expenditures. Similarly, redemption of corporate

debt securities receives the same tax treatment as, for instance, revenues from sales, and

receipts from redemption constitute a part of gross corporate income for investors. Thus,

it becomes obvious that this construction of the corporate tax base effectively increases a

cost of bond finance and bank loans making them more favorable as opposed to corporate

bonds, certificates of deposit, and sorne other corporate s e c ~ r i t i e s . ~ ~

The profits of permanent establishments are taxed at a basic rate of 30 %. For

purposes of this tax, profits are deemed to be the revenue, which the permanent

establishments would have obtained if it a) were a separate independent enterprise

involved in sirnilar activities on the same conditions as the foreign legal entity, and b) had

acted independently with respect to the foreign legal entitya5 Passive source income

received by non-residents who do not cany out business activities on the temtory of

Ukraine, and which are received in a f o m of dividends, interest, lease, royalty payments

and payrnents for insurance premiums, as well as from technical engineering services is

subject to a withholding tax of 15 % upon repatriation from ~ k r a i n e . ~ ' ~

In the case of Canadian investors, such repatriation would also be subject to the

Canada-Ukraine Incorne and Capital Tax Convention, which provides that proceeds

received fiom dividends, interest, royalty payrnents, capital gains and persona1 sentices

arising in a Contracting Party and paid to the resident of the other Contracting Party may

'O3 Long-rem debt instruments and annuities are exception in this case, as long-term debt instruments and annuitic& are subject to tax treatment similar to acquis&on of intangible assets. and depreciation rules would apply to the incwed acquisition costs. See Luzik P., "lnrernotional Experience of Tax Reform and Lessonsfir Ukraine", Discussion paper No. 99/04, Center of Economic Reform and Transformation, Febniary 1999, p. 36. 'OJ Ibid. 405 ibid., an. 13.5.

be taxed in that other tat te.^' The Convention provides that the profits of a Canadian

enterprise should only be taxable in Canada unless this enterprise carries on business in

Ukraine through a permanent representative located in ~ k r a i n e . ~ ~ If the enterprise carries

business through a permanent representative, the profits may be taxed in Ukraine, but

only to the extent that is attributable to that permanent representative.JOg In this scenario

the profits that this enterprise would be expected to make will be attributed in Ukraine as

if it is a distinct and separate enterprise engaged in any kind of activity4'0 It would also

be assumed that such an enterprise would cany out business totally independently with

the enterprise of which it is a permanent establishment and with al1 other persons.

The Convention provides that deductible expenses of that enterprise incurred for

the purposes of the permanent establishment should be allowed, including executive and

general administrative expenses, whether incurred in Ukraine or e~sewhere.~' ' However,

no such deductions are allowed if the permanent establishment has paid any amounts to

the head office or any other offices, by way of "royalties, fees or other similar payments

in retum for the use of patents or other rights, or by way of commission, for specific

sentices performed or for management, or, except in case of banking enterprise, by way

of interest on moneys lent to the permanent establishment by the enterprise. * r J I Z

The new Corporate Tax Law has created a tax regime for corporate debt

instruments that had a very negative effect on foreign investors, including those from al1

the countries, which have a double-taxation treaty with Ukraine. Particularly, it has

4M Ibid. 13.1 107 Canada-Ukraine lncome and Capital T a Convention of March 4, 1996, arts 1 1. 12, 13 and 14 on-line: (WL) wTD 408 Ibid.. art. 7.1. 'O9 Ibid. "O Ibid., an. 7.2. '" Ibid., art. 7.3.

affeczed foreign investors who own 1.9 billion worth of Ukrainian treasury bills. On

December 16, 1997, the Ukrainian Parliament passed amendments to the Law on

Taxation of Enterprise Profits and applied it retrospectively to July 1, 1 9 9 7 . ~ ' ~ As a

result, a 30 % tax on the profits fiom treasury bills was applied retrospectively to al1 non-

residents, irrespective of whether the non-resident was eligible to a tax relief under

double-taxation treaties. Such a shortsighted legislative move pushed the banking system

into total confiision. Some Ukrainian banks operating as custodians in this market have

decided to withhold the 30 % tax from investments profits in treasury bills purchased

after Juiy 1, 1997, covering both matuity proceeds and secondary market sales. Other

goups of banks decided to withhold only the 30 % tax fiom gains realized at the maturity

of bills purchased before July 1, 1997. The last group of banks decided not to withhold

the tax at all, citing the supremacy of international law over the national one.

Retrospective enactment of the amendment discouraged foreign investors from increasing

their portfolios, and seriously undemined the already very weak confidence of foreign

investors in the stability of the investment environment in ~ k r a i n e . ~ ' ~

ii) Persorrat I n corne Tax

Questions of persona1 income taxation are pnncipally regulated by the

Degree of the Ukrinian Cabinet of Ministers 'On Persona1 Income Tax" of December

26, 1992 and the Law of Ukraine "On Taxation of Persona1 Income" of December 26,

"' Ibid. ' 1 3 '*Taxarion ofPc'an-Resident Debt /nvestors", position paper, American Chamber of Commerce, Kyiv, Ukraine, 1998, on-Iine: (ACC Main) <http://www.amchamukrauieekiev.ua> "' Ibid.

1992. This legislation provides for rules in the taxation of income of Ukrainian citizens

and foreigners. For purposes of this iegislation, the following physical persons must pay

personal income tax?

- Residents - defined as citizens of Ukraine and foreign individuals who are physically

present in Ukraine at least 183 days in a calendar year; and

- Non-residents - defined as citizens of Ukraine and foreign individuals who do not

qualiQ as resident.

Residents are taxed on their aggregate worldwide income and non-residents are

taxed on al1 income derived fiom sources in Ukraine, but they are not eligible to receive

exemptions or deductions available to residents. The regulation provides for tax

exemptions for about 25 categories of incorne ranging fiom social welfare payments to

inheriiance and lonery ~ i n n i n ~ s . ~ ' ~ It also lists kinds of irregular income that are taxed at

reduced rates."' Certain categories of persons are totally exempt from taxation, including

fdl-time students, seasonal agriculhiral workers, veierans

The persona1 income tax base for workers includes not only their earnings, but

also "stock dividends" and the value of social and material benefits received at their place

of employment. The employees of joint ventures are specifically mentioned in this

~ a t e ~ o r ~ . . ' ' ~ The rates of income tax range from 12 % to 30 %."O The legislation uses a

withholding tax system, with the employer paying the tax on behalf of the employee.

The legislation does not provide any clear definition of persona1 income, and

there is still no separate category for capital gains. It only provides that taxable income is

4 15 The Law of Ukraine "On Taxation of Personal /ncorneW of December 26, 1992, art. 1. 416 Ibid., arts. 3 and 9. r i 7 Ibid., art. 10. "' Ibid.. art, 4.

deemed to be the difference between the aggregate arnount of a taxpayer's annual income

and the aggregate exemptions available to such a taxpayer under the applicable Wainian

tax legislation.i21 Applying deductions available under the relevant legislation may

fùrther reduce taxable income.

It looks rather unusual that the relevant legislation recognizes three major income

categories - employment income, income fiom independent business or profession, and

other i n ~ o r n e . ~ ~ ~ Al1 the specified categones have different sets of tax rates as well as

different rules concerning exemptions and deductions. For instance, a 10 % to 40 % tax

rates is applied to primary employment income, and income from independent businesses

and professions.423 A 20 % tax rate is applied to secondary employment income and any

Ukrainian source income for non-residents, and a 20 % to 60 % rate is applied to

royalties etc? Such preferential tax regimes established by legislation for different

forms of persona1 income can create an environment where people would change their

persona1 income structure and, consequently, could create some distortions in

e c ~ n o r n ~ . " ~

A taxpayer may get a tax credit towards Ukrainian taxes if he/she has made

income tax payments outside Ukraine. In such a case, the taxpayer must provide written

achowledgment fiom the foreign tax authority that such foreign taxes have actually been

paid. However, the total foreign tax paid may not exceed the amount of Ukrainian

ibid., an. 7. 4 20 Ibid., art. 8. '" Ibid., art. 2.

See Luzik P., "Inremarional Experience of T a Reform and Lessons for Ukraine", Discussion paper No. 99103. Center of Economic Reform and Transformation, February 1999, p. 33. '"3 The Law of Ukraine "On Tararion ofPersonal Income" of December 26, 1992, see tax rates provided in articles 8, 14, 17. '"' Ibid., an- 20.

persona1 income tax due, unless otherwise is specified by international tax agreements to

which Ukraine is a ~ i ~ n a t c . r ~ . ~ ~ ~ Ukrainian or foreign non-residents who have a Ukrainian

source income are taxed by the source of income.

The legislation provides for numerous deductions and exemptions, which have a

narrowing effect on the personal income tax base. Among the major exemptions are

interest denved kom persona1 bank accounts, savings certificates, governrnent bonds,

agricultural income, governrnent lottery winnings, inheritance etc. In addition to the

standard tax-free allowance, qualified taxpayers such as veterans, military personnel and

other categories are entitled to make up to 10 additional dedu~t ions .~~ ' Many of these

deductions and allowances lack better elaboration and economic justification. In their

current, state they can easily be used with the purpose of tax avoidance/evasion, and

consequently, keep actual income tax revenues l~w. ' '~ Additionally, the legislation does

not provide for the possibility to cany-over business and professional losses, which

creates an environment with a serious bias against business r i ~ k . ~ ~ '

iii) Value Added Tax

Commercial transactions involving the realization or sale of goods, labor or

services in Ukraine are subject to the value added tax (VAT), which is taxed at a 20 %

rate. The VAT c m be levied at a rate of zero % on exports of goods and provision of

'" See Luzik P. , "hernalional Experience of T m Reform and Lessons for Ukraine", Discussion paper No. 99/03, Center of Economic Reform and Transformation, Febmary 1999, p. 33.

The Law of Ukraine "On Taxation ofpersonal Incorne" of December 26, 1992, art. 5. '" Luzik P. , "Inrernarional Experience of T m Reform and Lessons for Ukraine". Discussion paper No. 99/03, Center of Economic Reform and Transformation, February 1999, p. 33. '" ibid.

ibid.

services to be used outside Ukraine, on international transport services and the import of

items classified as critical imports by the Ukrainian Government. 430 The VAT is

calculated and paid on a basis of the value added at each level of production. It must be

remitted on the difference between the VAT received fiom purchasers and that paid to

supplies with respect to other production costs. Payers of the VAT are both Ukrainian

and foreign legal entities and physical persons, who c m y out business activities on the

territory of

The liability of a VAT payer equals the arnount levied on the taxable transactions

within a reporting period. It arises at the earlier of the dates of either the dispatch of

goods to the customer, or receipt of payment fiom the c~s torner . '~~ The VAT credit is

equal to the amount which a taxpayer is entitled to offset his or her VAT liability in a

reporting penod. The VAT offsetting rights arise on the earlier of the dates of either the

date of payment to the supplier, or the date of obtaining the VAT voucher, which is used

for the recording of each taxable tran~action.~~'

Value added taxation replaced the former turnover tax that existed in Ukraine

until 1992. The newly enacted tax only remotely resembled the analogous VAT system

used by the EU counties and needed fiirther elaboration and clarification. The current

legislation offers a number of exemptions fiom the payment of VAT, which negatively

influences general corporate commercial strategies and lowers the budget revenue. The

VAT Law provides for exemptions for limited number of goods, including raw materials,

component parts, equipment, machinery and other goods and materials. It also provides

'30 The Law of Ukraine "On Value Added Tax" of April3, 1997, No. 168/97-BP, art. 6. "' ibid., art. 2. "' ibid., art. 7. "' ibid.

exemptions for energy supplies (oil and gas) imported by commercial enterprises for

production purposes and their own needs, with the exception of goods imported with the

purpose of r e s a ~ e . ~ ~ ~

Another important problem is double taxation, which increases selling prices and

creates strong incentives for illegal activities. For instance, the sarne supplies in Ukraine

c m be subject to the VAT, excise and custom duties, where the VAT is usually levied on

the amount, which already includes excises and customs duties (for i ~ n ~ o r t s ) . ~ ~ ~ Such

imbalances in a system of application of the VAT, in conjunction with other taxes,

creates a major problem in encouraging non-registered economic transactions, capital

outflow, barter transactions, tax evasion etc. Al1 these factors drarnatically distort the tax

system and the adequate investment environment in general.

iv) Excise and Customs Dulies

Tobacco, alcohol, certain meat products, coffee, fiels, cars and sorne other luxury

products are subject to excise duties, which are levied in accordance with the rules and

procedures established in the Law of Ukraine "On Certain Question Concerning Excise

Taxation" of November 16, 1995 and the Presidential Decree "On Rates of Excise Duty

on Petroleum Products" of June 24, 1998. The rates of excise duties Vary depending on

the type of product and range from 10% to 50%."~

434 Ibid.. art. 5 . 435 Luzik P., "lntenational Experience of Tax Reform and Lessonsfor Ukraine", Discussion paper No. 99/04. Center of Economic Refom and Transformation, February 1999, p. 37. 4 3 6 The Law of IMaine "On Certain Questions Concerning Excise Taxation" of November 1 6, 1 995, an. 5 .

Customs duties are levied at different rates depending on the status of the country

that is the source of goods. h p o n duties are levied in accordance widi the Ukrainian

Unified Customs Tariffs, which were approved on January 13, 1993. The Tariffs provide

for different levels of custom duties for products being imported in Ukraine, including

preferential, most-favored nation, and ful l status nation. The differences among the rates

applied depending on the status of the country can be very substantial. The first leveI is

applied to products onginating fkom the following countrie~:~~'

a) from countries with whom Ukraine bas entered into a customs union;

b) fiom countries with whom Ukraine has created special customs zones;

c) fiom countries which have provided 'preferential" treatment to Ukraine pursuant to a

bilateral agreements; and finally

d) countries, which are classified as "developing countries" by Ukraine, except for those

products from developing countries, which fa11 within classification No. 25-97. 438

The second level is applied to the countries that have p t e d Ukraine a most

favored nation treatment and to products fiom developing countries, which fa11 within

ciassification No. 25-97. By 1998, Ukraine had established a rnost favored nation regime

with 30 countries. The third ievel is applied to the rest of the irnporting countries.

v) State Duties and Stamp Duties

The presidentiai Decree "On State Duties" provides that al1 the legal entities and

physical pesons must pay "state duties" for issuance of official documents by

"' The Law of Ukraine "On rhe Un$ed Cusroms Tanf* of February S,l992, an. 22.

ernpowered state agencies and nie decree provides for various fees and duties

tha; are imposed by judicial and arbitrage agencies, various ministries etc. The list

includes duties for applications and appeals of creditors for judicial proceeding by

arbitrage, transactions with real estate, notary certification etc?' The fees Vary from

fixed amounts of money in local cumency to 30% of the amount of money that are

transferred by citizens outside of the territory of Ukraine.

All the subjects who carry out export operations on the territory of Ukraine must

pay stamp duties. The Law "On Stamp Duty" was effective until January 1,2000."' The

rates of the starnp duties depend on îhe value and kind of exported goods, and range fiom

10 to 20,000 Ukrainian hryvnas.442

vi) Payroll Taxes

Employees in Ukraine are guaranteed social security and pension benefits to the

extent that their employer has made contributions on their behalf. Both resident and non-

resident employers must make payments to the Pension Fund and Social Security

und.") Such contributions are paid separately in addition to the employees' salaries.

The Law of Ukraine "On Compuisory Payment to the Social Security Fund" estabIishes

the following rates of contributions to be made by employers:

- Pension Fund - 32%;

-138 See appendix to the Law of Ukraine "On Amendmenrs ro rhe Law On rhe Uni/ied Cusrorns T a r ~ r of $xi1 3. 1997.

Decree of the Cabinet of Ministers of Ukraine "On Srare Dury" of January 2 1, 1993, No. 7-93, an. 1. 440 Ibid., art. 2. 44 1 The Law of Ukraine "On the Sysrem of T u r i o n " of June 25, 199 1, No. 39, art. 14.22. u' The Law of Ukraine "On Stump Dufy" of M a y 13, 1999, No. 643-XIV, art. 4.

- Social SecurityFund-4%

- Unemployment Benefit Fund - 1.5%

The total contributions amount to 37.5% of the total amount of the employees'

salaries, constituting a considerable extra financial burden. Employers must also make

contributions to the Chornobyl Fund at rate of 12 % of the arnount of the employee'

salary.

vi i) Sfute Innovation Fund

Legal entities and ph iysical persons engaged in commercial activity on the

territory of Ukraine must make payment to the Ukrainian innovation Company, which

was created on the basis of the former Innovation h und? The Innovation Company

undertakes al1 the powers and obligations of the liquidated Innovation Fund. The rates

charged by the Company are paid by businesses monthly at the rate of 1% of sales

tumover.

viii) Road Tax and Vehicle T a

The Law "On Road Tax" has was passed in December 1991 The payers of the

tax are al1 the resident and non-resident Iegal entities and physical persons-owners of

types of vehicles indicated in the Law. Tt is levied on the tumover at a 1.2% rate.

sJ 3 The Law of Ukraine "On the System ofTuxarion" of June 25, 1991, No. 39, art. 14.16; See also Law of Ukraine "On Compulsory Payment ro the Social Secuniy Funà" of June 26, 1997, No. 402/97-BP, art. 1. .SI Decree o f the Cabinet of Ministers of Ukraine "On Creation o f Ukrainian innovation Company" of Apnl 13,2000, No. 654, art. 1.

Wholesale and retail businesses are charged 0.06 % of their turnover for road tax

purposes.

The tax on vehicles is levied in accordance to the Law of Ukraine "On Taxation

of Vehicle Owners" of February 18, 1997. It is levied on the owners of vehicles and other

transportation devises at rates that depend on the capacity of the vehicle's engine. The

law specifies the types of vehicles - objects of the tax. The rates range fiom EURO 0.5 to

EURO 4.55 per 100 cubic centime ter^.^

ix) Land T m

According to the Law "On Land Tax", resident owners of the land must pay a

land tax to the budget. The National Land Register determines the tax rate, depending on

the nature of the land, its location, and does not depend on the results of economic

activity on the land."' The tax is paid monthly in advance.

x) Nafural Resources Tar and Environmental Tax

The Ministry of Environment of Ukraine establishes the methodology and rates of

payments for environmental pollution resulting fiom economic activity, which must be

paid by al1 resident and non-resident legal entities and physical persons who, as a result

us The Law of Ukraine "On Road Tbx" of December 1 1, 199 1, No. 1963-MI. 446 The Law of Ukraine "On Taxarion of Vehicle Owners" of February 18, 1997, No. 75-97 - BP, an. 3.

The Law of Ukraine "On Land Tm" of July 3, 1992, No. 2535-XII, art. 4.

of their activity, cause pollution to the en~ i ron rnen t .~~ Rates for specific types of

pollution are established by the Cabinet of Ministers of Ukraine, and include pollution of

atmosphere with vehicles and other means of transportation, pollution of water objects,

and disposal of toxic wastes into the g r o ~ n d ? ~

xi) Foreign Vehicle Transit Duty

The Law of Ukraine "On the System of Taxation" was arnended in November

1999, with a provision empowering Ukrainian Customs to charge foreign transit vehicles

with a one-time fixed transit d ~ t y . ~ ~ The rate of the duty is estabiished by the Cabinet of

~Llinisters of Ukraine.

xi i) Rent T a und T a for a Sale of FueUZubricants

Al1 oil and gas cornpanies, which obtain their revenue fiom a Ukrainian source of

income, must make rent payments to the national budget of Ukraine.451 The current tariff

of rent for 1 ton of oil of own payment equals S3 (US) per ton."* Rent payrnent for

development of natural gas is implemented based on a rate of $5 (US) for 1000 cubic tons

4 1 8 M inistry of Envuonment of Ukraine "Methodology of Enumerating of Paymenrs for Causing Eniironmcntal Pollution" of May 24, 1993, No. vd930523, art. 1.2. 449 See -4nnexes 1 and II to the "Procedure of Enumerating of Paymenrs for Enrironmental Pollution" of March 1, 1999, No. 303. 450 Amendrnent to the Law of Ukraine "On the Sjzrtem of Taxation" of November 2, 1999, No. 51, art. 1. "' Degree of the Ministry of Economy, Ministry of Finance and National Oïl and Gas Cornmittee No. 1413- 787-5767.

Decree of the Minisûy of Finance of Ukraine "On Amendments to the Procedure of Calcularing and Irnplementation ofRent Payments for Oil and Gas of 20.02. f 998, NO. 39" of September 19, 1999, No. 13 1 an. 1.

of gas.453 The total amount of rental payment solely depends on the volumes of the

developed oil and gas for the budget year.

xiii) T d e Licensc

The Law of Ukraine "On Registration of Certain Types of Entrepreneurial

Activity" regdates commercial activity involving credit transactions, cash and other

types of commercial settlement instruments, involving transactions with foreign currency

exchange (including cash transactions in foreign c ~ r r e n c ~ ) . ~ " The law applies to both

resident and non-resident subjects of entrepreneunal activity and structural counterparts

of Iegal entities (affiliates, representative offices etc.), which are involved in the specified

types of commercial transaction^.'^^ The local municipal organs set the cost of the trade

license enabling the subjects to conduct the specified by the law commercial activities.

However, the law stipulates marginal cost that can be charged depending of the location

of the business of the purchaserf6

B. Local Taxes and Duties

The Law of Ukraine on the System of Taxation provides also for a number of

local taxes that must be paid by resident and non-resident legai entities and physical

ibid. 4 sa The Law of Ukraine "On Patenting of Certain Typm of Entrepreneurial Activiry" of March 23, 1996, No. 98/96 - BP, art. 1. 45s Ibid., art. 2. 4 56 Ibid., art. 3.4.

penons."57 As was mentioned earlier in the case of Russia and Kazakhstan, local taxes in

Ukraine also primarily perform an administrative role, rather than constitute any

significant financial burden on the taxpayer. However, it should be noted that the

Ukrainian legislation imposes the smallest arnount of local taxes than it is in the case of

Russia and Kazakhstan. The law provides for the following local taxes and duties:

1 ) Advertising Tax

2) Communal Tax

3) Hotel Duty

4) Vehicle Parking Duty

5) Market Duty

D . Double Taxation Treaties

Sirnilady to Russia, Ukraine has indicated that it will adhere to the tax treaties

entered into by the former USSR until such time as it has entered into its own tax treaties.

Presently, Ukraine has ratified its own treaty with approximately 20 countries, and

several treaties have aiready been signed, but are still awaiting an approval. Also, it is

currently negotiating tax treaties with another dozen countries. Ukraine and Canada have

signed a Treaty on Avoidance of Double Taxation in March, 1996.458

The treaty is applied to the persons who are residents of either of the countries-

signatones to the ~ r e a t y ~ ' ~ , providing that in the context of the treaty, the term "'person"

1 5 7 Decree of the Cabinet of Ministers "On Local Taxes and Duries" of May 20, 1993, No. 56-93, art. 2 1. "* "Convention Between Canada and Ukraine for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion" of March 4, 1996 on-line: (WL)'ITR 159 Ibid.. art. 1 .

can include "an individual, a company and any other body of penons" in the case of

Uh ine . ui the case of Canada, the texm "person" also includes an estate, a trust and

partnership. For the purpose of the taxation under the treaty the terni "resident of a

Contracting State", this includes the physical persons and legal entities liable to tax in the

respective States and the State-signatory's government or its fragment.460

In Ukrainian context, the Treaty is applied to the tax on the profit of enterprises,

and the income tax on the c i t i ~ e n s . ~ ~ ' In the case of Canada, the Treaty will be applied to

the taxes irnposed by the Govemment of Canada under the income Tax AC^.^^^ According

to the provisions of the Treaty, the taxes paid by a Canadian company in Ukraine on

profits, income or gains nom Ukrainian sources can be deducted fiom any Canadian tax

payable in respect of such profits, income or gains.463 Under the Treaty and in order to

compute Canadian taxes, a Canadian company-resident in Canada can deduct, in

cornputing its taxable income, any dividend received out of the exempt surplus of a

foreign affiliate which is a resident of Ukraine.

Ukraine is important to world energy markets because of its geographical

location, which makes it a critical transit center for exports of Russian oil and natural gas

to Eastern and Western Europe. It is also one of the largest energy consumers in a world.

ibid,, art. 4.1. 4 6 I ibid., art. 2.

Ibid.

However, Ukraine is far behind the Russian Federation and Kazakhstan regarding the

potentiai for development of oil and gas deposits, which already attract significant

foreign investment into the energy sector.

Ukraine has significantly smaller oil reserves than Russia or Kazakhstan. The

estimated volumes equal to about 395 million barrels and most of them located in Eastern

Ukraine in the Dnieper-Donets region.4G Ukrainian gas reserves are estimated at 800

billion cubic meten, and cmde oil resources are estimated at 147 million tonnes. Most of

the resources lie at a depth of 4 to 7 kilometers, making the process of extraction very

e ~ ~ e n s i v e . ~ ~ ' Over the last two decades, production of oil in the country declined by more

than 60 %, which was caused mostly by a general decline in the economy and the

inability of most of the major industrial enterprises to pay for increasing oit pnces.'66

The Ukrainian energy sector heavily relies on imports, which constitute about 80

% of current Ukrainian needs? Most of the imports come fiom the Russian Federation.

The government gave orders to local administrations to reduce gas consumption by 20%

fiom current levels and has adopted a National Program "Oil and Gas of Ukraine to the

year 2010" in order to meet at least half of the country's oil and gas needs within the next

11 to 12 years. The reason for dus move is the gradua1 decline in oil and gas resources in

Ukraine. The shallower and larger oil and gas pools have been depleted, and there are

- --

463 Ibid.. an. 23.1 .a. 4 s "Caspian Sea Region Counrry Anaiysls Brief' Energy information Administration (Eh), GGU University Library Guide, Analysis of Ukraine, June 1999, on-line: (EiA Main) <http://www.eia.doc.gov> "' "The Guide to Doing Business in Ukraine", Deparnent o f Foreign Affairs and International Trade, May 1998, Ch. 111.3.2. on-line: (DFAIT Main) <http://www.dfait-maeci.gc.ca> 464 ''Couni0 Anabsis Briefi Ukraine", GGU University Library Guide, June 1999, on-iine: (GGU Main) <hnp://~-.eia.doc.~ov>

Ibid,

only some reserves leA in smaller, deeper and less productive reservoirs, which are more

expensive to find, to drill and to produce.'68

Even though oïl and gas resources are being gradually depleted, Ukraine is rich in

minera1 deposits, including iron ore, manganese ore, rnercury, titanium and

However, existing mines need substantial investments for their modernization. The

mining industry has been continuously troubled by shortages of spare parts, unsafe mines,

failure of customers to pay for products, corruption and worker strikes.

The major share of minera1 production comes from coal, the production of which

has also decreased in the 1 s t decade to less than a half.'70 Al1 the mentioned factors have

also influenced the production cost of coal. According to the estimates produced by the

British firm International Mining Consultants, 3,200 of the 7,500 workers could be laid

off with no drop in output. The snidy indicated that th: amount of production by

Ukrâinian mines is half that of a similar mine in ~o land . "~

ï h e other important sector that so far produces great amounts of revenue is the

pipeline network that transports oil mostly fiom Russia to the importing countries in

Eastern and Western Europe. As previously mentioned, Ukraine's geographic size and its

strategic location on the crossroads of Europe and Russia, makes it very important

conveyer of oil and natural gas. Like the rest of the industry, the pipeline systern needs

major investments to sustain the 20-year old system. Ukrainian ministerial officials

466 "Highlighfs: Ukraine", UN-ECE Gas Center, on-line: <http://pc1S .tema.it/ungcpubdbIOULHTM> 449 Ukraine used to produce about 50 per cent of the entire Soviet output of iron ore and 40 per cent of manganese ore. "Business Report on Ukraine", Business Euro, 1998, Ch. VII, on-line: (Business -Europa Main) <http://www. business-europa.co.uk> 470 "Counrty Analysis Briefi Ukraine", GGU University Library Guide, June 1999 on-line: (GGU Main) ~http:/!www.eia.doc.gov> "' Ibid.

estimated that repairs of almost 500 kilometers of a pipeline were needed in 1998, but

there were enough resources for repairs of only 26 kilometers.472

According to the program launched by the government, foreign investments will

be used to finance a rnajority of the projects directed on development of the remaining

resources and the pipeline transit systern. Before the Law on Production Sharing

Agreements was passed by the Parliament of Ukraine in June 1999, investments in oil

and gas sectors were mostly p laced through joint venture agreements. Currentl y, foreign

investos have been complaining about the numerous barriers to investing in Ukraine,

including the unwillingness of the country's leadership to achieve consensus on the need

to achieve any significant changes in economic and legal refom and privatization.473

Investors have also mentioned a lack of understanding of international financial

procedures, fiequent resistance to western technologies by local parinen, and an

extremel y burdensome and confùsing tax system.

B. Taxation of Energy Sector

In September 1999, the Ukrainian Parliament finally passed the Law on

Production Sharing Agreements (PSA), which was eagerly awaited by numerous

potential foreign investors for years.'74 Before the law was adopted, there were two

principal ways for foreign companies to obtain the nght to exploit natural resources in

-- - ---

"' Ibid. 473 Paviiashvili I., Dmitriev V., Burger E. "The Needfor and Future o/Production Sharing Legislotion in Uhruine", B N A Eastern Europe Reporter, Vol. 8, No. 19, November 1998 on-line: ~hrrp://www.nilg.com/ukrJ~a.hmi> 474 The Law of Ukraine "On the Producrion Shanng Agreements" of September 14, 1999, No. 1039-XIV.

~ k r a i n e . ~ ~ ~ A fint way was throua the establishment of joint venture with a Ukrainian

Company, which had obtained a license for exploration or extraction of naturd resources.

The second type of cooperation was through the agreement on joint activities by

establishing an agreement with a Ukrainian company-license holder to jointly exploit the

resources.

With the adoption of the PSA Law, the general procedure as weil as the

guarantees given to foreign investors significantly improved. Under the iaw, the parties'

relationship is regulated by the production sharing agreement signed b y both parties,

governing the work on exploration and extraction of minera1 resources. The !aw

determines the sharing of extracted products, their transportation, processing, storage,

utilization and s e ~ l i n ~ . ~ ~ ~ The Cabinet of Ministers of Ukraine and relevant local

authorities are the state parties to the agreement. One or more Ukrainian or foreign legal

entities or citizens can be the other part of the agreement and must cary out a mutual

responsibility for the implementation of a PSA."~ Based on the agreement, an investor is

commissioned by Ukrainian authorities to perform al1 the work at his own expense and

risk, and is to be compensated with the product after it has been extracted and shared. A

significant advantage the Ukrainian PSA Law offers over the Russian one is that lists of

subsoil areas subject to PSAs in Ukraine are approved by the Cabinet of Ministers, rather

than by the Parliament.

The law establishes a special tax regime for the investor. It provides that the

investor is only subject to the following taxes and mandatory payments throughout the

- - -

475 "Legal Framework Affecting Foreign Invesment", Trade Mission of Ukraine, Apnl 1 5 , 1 997, Ch. Business Enterprises, on-1ine (Brama Main) <http://www.brarna.com> 476 The Law of Ukraine "On the Production Sharing Agreemenrs" of September 14, 1999, No. 1039-XIV, art. 2.

term of the validity of the PSA agreement, which may extend up to fi* years. 47s I,

accordance with the law, the investor must pay certain taxes in sharing production instead

of cash payment and is exempt fiom certain mandatory and local state taxes. The law

provides for the following taxes to be paid by the investor:

1. Value added tax;

2. Tax on the profit of enterprise;

3. Fee for geological exploration works perfomed at the expense of the state budget

4. Payroll taxes such as payments Social Security Fund and Pension Fund;

5. Payments for the use of mineral resources specified in the production sharing

agreement;

6. Payments for the issuance of special permits/licenses

Under the PSA agreement the value added tax must only be paid on the product

that is subsequently sold in ~kra ine . "~ The investor and subcontractors involved in PSA

activities do not pay VAT and custom duties (except custom fees) on goods and

equipment shipped into Ukraine and used for implementing a PSA, and shipped out aAer

a PSA agreement is c ~ m ~ l e t e . ' ~ ~ This equipment is not subject to exporthmport licensing

and quota limitation. Foreign investors have repeatedly complained that the Law does not

adequately specify the expenses that are deductible for profit tax cal~ulaiion.'~~ Also, the

477 Ibid., art. 5. 4 78 Ibid., art. 25. a 79 Ibid., art. 25.6. "O ibid., art. 25.7. 481 Pavliashvili I., Dmitriev V., Burger E. "The Need for und Future of Production Sharing Legislotion in Ukraine", BNA Eastern Europe Reporter, Vol. 8, No. 19, November 1998. Ch. II1.B.

law provides that the investor is also exempt fiom paying profit repatriation tax for the

profit received under a P S A . ~ ~ '

The product obtained by an investor under a PSA is subject to VAT payrnent

when sold localIy, and is not subject to any tax and custom duty payrnent (except custom

fee) when exporied fiom ~kraine ."~ However, the Law does not provide for any

simplified procedure for the customs clearance of items imported in comection with the

implernentation of a PSA. Additionally, the PSA Law neither allows for an excise tax

exemption for property imported into Ukraine nor does it allow for the temporary import

of goods (equipment) for a period longer than a year.

The law provides that a part of the extracted product that is intended to

compensate the investor's expenses ("compensation product") should not exceed 70 % of

the total extracted during the calculation period (usually one quarter), until the investor's

expenses are reimbursed in Unlike the Corporate Profit Law, which limits the

cany-forward of loses to a period of five years, PSA legislation specifically aIlows

investor to contribute its expenses to subsequent tax periods for taxation purposes without

any iirnitati~n.'~~

The procedure and amount of fee payment for geological exploration performed

at the expense of the state budget are specified individually by every PSA?~ The Cabinet

of Ministers may terminate, suspend, or restrict the investor's nght to utilize mineral

resources under a PSA, when there is a direct hazard to hurnan life, health or to the

environment. The investor's nghts are to be restored once the restrictive factors are

The Law of Ukraine "On the Production Sharing Agreernenfx" of September 14. 1999. No. 1039-XIV, art. 25.3 483 Ibid., art. 25.7. "' Ibid.

removed. The law also prohibits the unilateral withdrawal of h d s f?om the investor's

bank accounts opened in Ukraine to service the activities under a PSA.

Foreign investors c m also participate in the transportation and distribution of

natural gas under the Law on Concessions of July 1999 .~~ ' The Law provides that

existing facilities may be offered in concession to private companies, including foreign

investors, allowing also private companies to constnict new faciIities for the

ûansportation and distribution of natural gas under concession agreements.488 The

Ukrainian government provides state guarantees for private investments made under

concession agreements as well as approves the list of state-owned facilities that may be

offered by concession tenders. Other govemmental agencies, such as the Ministry of

Energy and Fuel and Naftogas of Ukraine may submit suggestions to the Cabinet of

Ministen in order to include certain facilities in the list. A list of municipal facilities

O ffered for concession tenders is approved by plenary sessions of local municipali t i e~ . "~

The Cabinet of Ministers approves concession tenders for state-owned facilities

and local municipalities approve tenders for municipal fa~ilit ies. '~ Concessionaire must

pay a concession fee upon the signing of a concession agreement with the authonties for

activities or facilities offered in conces~ion.~~' Concession agreements may be signed for

a period of 10 to 50 years.4g2 In order to perform a concession agreement on

transportation and distribution of natural gas, concessionaire will need to obtain an

-

485 Ibid., art. 25.4. 486 Ibid., art. 25.8. 4s 7 The Law of Ukraine "On Concessions" of July 16, 1999, No, 997-XIV, art. 3.2 on-line: (Ra& Main) <http:/hw.rada.kiev.ua> "' Ibid., art. 3. 1 8 9 Ibid., art. 3.3. 490 Ibid.. arts. 6.3. and 6.4. 49 1 Ibid., art. 6.7. 192 Ibid., art. 9.1.

appropnate license.") State authorities-parties to a concession agreement must obtain and

not disclose the concessionaire's commercial secret, and should not interfere in

commercial activities of the conce~sionaire.'~

The concessionaire has to use locally developed technologies, materials and

equipment, if the concession agreement does not speciQ o ther~ ise . '~~ Upon completion

of the agreement, the concessionaire must retum the concession facility back in an

appropriate technical condition, and may retain ownership rights for the product and

profit received under it.'% The concession offering entity cames the nsk of accidental

crash or damage of the concession facility, unless the concession agreement specifies

otherwise. The concession agreement does not offer any special tax exemptions for

concessionaire, as does the PSA. The concessionaire is subject to the import duties, VAT

and excise duty for products irnported into Ukraine for activities under concession

agreements to be paid as required by Ukrainian iegislation.497

V. Possible Improvements

1. Russia

In the case of Russia, significant changes to the system of taxation have been

made through the introduction of the new Tax Code on July 3 1, 1998. Only Part 1 of the

code was adopted, and it would be hard to speak about any concrete changes in the

- -

193 Ibid., art. 1 1. 494 Ibid., an. 17.2. 495 ibid., art. 18.2. 4% Ibid., art. 20.1.

system without adoption of the entire document. The first part o f the code has set out the

fundamental principies of the new, revised Russian tax systen:. It has refined some

concepts, including the rights and duties of a taxpayer, the competency of the Russian

Tax Service as well as a change in some procedural norrns.

The major change that has corne with the adoption of the first part of the code is

the substantial improvement of the taxpayer's status. The code has replaced the

provisions of the 1991 Law on the Fundarnentals of Taxation in the Russian Federation,

and adopted the universal principles of faimess and equity found in tax regulations of

many industnalized western c o u n t ~ i e s . ~ ~ ~ Even though the improvement of the taxpayer's

status seems like a positive change, the Russian Tax Service has not been able to find an

effective alternative to the previous extremely hi& fines in order to improve tax

collection.

The new tax code has drarnatically decreased the number of taxes fiom about 200

to 30, which has simplified the system to some extent. This has brought more clarity to

the system, as well as slightly reduced the tax burden, provided that after numerous taxes

were abolished, the major taxes were also increased to partially compensate for the lost

499 revenues.

The Russian tax system still relies heavily upon payroll, gross income, or

expenditures in calculating profitability. There have been numerous proposals made in

the Russian Parliament to abolish turnover taxes in favor of a system of indirect sales

taxes, as far as it is considerably easier to administer VAT than a direct sales tax. It

49: Ibid., art. 26. 498 Voltc henko M., "Russia Modfm Its T a Legis lation: New Russian Tar Code Signijicanrly Impro ves Tuxpayer 's Statu", Woridwide Tax Daily, December 7, 1998, para. 13, on-line:WL(WTD)SPR '* ibid., para. 1 .

would simpli* the administration of the taxes, given that the number of retailers in

Russia is much higher than the nurnber of producers and who~esalers.~" The need for

such changes that wouId make taxation of the retail sector more efficient. It was also

supported by the World Bank estimate, providing that 70 % of the taxable income in

Russia's retail sector is ~ n r e ~ o r t e d . ~ ~ '

There are numerous other problerns that the Russian tax system has to overcome

in order to imprwe the general tax and investing climate. They wouid include

arbitrariness and corruption among the State Tax Service representatives and the need of

formulation of tax policy by the centralized authority, which would ensure uniformity

and preclude contravening locally-designated policies. Thus, while 'fiscal federalism'

may be accepted in conducting tax collection, it should not be permitted in a tax policy

form~lation.~~' Even though the legislation provides for limits on deductibility for

essential business essentials, including scientific research, planning and development

expenses, business entities should also be afforded full deductions in order to attract and

encourage progressive growth of the hi-technology sector.

Kazakhstan has apparently been one of the most successful countries in the region

in irnplementing tax reform and attracting foreign investments to rebuild its economy.

The tax system is solidly based on the Tax Code, which was adopted in 1995, which gave

5 0 0 Herzog T., "Russian T a S'stem From Soviet Era Needs Reform in Almosr Every Phase", Journal of International Taxation, Vol. 8, No. 3, March, 1997, p. 116, on-line: WL(JINLT) SO 1 Ibid., p. 1 17.

ibid., p. 1 14.

Kazakhstan a comparative advantage by providing a stable and clear tax environment to

foreign investors before other counties in the region. The code contains ail tax laws in

Kazakstan, including the local ones. The nurnber of taxes was reduced from

approximately 50 to about 13 plus obligatory fees.

The new strearnlined and simplified tax system has considerably eased and

facilitated the investors' comprehension of their Iiabilities. The tax code has also

provided for a more strict control of any modifications through the system of their

obligatory adoption by the Ministry of Finance and the State Tax ~ e r v i c e . ~ ~ ~

There are also several important improvernents to the tax system that can be made

to fbrther increase the volume of foreign i n v e s t r n e n t ~ . ~ ~ One of the most important ones

concerns the unavailability of tax credits for VAT paid on capital goods, which basically

makes an investor pay 20 % tax on the value of in~estment .~ '~ Such improvement seems

to be of particular importance for Russia - country critically interested in foreign

investments.

Some tax analysts have also proposed that the Kazakh tax system should switch

from the conventional income tax to a flat taxM6. The flat tax is more simple and straight

forward, and encourages savings and investment, avoiding the inherent income tax

problem such as the mis-measurement of the tax base because of inflation."' It was also

suggested that the flat tax would be particularly beneficial for taxation of natural

503 McClure Jr., Charles E., "Lessonsfiom Tax Refonns in Kazakhstan", Tax Analysts. February 24, 1997, on-Iine: WL(WTI))NEW

%id. 'O5 See Law on Taxes to the Budget, art, 54, supra note 179. 5 0 6 It has also been called a cash-flow tax. See Ibid. s07 Ibid.

resources, because it would use economic rents as its tax base (the excess of income over

the costs of production including the cost of equity capital).M8

3. Ukraine

Like the Russian Federation and Kazakhstan, Ukraine faces a tough challenge of

overcoming numerous problems encountered with the economic and political transition

since its independence. Its political system still remains unstable, crime and bureaucracy

remain major obstacles on a course of fiuther improvement of the general investment

environment. Foreign investors confiont the legal impediment related to various areas,

including lack of clear legislation, erratic implementation of laws and decrees, and the

lack of confidence in Ukrainian legislation. However, the Ukrainian tax system remains

one of the most important obstacles hindenng the process of improvement of the general

investment environment, and consequently, the inflow of foreign investments into the

economy. European Bank of Reconstruction and Development characterized current state

of Ukrainian tax system as one, where "legal rules do not impose major obstacles to

creating investment vehicles and security or to repatriation of profits, however, they are

,, 509 in need of considerable improvements .

The tax reforrn that commenced in 19954997 has brought some changes to the

t a system of Ukraine, reducing the total number of taxes, introducing a single uniform

tax for small businesses, unifonn agricultural tax base on the value of the land and

procedure of writing off and restructuring of VAT debts for agricultural producers, and a

'Ofi ibid.

slight reduction of a general payroll taxes. However, al1 these changes have not been able

to make the general system of taxation much more effective and encouraging.

One of the improvernents of the tax system would be through the broadening of

the tax base through the Iiberalization of value added and income/profit taxati~n.~"

Broadening the s p e c t m of taxpayers would allow decreasing the tax burden currently

laid on the shoulders of that small fiaction of profitable entities, avoid significant

gains/losses in the future associated with changes in the tax5" This would also help to

reduce the tax burden in order to get back more taxpayers from operating in the shadow

economy.

It is vitally important that the improvement process of tax system comprises the

introduction of fair and effective rules of assessment and collection of persona1 income.

The personal incorne tax maximum threshold should be lowered to encourage savings,

which would be consequently reinvested back into economy. The income tax system

should refiain from using numerous deductions, except for standard deduction if it is used

instead of tax-fiee al l~wance."~

The key legislation regulating the collection of corporate income tau also lacks

significant improvements, such as proper stnicturing and providing several key

definitions. A complex structure of the legislation and inaccurate definitions contribute to

the increase of public and private costs of tax administration and cornpliance. The

- -- - - - - --

'O9 Ishaq M., "Foreign Direct Invesrmenrr in Ukraine Since Independence", CERT discussion paper, Herion-Watt University, Economic Department, May 1997, Ch. 4.1. 5'@Stuben, N.,"Concepmal Smcture of the T a System in Ukraine", September 1997, on-line: chttp://www.tax.com> ' ' ' 1s haq M., "Foreign Direct Investmenrs in Ukraine Sînce Independence", CERT discussion paper, Heriott-Watt University, Economic Department, M a y 1997, Ch. 4.1. 5 1' Luzik P., "International Experience of T a Refonn and Lessons for Ukraine", Discussion paper No. 99/03, Center of Economic Rciorm and Transformation, February 1999, p. 45.

legislation should eliminate barrien for legal portfolio investments abroad by providing a

possibility of obtaining tax credit for foreign tax on passive income and capital ,gains.'"

Issues of clarity, stability and predictability of the tax system also deserve

separate attention. Ukrainian tax authorities have been repeatedly making interpretations,

which conflict with official laws and decrees. A good example of this would be

cancellation of the decree providing £ive-year tax holidays for qualified foreign investors

after January 1, 1995, or abolishing of VAT privileges for goods produced by enterprises

with foreign investments in 1 995 .'la

Currently, there are several proposals to reform the VAT in ~kra ine .~ ' ' One of

them is an introduction of a European version of value-added tax with a broad base and a

single reasonable tax rate. This introduction would reduce general administrative costs

and allow cross-checking between VAT and corporate ôssessrnent~.~'~ Another proposal

Iooks for exclusion of taxable supplies fiom any additional indirect taxes where it is

practically

The Ukrainian tax system needs further synchronization to reconcile common

matters among al1 the regulative noms. These measures would attract foreign investors,

who may appreciate compatibility in tax mles as much as the difference in tax rates.

Currently, it is being done through the introduction of a new Tax Code of Ukraine, which

\vas passed by the Parliament of Ukraine on July 13, 2000. In the area of effectiveness of

5 13 Ibid., p. 36. "' Five-year tax holidays were repealed by the Corporate Profit Tax of 1995. VAT privileges were abolished in spite of the fact that Cabinet of Ministers' Decree "On the Regime of Foreign Investments" of May 1995 exempted companies with foreign investrnents from al1 types of taxes for five years.

Luzik P., "/nrernarional Experience of T a Rejorm and Lessonsfor Ukraine", Discussion paper No. 99/04, Center of Economic Reform and Transformation, February 1999, p. 45. "6 ibid. SI7 Stuben, N.,"Conceptual Srmcrure of rhe T m System in Uhaine", September 1997, on-line: chnp://www.tax.com>

legal rules on investment, the European Bank of Reconstruction and Development placed

Ukraine in the second category, defining the niles of the country as: "Legal rules are

usually unc1ea.r and sometimes contradictory. Legal advice is ofien difficult to obtain.

rr 518 The administration and judicial support of the law is rudimentary .

VI. Conclusion

The analysis of the systems of taxation in Russia, Kazakhstan and Ukraine

demonstrates that there has been a great amount of work done by the govemments and

parliarnents of the respective countries in order to improve and encourage foreign direct

invesmient that would Eurther fuel the process of market transformation. There are

numerous achievements as well as numerous deficiencies and irregularities that have to

be rectified in order to facilitate the infusion of foreign investments in their developing

economies.

Kazazakhstan has made substantial progress in transforming its economy into a

market-based system. The country's macro-economic indicators were stabilized, and the

domestic market is fairly liberalized and opened to foreign competition. At the time when

the overall regulatory role of the state was considerably reduced, its political leadership

was able to achieve and sustain reform-oriented political and economic initiatives. The

country's GDP is on a rise again, afier the dramatic consequences of the Russian crisis,

which affected almost al1 CIS republics. The resuits of the most recent economic reports

518 Ishaq M. , "Foreign Direcr Invesnnenrs in Ukraine Since Independence", CERT discussion paper, Henott-Watt University, Economic Department, May 1997, Ch. 4.1.

published by the European Bank of Reconstruction and Development indicated that the

annual inflation rate has also fallen fiom a peak of 3,000 % in mid-1994 to a record low

levels of 1 1 % by the end of 1 997, and is projected to reach 8.8 % by the end of 2000. The

country's external deficit has slightly increased during the last few years, but mostly

because of the imports of capital goods needed to deveiop Kazakhstan's rich natural

resources. The problem of hancing the extemal deficit does not currently constitute a

major problem since the country has significantly benefited fiom large foreign direct

investrnent inflows, mainly into the gas and oil sectors.

The country has been able to achieve significant positive results in the

transformation of its tax system. On advise of UIF tax experts, the Kazakhstani tax

system reform was started quite early, which gave the country a comparative advantage

as compared to the Russian Federation and Ukraine. The reform has brought the tax rates

to a rensonable level, and helped the government to bener stnicture and use special

incentives for investors-

Refonn of the system of taxation was predominantly based on the reform of the

general tax policy, and it must be admitted that the country was able to achieve

significant improvements. It was dramatically modified and brought up to the

international standards. The policy has modified VAT and excise taxes, revised export

taxes and introduced a modem western-style global income tax on individuals.

The country has also introduced a new simplified and refined comprehensive Tax

Code, which includes al1 the taxes collected on the temtory of Kazakhstan. However, like

Russia and Ukraine, in Kazakhstan one of the major pitfalls of the tax reform was its

predominant preoccupation with tax policy. Kazakhstan, in particular, neglected to follow

a western advise, and gave a low priority to modernizing tax administration.

Both Ukraine and Russia have not been even able to finish the work on

modemization of their respective tax policies. Largely infiuenced by the lack of political

unity and will to proceed with the generai economic refoms, including reform of their

respective tax systems, the parliaments of both countries have been continuously

modimng and reverting the legal rules affecting activity of the foreign investon.

In the case of Ukraine tax reform has been stalled for the last decade

predominantly because of the absence of political consensus that resulted from the

division along ethnic and politicai lines. On one side, there is mostly Russian-speaking

population of the Eastern Ukraine and the Cnmea that strongIy supports a closer

economic and political integration, and customs union with Russia and the CIS countries.

On the other side, there is a predominantly Ukrainian-speaking population of western and

central parts of Ukraine that supports establishment of closer ties with the western

European countries and economic organizations, including the adoption of a western type

tax system. Ukraine was able to pass the new tax code in a first reading only last June.

In the area of fiscal policy, Ukraine w s continuing to make progress towards

economic stabilization. The rates of inflation were brought down by the end of 1998

since their steep decline that started in 1991 -1 992. Currently, Ukraine was also able to

reduce the budget deficit and straighten up its monetary policy. Some of the progress was

lost afier it was affected by the Russian cnsis, but by the end of 1999 the country

managed to maintain a measure of financial stabilïty. Since 1997, inflation was up ten per

cent fî-om 10 % in 1997. However, in 1999 it reached 20 % and is expected to stay the

same for the year 2 0 0 0 . ~ ~ ~

There is no doubt that throughout the last few years economic developments in

Ukraine had a negative effect on the investors confidence in emerging market economies

following the crisis in Russia and Southeast Asia in 1998, that also caused significant

outflows of capital. The current budget deficit remains at 2 % of the country's GDP,

down îÏom 25 % and 16 % in 1992 and 1993 r e ~ ~ e c t i v e l ~ . ~ ~ ~ However, the budgetary

situation remains difficult. Cash revenues were weaker than expected partly because of

the weak economic situation, but mostly because of delays in implementation of a

comprehensive economic and tax reforms.

International financial institutions have aiso been concemed with the stalled

economic reforms in the country. The major concem of the current tax reform includes

major structural measures, such as M e r revision of the persona1 income tax, VAT and

business profits tax. Government failed to reduce the nurnber of tax exemptions and other

structural obstacles such as the earmarking of revenues.

Continuous modification of the country's tax was repeatedly criticized by foreign

investors as one of the most destabilizing factors hindering the inflow of FDI in the

country. The most famous examples are the canceilation by the 1998 Profits Tax Iaw of

five-year tax holidays for companies with qualified foreign investments previously

offered by the Cabinet Decree in 1995. In August, 1999 the Cabinet of Ministers

abolished tax privileges for joint ventures with foreign investments and restored them

519 Table 5 , Chapter 11. See also European Bank of Reconsttuction and Development "Transition Repon Upciare", Economic transition in Central and Eastern Europe, the Baltic States and the CIS, May 2000, p. 9.

four days later, motivating such action by the intention to fil1 up the budget and clear off

social payment arrears. The govemment canceled the resolution four days later

influenced by the fact that joint ventures bnng the majority of oil products into Ukraine.

The government also gave more importance to the fact that foreign ventures provide fuel

and keep fuel prices 10w.'~'

The Parliament's constant revision of foreign investment legislation seriously

undermined the country's promises contained in the prior legislation, and mistrated plans

of a lot of investors. The recent cancellation of tax holidays is particularly disturbing,

because they can be retroactively revoked at any tirne. The revocation of the tax holidays,

and particularly the cmde methods of their cancellation, has proven disruptive primarily

to foreign investors' morale. A11 these factors together have had a negative effect on the

overalI economic performance of the country, what can be proved by the FDI inflow

indicator~.'~

Curent rules and regulations create unbearable obstacles both for Russian and

foreign investors, what has an effect of slowing down foreign investments. Foreign

investors determine that major diseases of the Russian economy are an inadequate and

unbalanced system of taxation, customs regulations, and cumency laws.'*'

The Russian tax system has performed very poorly for the last decade for a

number of reasons. First of all, it is very cumbersome, complicated with the temtoriai

''O Table 4. Chapter II. See also European Bank of Reconstruction and Development "Transition Reporr Wpdare", Economic transition in Central and Eastern Europe, the Baltic States and the CIS, May 2000, p. 1 1 . '" "Uhrainian Cabinet Resrores T m Privileges for Joint Enterprises", British Broadcasting Corporation, August 20, 1999. '" See Table 1 , Ch. II. See also European Bank of Reconstruction and Development "Transirion Reporr Wphre", Economic transition in Cenaal and Eastern Europe, the Baltic States and the CIS, May 2000, p. 15. ''' A. Andryukin, " What do Foreigners Seek in Rursia", Commercant Daily, November 16, 1999.

structure of the Russian Federation. In addition to the federal tax regulations and applied

with them rates, foreign investors has to take into consideration the regulations of about

56 republics, krak, oblasts and regions - subjects of the Russian Federation. This resulted

in& about 30 federal taxes and over 200 local and regional taxes-Using the momentary

weakness of the central govemment in Moscow, Russian most powerfùl republics, such

as Tatarstan and ingushetia were able to obtain most favorable tax treatment out of the

rest of the subjects of the Russian Federation. This disbalance in the tax regulatory

frarnework has created a 'tax anarchy' where each of the subjects of the Federation could

enact its own taxes and give its separate interpretation of the tax regulations.

The ability of Russia to start implementation of economic refoms was also

complicated by the continuing political instability. In addition to militaiy conflict in

Chechnia in 1998, for the last decade, the Russian Durna was dominated by the

Communist Party, which has become a major irnpediment in comrnencing cornprehensive

economic reforms, including the tax refonn.

Like Ukraine and Kazakhstan, Russia has started reforms in the sphere of tax

policy giving the last pnonty to the modernization of its tax administration and

introduction of international standards of bookkeeping and accounting. The levels of

evasion are epidemic, as the nominal tax rates are very high. Because foreign companies

are outsiders and have more at nsk, they c m not afford to ignore taxes as do many local

companies. Therefore, in order to fil1 out the budget, the tax rates imposed are very high,

considering that they are paid by a very few taxpayers.

This situation has dnven a lot of small businesses underground or made them

choose cash payments and barter as alternative ways of conducting business. Also, there

are nurnerous exemptions for a wide range of favorably treated taxpayers. Because of the

absence of clear legislation and procedures, as well as ineffective coordination and

interpretation of the tax legisiation by the Russian State Tax Service, Russian tax

inspectors have acted autonomously, leading to a very uneven treatment of taxpayers.

Not surprisingly, the outcome is a tax system, which fails to produce adequate

revenue to government. The current system with its many exemptions, underdeveloped

international tax d e s and dubious treaties with tax havens has also been prone to

facilitate a substantial capital flight and scare away foreign investon. Therefore, a major

cornprehensive refonn is long overdue and represents the only feasible escape from the

current situation.

Russia and Kazakhstan have been heavily relying on revenues from the

development of energy and mineral resources. This allowed both countries to receive a

sipificant inflow of revenues fiom their exports. On the other side, Ukraine has to find

the ways to receive the money inflow into the budget by finther improving the general

investment environment. Even though Ukraine does not have such massive natural

resources as the other two countries do, in order to be more cornpetitive on international

capital markets, it has to provide a maximally favorable investment environment through

improvement of al1 the other factors influencing investment. Otherwise, it will not be able

to cornpete with its neighboring natural resource titans, and will remain an outsider on

international capital markets.

The current attractions and obstacles to FDI of each of the countries cm be

surnmarized in the following table:

Table 14 Attractions and obstacles to foreign investors

Country/ 1 Russian Federation

2. Vast domestic consu- mer market;

3. Cheap and skiIled la- bor;

attributes Amactions

Obstacles

1. Mineral resources;

Crime; Conuption; Political instability; Legal uncertainty over investor nghts; De ficient tax system; Infrastructure Weak bank system

--

1. Political stabi!iv; 2. Mineral resources: 3. Cheap labor; 4. Balanced and moder-

nized tax system; 5. Currency regime 6. Strengthening bank sys-

Kazakhstan

1. Vast domestic market; 2. Geopolitical location; 3. Cheap and skilled labor, 4. Infrasmicture

Ukraine

The results in the table clearly demonstrate that Kazakhstan has an overall higher nurnber

of attractions as compared with the Russian Federation and Ukraine. It also supports the

findings that Kazakhstan was most successfûl in resmicturing and modemizing its tax

system as well as in attracting foreign direct investrnents.

Al1 three countries face numerous problems with their tax regulations related to

their consistency, mechanisms of implementation, and bureaucratie barriers. The finding

in the table are also reflected by the fact that Kazakhstan has been able to create the most

simple and stable taxation system, as well as a lower crime level, and more stable

political environment than in Russia or in Ukraine. Out of the three countries, Kazakhstan

has also provided the most favorable general tax holiday provisions for foreign investors.

The Kazakh t a system provides for fewer taxes, imposes lower rates on investors

and has been less fiequently modified that has been the case in Russia and Ukraine. This

situation can be partly explained by the unitary structure of Kazakhstan, which has been

tem 1. Relatively small cousu-

mer market 2. Bureaucracy 3. Comption 4. Infrastmcnirc

1. Crime; 2 Corruption; 3. Political insîabihîy; 4. Legal uncertainty over

investor rights; 5. Deficient tax system

ultimately able to provide a stable general investment climate through strong political

control of tax policy formulation by the central governrnent. By contrast, the tax system

in Russia and, to a lesser extent, in Ukraine remain very complex and unpredictable,

where foreign investon have to pay varying and constantly changing republican, regional

and additional local taxes.

Based on the findings of this study, a variety of different factors make a good tax

system. One of the central positive elements of a good system is its clarity. Dubious and

very complex tax systems create more space of arbitrary interpretation by the tax

collection senice. Consistency in interpretation is a concurrent requirement. A good tax

system should also tend to have a small nurnber of taxes. The system should be based on

major taxes, such as, personal income tax, business profits tax and VAT, with a limited

number of excises. The system should also offer reasonable rules of deductions,

depreciation, loss carryover and other mechanisms of facilitation of economic activity of

the subjects of taxation.

Al1 three countries have become Parties to investment and taxation treaties with

Canada and other countries in attempt to avoid tax barriers to cross-border transactions

and investment. The tax treaties signed by each of the three countries with Canada are

primariIy directed towards avoidance of double taxation. While these treaties can not and

do not resolve al1 the problems related to cross-border taxation, they undoubtedly indicate

a continuing interest of al1 three countries in encouraging foreign investments.

Bibliography

Legislation -

Legislation of the Russian Federation:

In rem arion al Agreements

- Canada's Bill C-37 Relating to Agreements Between Canada and Numerous Couniries for Avoidance of Double Taxation and Fiscai Evasion With Respect to Taxes on Income of May 17, 1996, World Tax Daily, October 9, 1996 on-line: WL(WTD)TTB

Na tio rz al L egislation

T a Code of the Russian Federiztion of January 1, 1999, General Part on-line: Lexis (Ruslegisline)

The Law "On Foreign Investments in the RSFSR", July25, 199 1 on-line: Lexis (Ruslegisline)

The Law of the Russian Federation "On the Subsuflace", of October 28, 1992 on- line: <http://www.ist.ru>

The Law of the Russian Federation "Concerning the Fundamental Principles of the Taxation System in the Russian Federation" of December 27, 199 1, no. 2 1 18- 1 on- line: Lexis (Ruslegisline)

The Law of the Russian Federation No. 21 16-1 "On the Taxation of the Profirs of Enrerprises and Organizations", of December 27, 199 1 on-line: Lexis (Ruslegisline)

The Law of the Russian Federation "On Amending the Law of the Russian Federation oti rhe Tau on the Profit of Enterprises and Organizations", No. 62-FZ, of March 12, 1999 on-line: Lexis (Ruslegisline)

The Law of the Russian Federation "Concerning Value Added Tu" of December 6 , 199 1, No. 1992-1 on-line: Lexis (Ruslegisline)

The Law of the Russian Federation "On Excise" of FebruaIy 1 , 1996, No. 93-FZ on- line: (IST Main) <http://www.ist.ru >

The Law of the Russian Federation "On the Customs Duries" of February 5, 1997, No. 25-FZ on-line: Lexis (Ruslegisline)

The Law of the Russian Federation "On the Tax Levied on Operations ivith Seeurifies" of March 23 1998, No. 36-FZ on-line: Lexis (Ruslegisline)

Law of the Russian Federation "On Subsurface" of February 2 1 1992, No. 2396-1 on- line: Lexis (Ruslegisline)

The Law of the Russian Federation No. 2395- 1 "On Underground Resources" of February 2 1, 1992 on-line: Lexis (Ruslegisline)

The Law of the Russian Federation No. 187-FZ "On the Continental Shelfof the Russian Federation", of November 30, 1995 on-line: Lexis (Ruslegisline)

The Law of the Russian Federation "On the Rates of the Allocations for the Reproduction of the Mineral Raw-Material Base", No. 224-FZ of December 30, 1995 on-line: Lexis (Ruslegisline)

The Law of the Russian Federation "On the Federal Budget for 1997 No. 29-FZ of February 26, 1997 on-line: Lexis (Ruslegisline)

The Law of the Russian Federation "Or1 the Rates of the Allocations for the Reproducfion of the Mineral Raw-Material Base", No. 224-FZ of December 30, 1 995 on-line: Lexis (Ruslegisline)

The Law of the Russian Federation "On the Highwuy Funds" No. 1759- 1 of October 1 8, 199 1 on-line: Lexis (Ruslegisline)

The Law of the Russian Federation "On the Sfate Revenue Duy" of December 9, 199 1 arnended by the Federal Law No. 226-FZ "On lntroducing rhe Amendments and Addenda fo the law of the Russian Federation on the State Duty" of December 3 1, 1995 on-Iine: Lexis (Ruslegisline)

The Law of the Russian Federation "On Income Tax on Individuals" of December 7 , 199 1 on-line: Lexis (Ruslegisline)

The Law of the Russian Federation "On the Licensing of Certain Types ojActivities" No. 158-FZ of September 25, 1998 (with the Amendments and Additions of November 26, 1998, December 22, 1999) on-line: Lexis (Ruslegisline)

The Law of the Russian Federation "On Tanffs of lnsurance Premiums Payable to the Peusion Fund of t he Russian Federation, the Social Insurance Fund of the Russian Federation. the State Employment Fund of the Russian Federation, and the

Mandatos. Medical Insurance Funds for 1999" No. 1 -FZ (with the Amendments and Additions of October 25, 1999), of January 4, 1999 on-line: Lexis (Ruslegisline)

- The Law of the Russian Federation No. 2030-1 "On the Property T a of Enterprises" of December 13, 199 1 (with the Amendments and Additions of July 16, December 22, 1992, March 6, June 3,1993, November 1 1,1994, Apnl25, June 23, August 22, 1995, January 8, 1998, Febmary 10, May 4, 1999) on-line: Lexis (Ruslegisline)

Decrees

- Decree of the President of the Russian Federation No. 2270 of December 22, 1993 "On Certain Changes in Taxation and Interrelationship of Budgets of Drfirent Levels", with additions and arnendments as of December 24, 1993 online: W L (TST) Foreign Taxation

- Decree of the President of the Russian Federation No. 1004, "Concerning Some Questions of 7' Policy" o f May 23, 1994 on-line: Lexis (Ruslegisline)

- Decision of the Government of the Russian Federation No. 986 "On the Approval of the Regdations on the Fund for the Reproduction of Mineral Raw Materials Base", o f August 2, 1997 on-line: Lexis (Ruslegisline)

Instruction of the Finance Ministry of the Russian Federation No. 1 11 "On Procedure of Payment for Ercise Tax on Oil including Gas Condensate", para 1 , Rus legisline, News of December 1, 1992 on-line: Lexis (Ruslegisline) News

Resolution of the Government of Russian Federation of November 1, 1992 No. 847 "Excise Dury on Oil Exctracted on RF Territory" on-line: Lexis (Ruslegisline)

The Governrnental Resolution of the Russian Federation "On Introduction of &port Tariff on Goods Exported from the Russian Federation", Decree No. 91 of December 3 1, 1 99 1, reprinted in Economicheskaya Gazeta, February 1 5, 1992

Instruction of the State Tax Service of the Russian Federation No. 44 "On the Order of the Calculation and Payment to the Budget and the Target-oriented Use of Deductions for rhe Reproduction of the Mineral-Raw Material Resources" of December 3 1, 1996 on-line: Lexis (Ruslegisline)

the Letter of the State Tax Service of the Russian Federation No. ShS-6-07/611 "On Melhodological Directions for the Conducr of Documentary Inspections of the Tarpayers Paying Taxes for the Benefit of the Road Funds to Be Used in Practical Operation" of September 14, 1998 on-line: Lexis (Ruslegisline)

Procedure for Collecting Insurance Prerniurns and Temporary Target Fee for the Benefit of the Pension Fund of the Russian Federation (Approved by the No. 800 of July 2 1, 1998) on-line: Lexis (Ruslegisline)

Letter of the State Tax Service of the Russian Federation No. ShS-6-0716 1 1 "On Methodological Directions for the Conduct of Documentaty Inspections of the Tàxpayers Paying Taxes for the Benejil of the Roud Funds to Be Used in Practical Operation" of September 14, 1998 on-line: Lexis (Ruslegisline)

Letter of the Moscow Department of the Ministry of Taxes and Fees No. 1 1 - 1411 739 1 "On the Order of the Introduction of the Sales T m on the Tem-toty of the City of Moscow" of June 23, 1999 on-line: Lexis (Ruslegisline)

Power-Sharin P Treaties

" n e Supplemental Treaty Beîween the Rwian Federation and the Administratiou of Irkutsk Oblast in Area of Budget and T a Policies ," of May 27, 1 996 on-line: h t t p : / / b l a c k . i n f o r i s . ~ o v . s d i n f o b a s e / ~ c = 1 4 149

"The Supplemental Treaty Beiween the Organs of State Power of the Russian Federation and the Administration of the Republic of Komi in Area of Budget and T m Policies ," arî.3, of March 20, 1 996 on-line: http://black.infons.~iov.su/ infobase/wwwr.exe/a/90.new/?doc=3 5 1 1 9

"The Supplemental Treaty Between the Organs of State Power of the Russian Federation and the Administration of Rostov Oblast in Area of Budget and T m Policies," art.3, of May 29, 1996 on-line: http://black.inforis.nnov.su/infobase/ wwwr.exe/ a/90.new/?doc=15483

The S~rpplemental Treaty Berneen the Organs of State Power of the Russian Federotion and the Administration of Khabarovsk Krai in Area of Budget and T a Policies ," art.2, of July 24, 1996 on-line: http://black.inforis.~ov.su/infobase /wwwr.exe/ a/90.new/?doc=34669

Legislation of Kazakhstan:

International Agreements

- Canada-Kazakhstan Income and Capital Tax Convention and Protocol, signed on September 25, 1 996, Tax Analysts on-line: WL(WTD)TTR

The Law "On State Support for Direct Investment" of February 1997 on-line: < http ://www . herald.asdc. kz/research/index. h t m b

The Law of the Republic of Kazakhstan "Concerning State Support to Direct Investments" of February 28, 1997 on-line: ~http://www.herald.asdc.kz/researchl index. h t m P

The Law of the Republic of Kazakhstan "Concerning the Road Fun# of December 1 9, 1 99 1 on-line: Qttp://www.herald.asdc.kz/researchl index.html>

The Law of the Republic of Kazakhstan "Concerning Petroleum" as amended by the Law of the Republic of Kazakhstan "Concerning ~ h e Introduction of Amendments and Addilions to Several Legtslatzve Acts on the Subsur$ace and Petroimm Operations in the Republic of Kazakhstan" No. 467- 1 of August 1 1, 1999, on-line: <http ://www. herald-asdc. WresearcM index. htmP

Decrees

- Decree of the President of the Republic of Kazakhstan having the force of Law, "On State Registration of Legal Entities", of December 10, 1993 on-line: chttp ://www.herald.asdc.Wresearch/ index.html>

- Edict of the President of the Republic of Kazakhstan having the force of Law No. 2828 "On the Subsurface and lts Utilization" arnended by the Law of the President of the Republic of Kazakhstan of August 11, 1999 on-line: < h ~ p : / / w w w . h e r a l d . a s d c . k z / r e s e i l r ~ h / c o ~ I ~

- Edict of the President of the Republic of Kazakhstan having the force of Law "On Accounting Having the Effect of Law", of December 10, 1993 on-line: chttp ://www. herald.asdc.Wresearchl index.htmb

- Edict No. 2235 Having the Force of Law of the President of the Republic of Kazakhstan "Concerning Taxes and Other Obligatov P ayments to the Budget", of April 24, 1 995 on-line: chttp://www.herald.asdc.kz/research~index.htmI~

Legislation of Ukraine:

International Agreements

- Canada-Ukraine Income and Capital T m Convention signed on March 4, 1996 Tau Analysts on-line: WL(WTD)TTR

- The Law of Ukraine "On the System of Taration" of June 25, 1991, No. 39 on-line: (Rada Main) chtrp://ww~.rada.kiev~u~

- The Law of Ukraine "On the T m t i o n of the Profis of Enterprises", of December 28, 1994. No. 335194-BP on-line: (Rada Main) <http://www.rada.kiev.ua>

- nie Law of Ukraine "On Amendments to the Law of Ukraine On the Taration of the Projir of Enferprises" of May 22, 1997, No. 283-97-BP on-line: (Rada Main) <http://www.rada.kiev.ua>

- The Law of Ukraine "On Enterprises and Orgoriization Incorne Tax" of February 2 1, 1992, No. 2 146-12, art. 5.1 on-line: (Rada Main) <http://www.rada.kiev.u;~

- The Law of Ukraine "On Taxation of Personal Incorne*' of July 5, 1 99 1 , N 1 306-XII on-line: (Rada Main) <http://www.rada.kiev.ua>

- The Law of Ukraine "On Value Added Tàx" o f Apnl3,1997, No. 168/97-BP on-line: (Rada Main) chtrp://www.rada.kiev.u~

- The Law of Ukraine "On Cemin Questions Concerning Excise Taxation" of November 16, 1995 on-line: (Rada Main) ~http://www.rada.kiev.ua>

- The Law of Ukraine "On the Llnified Cusfoms T a n ? ' of February 5, 1992 on-line: (Rada Main) <http://www.rada.kiev.ua>

- The Law of Ukraine "On Amendments to the Law On the Unified Customs Tarzy' of April 3, 1997 on-line: (Rada Main) <http://www.rada.kiev.u@

- The Law of Ukraine "On Stamp Dufy" of May 13, 1999, No. 643-XIV on-line: (Rada Main) ~http://www.rada.kiev.ua>

- Law of Ukraine "On Cornpulsory Payment to the Social Security Funcï' of June 26, 1997, No. 402197-BP on-line: (Rada Main) <http://www.rada.kiev.ua~

- The Law of Ukraine "On Road Tar" of December 1 1, 199 1 , No. 1963-XII on-line: (Rada Main) <http://www.rada.kiev.ua>

- The Law of Ukraine "On Tarntion of Vehicle Owners" of February 18, 1997, No. 75- 97 - BP on-line: (Rada Main) <http://www.rada.kiev.ua>

- The Law of Ukraine "On Land Tar" of July 3 , 1992, No. 2535411 on-line: (Rada Main) ~http://www.rada.kiev.ua~

- TlieLawofUkraine"0nPatentingofCertain TypesofEntrepreneurialAaivity"of March 23, 1996, No. 98/96 - BP on-line: (Rada Main) Qttp://www.rada.kiev.ua>

- The Law of Ukraine "OH the Production Sharing Agreements" of September 14, 1999, No. 1039-XIV on-line: (Rada Main) <http://www.rada.kiev.ua>

- The Law of Ukraine "On Concessions" of July 16, 1999, No. 997-XIV, art. 3.2 on- line: (Rada Main) <http://w.rada.kiev.ua>

Decrees

- Decree of the Cabinet of Ministers of Ukraine "On the Regime of Foreign Irrvesrntent" of June 5, 1993, No. 55-93 on-line: (Rada Main) <hnp ://www.rada.kiev.ua>

- Decree of the Cabinet of Ministers of Ukraine "On State Duty" of January 2 1, 1993, No. 7-93 on-line: (Rada Main) <http://m.rada.kiev.ua>

- Decree of the Cabinet of Ministers of Ukraine "On Creation of the Ukrainian I>rnovation Company*' of Apnl 13,2000, No. 654 on-line: (Rada Main) <http:I/www.rada,kiev.ua>

- Degree of the Ministry of Economy, Ministry of Finance and National Oil and Gas Cornmittee No. 14/3-787-5767 on-line: (Rada Main) <http://www.rada.kiev.ua>

- Decree of the Minisüy of Finance of Ukraine "On Amendments ro the Procedure of Calculafing and Implementation of Rent Paynients for Oil and Gas of 20.02.1998, No. 39" of September 19, 1999, No. 13 1 on-line: (Rada Main) Qttp://www.rada.kiev.ua>

- Decree of the Cabinet of Ministers "On Local Taxes and Duties" of May 20, 1993, Xo. 56-93 on-line: (Rada Main) <http://www.rada. kiev.ua>

- The Order of the State Tax Administration "Regulations on the Procedure for Regisfration of Permanent Establishments of Non-Residents in Ukraine as Inconze Tar Payers" of January 16, 1 998, No. 23 on-line: (Rada Main) <http://mv.rada.kiev.ua>

- Instruction of the Ministry of Environment of Ukraine b'Methodoto~ of Enumerating of Paynlents for Causing Environmental Pollution" of May 24, 1993, No. vd930524

- Annexes 1 and II to the b'Procedure of Enumerating of Payments for Environmental Poiitrrion" of March 1, 1999, No. 303 on-line: (Rada Main) <http://www.rada.kiev.ua>

Seconda- Material: Country Reports

Amencan Chamber of Commerce, " Taration of Non-Residerr t Debr Investors", position paper, Kyiv, Ukraine, 1998 on-line: (ACC Main) cht~://www.amcharnukraine.kiev.ua>

Business Information Service for the Newly Independent States (BISNIS), "Tax Q Accounting", Country report on-Iine: (BISNIS Main) ~http://www.bisnis.doc.gov>

Business Information Service for the Newly Independent States (BISMS), "hvestrnent CZimate in Kazakhstan", December 1999 on-line: (BISNIS Main) ~ h t t p : / / w w w . b i s n i s . d o c . g o v / b i s n i s / c o ~ 7 . h t m >

Business Information Service for the Newly Independent States (BISNIS), "l)rvestment CZimate in Kazakhstan", Country Report, BISNIS, 1998 on-Iine (BISMS Main) <http://www.bisnis.doc.gov>

Business Information Service for the Newly Independent States (BISNIS),"Commercial Overview of Kazakstad', December 1999 on-line (BISNIS Main) http://www.bisnis.doc.govlbisnis/ country/kazakstan.ht~

Business Euro, "Business Report on Ukraine", 1998, Ch. VII, on-line: (Business - Europa Main) ~http://www.business-europa.co.~k>

Department of Foreign Affairs and international Trade "A Guide ta Doing Busi~tess in Ukraine" on-line: (DFAIT Main) <http://www.dfait-maeci.gc.ca>

Department of Foreign Affain and International Trade, "The Guide to Doing Business in Ukraine", May 1998, Ch. IIi.3.2 on-line: (DFAIT Main)

East European Banker, "Eastern and Central European FDI Levels Up", news brief, Lafferty Publications Limited, June 1999

Emst & Young , "The Invesrment CZimare in Russia", Expert Institute, 1999 on-line: WL(WTD)

Emst & Young, "Doing Busi~zess in Kazakhstan", International Taxation, October 1. 1994 on-line: WL(WTD)

Energy Information Administration (EIA), "Caspian Sea Region Country Analysis Brief' GGU University Library Guide, Analysis of Ukraine, June 1999, on-line: (EiA iMain) <http://www.eia.doc.gov>

European Bank of Reconstruction and Development b'Trunsition Report Updare", Economic transition in Central and Eastern Europe, the Baltic States and the CIS, May 2000

GGU University Library Guide, "Country Analysis Brie$ Ukraine", June 1999, on- line: (GGU Main) <http://www.eia.doc.gov>

Janet Matthews Information Services, "Certtral and Eastern Europe: Conclusions", Quest Econoniic Database, June 1 1, 1999

Show Case Europe, ''Country Commercial Guide: Ukraine", Fiscal Year 2000, U. S. Commercial Service on-line: (SCE Main) <http://www.sce.doc.gov>

The International Tax and Investment Center (ITIC), "Report on Transition in CIS' , Moscow, June 1999

Trade Mission of Ukraine, "Legui Framework m c t i n g Foreign Investment", , April 15, 1997 on-line (Brama Main) <http://www.brarna.com>

UN-ECE Gas Center, "Highlighw: Ukrairie", on-Iine: W - E C E Main) <http://pclS.tema.it~ungcpubdb/OULHTM>

US. Department of State, "Commercial Guide of Ukraine", Country Commercial Guidefinancial year 2000 on-line: (U.S. Department of State Main) <http://wvw.state.gov>

Monograpbs

- Bedel J., Horowitz D., and Nordberg C. A. Jr. "Stangers in a New Land: U.S. Layvers Corne to Kazakhstan", Journal o f International Taxation, Vol. 4, No. 7, July 1993 on-line: WL(JINLT)

- Black,D.,"So YOM WanrioInvestIn Russia?ALegislativeAnalysisuftheForeigr~ Iwestrnenr CIimate in Russia", Minnesota Journal of Global Trade, no. 5, Winter 1996 on-line: WL(MJGT)

- Co Ilins S ., *bNatural Resources and Investment Poten tial Lure US F i m s ro KariaX-hsran", Central Asian Hot Spot Senes, Aspen Law and Business, November 1995 on-line: (ITIC-CIS Main) ~http://inicnet.org/publications/Default.htm~

- Coopers & Limbrand, "Taxation in Kazakhstan", Country Report, September 7, 1995 on-line: (Mondaq Main) <http://www.mondaq.com>

Dean R. "Considering Business Opportunities in the Soviet Uniou in the 1990 Y, Vand. Journal of Transnational Law, No. 24, 199 1 on-line: WL(V1TL)

Frenkel W. and Sukhman M. "New Foreign Invesrmenr Regimes of Russia and Other Repzrblics of the Former USSR: A Legislative AnaZysis and Hisiorical Perspective", Boston College of International and Comparative Law Review, Summer 1993. no. 16 on-line: WL(BC1CLR)

Frommeyer T. A., "Power-Sharing Treaties in Russia 5 Federal Sysrenr", Loyola of Los Angeles International and Comparative Law Journal, March 1999 online: WL (JLR) LYLAICLJ

Gialdini L., "'Kazahtan Lkts Priority Sectors for Investmeni", International Taxation, July 15, 1997 on-line: WL (WTD)MW

Harrison S., " Two Special T m Regimes: An Opportuni@ for Foreign Investon?", International Bureau of Fiscal Documentation, European Taxation, October 1, 1996, vol. 36 - 1996, no. 10 on-line: WL (WTD)NEW

Herzog T., "Russian Tax System From Soviet Era Needs Reform in Almost Every Phase", Journal of International Taxation, Vol. 8, No. 3, March, 1997, on-line: W L ( J N T )

Himes S., "Russia 's T m Reform", Observer, No. 2 15, January 1999

1s haq M., "Foreign Direct Investments in Ukraine Since Independen ce", CE RT discussion paper, Heriott-Watt University, Economic Department, May 1997, Ch. 4.1

Stuben, N.,"Conceptual Structure of the T a Sysiem in Ukraine", September 1997, on-line: <http://www.tax.corn>

Jenkins R., "Kazakhstan Amends Tax Code. lncluding Transfer Pricing Provisions", Tax Notes International, February 8, 1999 on-line: WL(JLR)

Lavrov A., "'Federalizing Russia S Budget System: A ntorny Path", Current Digest of the Post-Soviet Press, July 5, 1995, vol. XLW, No. 23 online: WL (TNI)

L ieb ennan E ., "Russia Modernizes Its Tax System. But Ghosts of the USSR Still Hamr", Commercial Law and Practice Course Handbook Senes, Practicing Law Institute, March 22-23, 1993 on-line: WL(JLR)

Luzik P., "'international Experience of Tax Reform and Lessons for (Ikraine", Discussion paper No. 99/04, Center of Economic Reform and Transformation, February 1999 on-line: (CERT Main) chttp://www.hw.ac.uk>

McClure Jr., Charles E., "Lessons front T a Reforrns in Kazakhstan", Tax Analysts, February 24, 1997 on-line: ihl(WTD)NE W

Pavliashvili I., Dmitriev V., Burger E. "The Need for and Future of Production Sltaring Legislation in Ukraine", BNA Eastern Europe Reporter, Vol. 8, No. 19, Novernber 1998 on-line: <http://www.nilg.com/ukr~sa~htm>

Pollack R., Bernstein A. and Minakova L., "Foreign Investment in Russia: The Perspective of the Russian Government and Problems Faced by Westeni Investors", Commercial Law and Practice Course Handbook Series, no. A4-4420, March 22-23, 1993 on-line: WL(JLR)

Samoylenko V., "Tax Reform in Russia: Yesterday, Toduy and in ~ h e Near Furure" International Tax and investment Center on-line: (ITIC-CIS Main) ~http://inicnet.org/publications/Default.htrn~

Samoylenko V., "The Fate of the Russian Tar Code: A Look from Inside the State Duma Walls", International Tax and Investment Center on-line: (ITIC-CIS Main) <http://inicnet.org/publications/Default.htm~

Vol tchenko M., "Russia Modijies Ils Tax Legislation: New Russian T u Code Sign~ficantly Improves Tàxpayer 's Status", Worldwide Tax Dai ly, December 7, 1 998 on-line: WL(WTD)SPR

"Cenfral Asia, Caucasus Performed Better in 1998 than Russia, Okraine", 1999 on- line: (Kazakhstan Herald Main) <http://www. herald.asdc. kz/public/research/ cornentA O.html>

Secondary Material: Articles

Antel S.. Starygin A., "1 999 Russian Ta. Reform - Still Waiting", Tax Notes International, March 1999 on-line: WL(WTD)

Antel C. "Russia Enacts Tax, Currency Changes", Tax Notes International, May 17, 1999 on-line: WL(WTD)

Guboglo M., "Federalizm Vlasti i V l a d Federalizma", in Federalizrn Vlasti i Vlast' Federalima, Moscow, 1997

Gurushina N., "Russian Consritutional Court Says Regions ' Taxing Power Liniitecî', Press Watch International, OMRI, March 25, 1997 on-line: WL (WTD) PWI.

Eastern Economist Daily, "Tax Code Making Its Wajf Through VR", July 13,2000 on- line: WL (ALLNEWS)

- Freeland M, "Crackdown Plan for Russian Companies ' Access to Cash", Financial Times, March 22, 1996 on-line: W L W W )

- Markina O., b'Sonte Problems of Company Taration", Bulletin for International Fiscal Documentation, Apnl 1995 on-line: WL(WTD)

- Business Information Service for the Newly Independent States, "Commercial Overview of Kazakhstan", October 1999 on-line: (BISMS Main) http://www. bisnis.doc.gov/bisnis/country/ kazakhstan. htm>

- "Central Asia, Caucasus Pe$ormed Better in 1998 than Russia. Ukraine", Kazakhstan Herald newspaper, 1999 on-line: (Kazakhstan Herald Main) ~http://www.herald.asdc.Wpublic/researcW cornent11 O.htxnl>

- Emerging Markets Group, "Comments" , Introduction, newspaper "Kazakhstan Herald", on-line: (Kazakhstan Herald Main) Qttp://www.herald.asdc.kz/ public/researchkoment/ 1 O. htmb

- Edi tonal note, newspaper "Rabochaya Tribuna", no. 170 (1 069) October 1, 1994

- "Russian Government Says VATShouldBe 2OPercent in 199V',Reuters,Apr.26, 1999 on-line: (CNN Main) ~http://custornnews.cm.com~

- "Kazakhstan ParliumentApprovesIncon~e TaxHikes",TaxNotesIntemational, March 29, 1999 on-line: WL(TN1)

- "NIKoil Sees Major Inflow of Western Investments to Rusia", Alexander's Gas and Oil Connections, Vol. 5, issue No. 7, April 27, 2000, on-line: http://www.gasandoil. corn>