Install

Get the latest updates as we post them — right on your browser

. Last Updated: 07/27/2016

Taxing Expats' Patience

Doing business in Russia has never been a picnic, but it took a turn for the worse earlier this month when the Russian government reversed a set of tax incentives for Western firms, some of which had been decreed just months earlier. For our small company, which is planning to build up to 80 additional telecommunications centers in Russia to anchor our satellite-based network there, the cost of doing so has just risen by $8.6 million dollars.


The new tax law ends an exemption that Western firms investing capital in Russia were set to enjoy from Russia's 21.5% value added tax on imported goods. The exemption, which ostensibly took effect on January 1, 1995, was repealed even before regulations implementing it could be drafted. Each telecommunications center we plan to add to our existing network of six requires approximately $500,000 of imported Western equipment. Do the math and you quickly find that the $40 million investment in hardware we were planning on is now a $48.6 million investment.


If the flip-flop on the value-added tax were the only obstacle to investing in Russia, most companies could live with it. But among the reasons why Russia is attracting only 4% of the foreign investment flooding into China is a Byzantine tax system that provides no sense of stability or predictability. While investing in Russia is not for the faint of heart, this latest news is sure to scare off foreign investment the country badly needs.


In the telecommunications field, for example, CS First Boston, the prestigious investment banking firm, has estimated that it will take $100 billion in infrastructure investment to bring Russia's antiquated system up to the level of Spain which has Western Europe's least developed telecom system. Compare this with the total of $1.2 billion in foreign investment made in Russia last year and you realize how far Russia has to go in attracting the foreign investment essential to economic reform.


In addition to the re-imposed value-added tax on imported equipment, we and our Russian joint venture face a 13% profits tax, a 38% "excess wages" tax on employee salaries that exceed by a factor of six Russia's paltry minimum wage, and various payroll and capital investment taxes. The excess wages tax, which was thought to be inapplicable to Western firms, was imposed retroactively to January 1, 1994, by recent edict of the Russian tax ministry. To avoid one of Russia's more bizarre taxes -- a 1% of gross revenues tax imposed on ventures whose names include derivations of the name "Russia" -- we changed the name of our Russian joint venture from "Russtel" to "Rustel."


There are other costs associated with this tax madness, too. To stay within the law we consult several legal and financial advisors who often provide advice inconsistent with one another, and whose advice has, through no fault of their own, a shelf life shorter than milk.


It would be easy to blame the confusion and chaos that permeate the business environment in Russia on a sometimes erratic President Yeltsin, his ideologically diverse government, and an ornery and disorderly legislature. Some blame belongs there, to be sure. But, according to some news accounts, at least some of the blame can be placed on Western institutions. The Russian government is being pressured hard by the International Monetary Fund and other lenders to reduce its huge budget deficit which in turn is leading to higher and more varied taxes. Thus, Russia is caught between the rock of the IMF on the one hand, and the hard place of desperately needing greatly increased foreign investment on the other.


And, if the Russian government and the vagaries of the Russian business environment are maddening to Western investors, the United States has not exactly proven to be a reliable partner in Russian economic and political reform. Long-promised aid has been slow to flow, and a complete cut-off of U.S. foreign aid is possible in the Republican-controlled Congress. Furthermore, for small U.S. firms like ours it can be an expensive and arduous process to access funds established by the U.S. Agency for International Development to support U.S. businesses in Russia. Yet, small companies have much to contribute to the development of Russia and its business culture, and are often more adaptable to Russia's confusing business environment than large companies.


It is profoundly in the interests of Russia, the United States, and their respective business communities to help stabilize the Russian business climate. The Gore-Chernomyrdin Commission, chaired by Vice President Al Gore and Russian Prime Minister Viktor Chernomyrdin, is making significant efforts towards this end, and indeed Vice President Gore has been a strong voice for American business in Russia.


As the post-Cold War era continues, however, three steps must be taken if Western, and particularly American business is to play the role that it can and should play in Russia's economic development. First, the Russian regulatory and legal environments must stabilize so that the rules for doing business become more predictable. Second, international monetary institutions should take a long-term view of Russia's future. Increased taxes to reduce budget deficits will not cure Russia's long-term woes, especially if it discourages foreign investment. Only foreign investment can re-build Russia's economy over the long haul. Third, the U.S. must be a consistent and reliable partner in reform. This means not only providing the Russians with stability in their foreign aid expectations, but making it simpler and easier for U.S. firms to obtain loans and other investments from the various government and quasi-governmental agencies that manage funds created for that purpose.





James L. Hickman is Chairman of International Business Communication Systems, Inc. and Director General of Rustel. Mark C. Butts is Chief Financial Officer of IBCS. They contributed this comment to The Moscow Times.