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YUGANSKNEFTEGAZ Is Designated a Great Public Future // Kommersant. January 11, 2005). The option of the RF Ministry of Economic Development and Trade presented in January 2005 by G. Gref (privatization of ROSNEFT and YUGANSKNEFTEGAZ), as well as the option of . Illarionov, Advisory to the RF President, (YUGANSKNEFTEGAZ remains with YUKOS) are very unlikely to be applied in practice.

RUSSIAN ECONOMY in trends and outlooks ary 2005, the idea of ROSNEFT independency and its transformation into a major public oil exporter was reanimated again (in this case, YUGANSKNEFTEGAZ would remain inte grated into ROSNEFT). According to this option, GAZPROM would not acquire 100% of ROSNEFT. Instead, treasury shares of GAZPROM would be assigned to the government in exchange for the minority share in independent ROSNEFT 38.

Ultimately, three basic criteria should be relied on in selecting other options: the government should obtain a controlling stake in GAZPROM OJSC; key participants in the events associated with YUGANSKNEFTEGAZ should be protected from legal risks (on the part of the purchaser) ; the balance of influences and interests in the RF Presidents Office and its projection on GAZPROM and ROSNEFT should be maintained. Such balance is most likely to determine a critical decision regardless of whether ROSNEFT is going to be come an independent oil player. It is our opinion that this is the main challenge which gov erns, first, prevalence of foreign economic criteria in planning acquisition in prejudice of corporate interests (both for GAZPROM OJSC and ROSNEFT); second, incompetence in take over represented by using illegal techniques, especially in estimating purely eco nomic effects and risks; third, it is necessary to make responsible decisions (which are worth billions of dollars and reputation) in the fire squad mode. Responsible strategic decisions, for which parties have to get prepared over years in common world practice, are made and revoked within several hours subject to the current political situation and quite a flexible balance of administrative influences.

4.2.2. Economic Rent, Licensing and Fiscal Policy The issues of economic rent and fiscal policy are fundamental. The YUKOS case of 2003 2004 is most likely to have impact on this field. There are two interconnected trends that are worth mentioning.

On the one hand, the large Russian businesses demonstrated their almost unani mous tolerance (absolutely demonstrative though) to various governments innovations and goodwill in relation to tax load (in 2003, a series of oil companies declared that they would employ no tax minimization schemes, in 2004 LUKOIL announced a voluntary de crease of gasoline prices by 5%, etc.). The subject of corporate social responsibility be came a popular topic for discussions. However, the idea of such subject seems to be quite cloudy for any business organization which pays all taxes in good faith.

At the same time, in the period between 2003 and 2004, the business community found itself to be able to protect its interests with the government. In fact, the existing business associations (RSPP, OPORA Rossii, Delovaya Rossiya, etc.) accepted the rules of the game and acted as applicants rather than independent political force.

In the 90, the mechanism of relationship between large businesses and the govern ment was distinguished by the possibility for major financial and industrial groups to di rectly participate in developing and imposing upon the government vital political decisions which surely served for the benefit of these groups. The 2000 saw quite an opposite situa tion, when the government began to deliberately disregard the interests of private busi ness in general and enforced new rules of the game to be observed by the business com munity through a wide range of enforcement techniques. The YUKOS case draw a line under the era of tycoons. However, one cannot but take into consideration that pursuing the policy of state capitalism for insiders may logically create the situation of the 90, be cause the model under construction means that new potential tycoons may emerge.

Press conference of S. Oganesyan, Head of the Federal Agency for Power Engineering (member of the Board of Directors of ROSNEFT, former vice president) on February 1, 2005. (www.lin.ru).

Section 4.

Institutional and Macroeconomic Challenges At present, there are two interdependent forces existing in the country, each climb ing to power. One is represented by advocates of capitalism, i.e. a party of governmental bourgeoisie. It is currently being in power, alone. Obviously, there should be another party of independent bourgeoisie, business 39. Establishing a political party to represent the in terests of the Russian independent bourgeoisie (not only large business) would be a civi lized option, but such party is very unlikely to emerge at the present time. In addition, one should understand whether there is any business in this country which is totally independ ent from the government, and what are the chances to establish a true political party rather than a dummy one. The existing business associations are unlikely to fit this role.

On the other hand, the government continued its policy aimed at tightening the rules of the game for large businesses in 2004 and early in 2005. Late in 2004 and early in 2005, practical testing of the tax arrears compensation 40 extra bankruptcy schemes was accompanied by introducing a series of tax innovations in regard to business. Though some of the rules seem to be quite positive, that is not the point. It is our opinion that the measures discussed at the beginning of 2005 (rationalizing tax audit mechanisms, regulat ing transfer costs in the RF Tax Code, making confiscation amendments to the RF Criminal Code, imposing restrictions for offshore companies at natural resources auctions, etc.) were too alien in terms of expected effects to be conceived as a reasonable and compre hensive system of measures.

In substance, the only proposal that was found favorable for the private business was an initiative of the RF Ministry of Finance presented on February 8, 2005 at a meeting on rationalizing tax audit mechanisms chaired by the President of the Russian Federation. It was proposed to approve a full list of documents requested for the purposes of tax audit;

to establish a fixed number of tax audits for a certain period; to approve large amounts in arrears by superior bodies; to perform additional tax audits only in exceptional circum stances41; and to set up a special body to consider conflicts arising during tax audits.

The issues of tax amnesty (especially establishing a limited period to make additional tax payments) are not considered by the government. Instead, the RF President made an amendment to the RF Tax Code (in January 2005) allowing the RF Federal Tax Service to collect tax penalties (from legal entities and physical bodies) without any judgment.

In January 2005, (upon five years of discussion of this issue at different levels) the RF Ministry of Finance submitted a package of draft amendments to Article 20 and 40 of the RF Tax Code on regulating market prices (transfer pricing) for taxation purposes. In par ticular, they determine specific features of interdependent entities and principles of pric ing of goods, works and services for taxation purposes, as well as circumstances when additional tax payments should be made in case of transfer prices overshooting the market ones, etc.

There is a point of view that the idea of such regulation is insignificant for the time be ing due to introduction of fixed tax rates in RUR for oil companies, the use of export duties and other methods of skimming of excess profits, and liquidation of internal offshore com panies. The idea, however, is not rejected, since it is widely employed in the world practice, and transfer prices are used in a variety of other industries. The fact that transfer prices are employed not only for tax evasion but also simply for optimizing the management system Rodionov I., Need for a Swing // Expert. 2004. No. 35. P. 42.

We believe, however, that other well known (by mid February 2005) major claims by the Federal Tax Service on large companies (Sibneft, Vympelkom, Dalsvyaz) should not yet be bracketed with the YUKOS case. These cases along with a variety of other ones may be based on quite different motives: from execution of duties in good faith to settlement of ac counts between senior government officials and a company, trivial incompetence or intention to prove political loyalty.

It were additional (second) tax audits that caused basic additional tax payments with regard to the YUKOS case.

RUSSIAN ECONOMY in trends and outlooks within a group of companies, creates a serious problem which can not be settled legisla tively. This is accompanied by another objective problem which lies in the fact that, on the one hand, it is impossible to determine legislatively all types of interdependence and hence is subject to judicial decision. On the other hand, according to the practice, courts are not qualified to provide judgment to such specific issues, while it is not only availability of precedents but also effective and non commercialized judicial system at large that is criti cal for identifying specific features of interdependence according to other grounds. The foregoing problem will also be encountered by tax agencies in making decisions on addi tional tax payments, because it is extremely difficult to determine price deviations.

Therefore, a new material risk of subjectivity is arising in the context of relationship be tween the government and the business in relation to the latter. Another material risk is represented by emergence of a new tool of exerting pressure upon competitors by using administrative mechanisms.

Amendments to the RF Criminal Code (Article 104.1) proposed by the RF President at the beginning of 2005 may be become another serious innovation. Virtually, the ques tion at issue concerns restoration of forfeiture regulations which were excluded from the RF Criminal Code on the initiative of the RF President as early as 2003. Forfeiture is ex pected to be applied to all types of criminal offences, and provision is made for forfeiture of property for the benefit of the government. It may also include:

earnings and revenues generated from criminally made property (in order to confiscate all assets of a company, it is sufficient to prove a criminal origin of the initial million of a capital or unlawfulness of privatization transactions) ;

property intended to finance organized criminal groups or criminal activity (it is well known that YUKOSs principal shareholders were also accused of creating such a group) ;

property assigned by a convicted person to other person, provided that the latter has evidence to suggest that it has been obtained by criminal activity (in January 2005, M.

Khodorkovsky announced that he transferred 59.9% shares of MENATEP Group to other shareholder, L. Nevzlin42. According to the estimates, such innovation allows even wages of employees of a company to be seized assuming that they suspect the man agement of criminal actions)43.

Adoption of a revised RF Law On Mineral Resources is an essential factor of gov ernments attitude towards economic rent and the related issues of strengthening public control44. The following key issues were considered in 2004: participation of local govern ments in distributing rights to mineral resources (this is specified in the Constitution of the Russian Federation), searching an alternative to licenses (for example, exclusive right to utilize the area of mineral resources purchased at an auction), terms and conditions of granting rights to mineral resources, and geologic exploration issues. Most likely a con cessionary mechanism of mineral resources utilization is going to be introduced to impose restrictions on private sector operations in this field. In 2004, however, licensing was used 50% of shares of Gibraltar MENATEP Group are allocated in a special trust. M. Khodorkovsky was its manager and benefi ciary prior to the legal against YUKOS. L. Nevzlin became a beneficiary of the trust (under the terms and conditions of the trust) upon M. Khodorkovsky was put under arrest in October 2003. L. Nevzlin was granted the right to dispose 50% of shares in trust according to the terms and conditions of the trust upon the loss of the principal asset YUGANSKNEFTEGAZ on December 19, 2004. Certain rights to 9.5% of shares held by M. Khodorkovsky were transferred directly L. Nevzlin in addi tion to the shares in trust.

Refer to : Tightening // Trade secret. February 7 thru 13, 2005. P. 8 9.

RF Law Mineral Resources of February 21, 1992. No. 2395 1 is currently effective. Latest updates of June 29, 2004, No. 58 FL and August 22, 2004, No. 122 FL were related to the changes caused by adoption of a series of other laws and made no changes in the previously accepted approaches.

Section 4.

Institutional and Macroeconomic Challenges quite extensively as a mechanism of public regulation in oil and gas sector (both for the purposes of direct redistribution of control and trivial competitive pressure). In doing so, however, no transparency of procedures and claims was provided. According to the RF Ministry of Natural Resources, 50 out of 110 examined license agreements were revoked in 2004.

A proposal of the RF Ministry of Natural Resources 45 to tighten the procedure allow ing extractive companies to participate in field development auctions became an innova tion at the beginning of 2005. This means that offshore companies will be excluded from the list of participants in future auctions as a soft option, or licenses of these companies will be revoked46 as a hard option. Unconditional registration of at least subsidiaries of for eign (foreign de jure and Russian de facto) offshore and other holding companies in the Russian Federation is proposed as the only alternative, while transparency of ownership structure and tax and judicial jurisdictions of the Russian Federation are presented as a positive effect. Such initiative also provides an ambiguous character.

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