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* Prior to 2001, the Mineral Tax was calculated as a total amount of oil excise, mineral excises and duties and contributions to rehabilitation of mineral resources.

As is evident from Table 3, the downward trend in profit tax revenues which started in 2001, ceased to exist in 2004. At the end of 2004, the budgetary profit tax revenues ac counted for nearly 5,2% of GDP thus exceeding by 1.2 percentage points of GDP that of 2003. The tax revenues growth is based mostly on the increased profit tax base. According to the Russian Statistics Agencys data, the growth in consolidated financial figures (total corporate income less losses) over the period between January thru October 2004 ac counted for 50% against the same period of the preceding year, while in 2003 the growth of this parameter accounted for12% (negative). The growth in tax revenues can be ex plained to some extent by termination of various profit tax allowances which entered into force prior to the tax reform in 2002.

At the end of 2004, a share of income tax revenues in GDP, as well as a share of the single social tax in GDP remained the same as compared to the previous year, 3.4 and RUSSIAN ECONOMY in trends and outlooks 2.7% of GDP correspondingly. Moreover, according to the Russian Statistics Agency, real income of the population in 2004 accounted for 7.8%, and 10.8% in real wages increase, which is exceeding the 2004 GDP growth rate by 1 percentage point and 4 percentage points correspondingly. Thus, the effective rate of single social tax in real terms appears to be lower in 2004 against 2003, while that of the income tax remained almost unchanged.

The reduction of the effective rate of single social tax in 2004 can be explained by the fact that in the previous periods the Russian federal budget revenues on single social tax also included the arrears on single social tax which used to be credited to the Pension Fund.

VAT revenues to the budgetary system of the Russian Federation remain the biggest ones thus accounting for more than RUR1 trillion or 19.7% of the consolidated budget revenues and 31.2% of the federal budget revenues by the end of 2004. In spite of the de crease in the basic VAT rate from 20 to 18% from January 1, 2004, a share of VAT reve nues in GDP decreased by barely 0.2 percentage points of GDP, while the forecasted de crease was expected to be by nearly 0.6 percentage points of GDP. The increase in VAT revenues was to some extent based on the decrease in VAT refund volumes. For instance, according to the Federal Tax Service, the volume of refunded VAT accounted for 1.8% of GDP over the first 8 months in 2004, while that of the similar previous period accounted for 2,3% of GDP.

In 2004, excise revenues reduced by 1.1 percentage points of GDP and accounted for nearly 1.5% of GDP as compared to the previous year. Such a substantial reduction is caused by abolition of the natural gas excise from January 1, 2004. The revenues from this excise in 2003 accounted for more than 45% of the budget aggregate revenues on ex cises.

The mineral tax revenues its maximum (since its initial introduction), 3% of GDP, in 2004. As noted above, the tax growth was primarily caused by high oil prices and the in crease in the mineral tax base rate from RUR340 to RUR347 per 1 ton of raw materials. In addition, the growth in mineral tax revenues was encouraged by the increase in oil produc tion in 2004 which exceeded by 8.6% that of the previous year, according to the Russian Statistics Agencys data.

The volume of the foreign trade tax revenues in 2004 was in excess of by 1.7 per centage points of GDP as compared to the previous year and accounted for 5.1% of GDP.

This was mainly caused by high oil prices in 2004 and changes in export tax from the sec ond half of 2004, both for foreign trade tax and mineral tax.

2.2.3. Budget Expenditures No essential changes were made in the structure of the consolidated budget expen ditures in 2004 (refer to Table 4) as compared to 2003. Slightly reduced were the consoli dated budget expenditures on state debt service (from 1.8% of GDP in 2003 to 1.4% of GDP in 2004), expenditures on municipal housing and public utilities (from 1.9% of GDP in 2003 to 1.7% of GDP in 2004), and on Industry, construction and power energy item (from 2.5% of GDP in 2003 to 2.3% of GDP in 2004).

No expenditures were increased other than that on International activity item (by 0.1 percentage points of GDP) for the federal and consolidated budgets, and social policy item by (also by 0.1 percentage points of GDP) local budgets. Thus, the aggregate expen ditures at the end of 2004 were smaller than that in the previous year for the budgets at all levels: by 1.6 percentage points of GDP for the federal budget, by 0.8 percentage points of GDP for the local budgets, and by 1.9 percentage points of GDP for the consolidated budget.

Section 2.

Monetary and budgetary spheres Table Expenditures of Federal Budget, Local Budgets and Consolidated Budgets in 2002 thru 2005 (% of GDP) 2002 2003 Con Con Con Fed Fed Fed Local soli Local soli Local soli eral eral eral Budg dated Budg dated Budg dated Budg Budg Budg ets Budg ets Budg ets Budg et et et ets ets ets Public administration and 0.5 0.8 1.4 0.5 0.9 1.4 0.5 0.8 1.local self administration Judicial power 0.2 0 0.2 0.2 0 0.2 0.2 0.0 0.International activity 0.3 0 0.3 0.2 0 0.2 0.3 0.0 0.National defense 2.7 2.7 2.7 0 2.7 2.6 0.0 2.Law enforcement and na 1.7 0.5 2.2 1.9 0.4 2.3 1.9 0.4 2.tional security Fundamental scientific re search and scientific pro 0.3 0 0.3 0.3 0 0.3 0.3 0.0 0.gress promotion Industry, power energy and 1 1.3 2.3 0.5 2 2.5 0.5 1.9 2.construction Agriculture and fishery 0.3 0.3 0.5 0.2 0.3 0.5 0.2 0.3 0.Transport, road network, communication and infor 0.1 0.4 0.5 0 0.3 0.3 0.0 0.2 0.matics * Housing and public utilities 0 2.3 2.3 0 1.9 1.9 0.0 1.7 1.Education 0.7 3 3.8 0.8 2.8 3.6 0.7 2.8 3.Culture, arts and cinematog 0.1 0.4 0.5 0.1 0.3 0.5 0.1 0.3 0.raphy Mass media. 0.1 0.1 0.2 0.1 0.1 0.2 0.1 0.1 0.Health care and sport. 0.3 2.1 2.4 0.3 1.9 2.2 0.3 1.9 2.Social policy 4.4** 1.3 5.7** 1 1.4 2.4 0.9 1.5 2.State debt service 2 0.1 2.2 1.7 0.1 1.8 1.2 0.2 1.Financial aid to budgets at 2.7 0 6.0*** 0 3.2*** 5.4 0.0 3.other levels Military reform 0.1 0 0.1 0.1 0 0.1 0.0 0.0 0.Road network 0.4 0.4 0.7 0.3 0.5 0.8 0.3 0.2 0.Targeted budget funds 0.1 1.4 1.6 0.1 1.1 1.2 0.1 1.0 1.Total expenditures 18.7 15.3 31.1 17.7 14.9 29.7 16.1 14.1 27.* In 2001, including road network expenditures.

** Including transfers to the RF Pension Fund for financing basic part of pension at the expense of a single social taxs share centralized in the federal budget.

*** Since 2003, this item reflects transfers to public extra budgetary funds.

2.2.4. Main Events in the Budget System and Changes in Tax Law In 2004, various amendments were made as part of the tax reform to the RF tax law and budget law, in particular, single social tax (the basic rate of single social tax was re duced from 35.6 to 26% for annual wages of employees within RUR280 thousand; the sin gle social tax rate is established at 10% for annual wages of employees ranging between RUR280 thousand and RUR600 thousand, and 2% for wages in excess of RUR600 thou sand). Changes in single social tax are to become effective from 2005, which is expected to result in budget losses of nearly RUR280 billion in 2005, according to the estimates of RF Ministry of Finance.

The legislation was also amended in relation to oil export tax and mineral tax. These amendments were generally expected to result to increase load on the petroleum industry RUSSIAN ECONOMY in trends and outlooks and partially compensate the RF Pension Funds deficit, according to the RF Governments plans. According to a new export tax schedule, a tax would be 0% if oil price was up to $per barrel; up to 35% of the difference between actual oil price and $15 if oil price was $to $20 per barrel; not more than $12,78 plus 45% of the difference between actual oil price and $20 if oil price was $20 to $25 per barrel; not more than $29,2 and 65% of the differ ence between actual oil price and $20 if oil price was more than $25 per barrel. At the same time, the basic mineral tax rate was increased from RUR347 to RUR400 per ton in the Mineral Tax calculation formula. The tax free oil price threshold was also increased from $8 up to $9. In addition, the RUR exchange rate was revised from RUR31.5 to RUR29 per $1. According to the Governments estimates, the understated RUR exchange rate in the Mineral Tax calculation formula resulted in extra amount of nearly $1 billion remained in the petroleum industry. The corresponding amendments to the Mineral Tax are to come into force since 2005.

Furthermore, for the purpose of compensating federal budgets losses incurred from the reduced single social tax rate, amendments were made to the Budget Code in relation to reallocation of 1.5% percentage points of the profit tax rate for the benefit of the federal budget. As a result, the rate at which profit income revenues are credited to the federal budget is increasing up to 6.5%. Amendments to the budget law were also related to a growth in the standards of mineral tax contributions and regular payments payable to the federal budget from 2005, transition of water tax to the federal level and consequently crediting the entire single agricultural tax to the revenues of the constituent entities of the Russian Federation.

In collecting value added tax, the RF Government plans from 2005 to shift from the country of origin principle to the country of destination on oil and gas in its relations with the CIS countries (Ukraine, Byelorussia, Kazakhstan and Moldova). As a result, the RF budget is expected to lose RUR39,9 billion. The RF Government believes that the budget losses can be compensated by increasing the mineral tax rate for production of oil and gas.

During 2004, the issues related to reforming the value added tax were under active discussion. In particular, as early as in 2004, amendments to the VAT law were adopted, including establishing a procedure of VAT collection under the country of destination principle in relation to transactions with Byelorussia. In 2005, the RF Ministry of Finance plans to consider the issue of reducing the basic VAT rate from 18 to 15%16% and simul taneous abolishing the preferential 10% rate since 2006. Other options are also under consideration, down to establishing a single rate of 13%. From 2006, transition from the cash basis to the accrual basis for VAT payment is scheduled, with some exceptions which are likely to be granted for small businesses. The RF Government also made its proposals on considering options of accelerated VAT refunding. In addition, consideration was made of an option of authorizing banks to collect data on value added tax payment. According to the official statements of representatives of the RF Ministry of Finance, in 2004, the RF Government totally refused the idea of introducing VAT accounts. As a reminder, the basic VAT rate was reduced from 20 to 18% from January 1, 2004.

In 2004, the RF Ministry of Finance commenced to consider the issue of amending the Tax Code in relation to transfer pricing. Basic amendments should be referred to specifying a list of interdependent persons and its enlarging by including companies with different structure of ownership. Also, for purpose of substantiating a transaction price, the taxpayer must provide a series of documents, as requested by tax authorities, accord ing to a well defined list including marketing research data.

Section 2.

Monetary and budgetary spheres On august 22, 2004, the RF State Duma adopted a low that replaces welfare benefits with cash payments, including well fare benefits related to healthcare, public utilities ser vice, transport fees, etc. The majority of the welfare benefits specified in the law are to be financed with the federal budget funds with total expenditures being estimated nearly RUR171,2 billion. In this case, the constituent entities of the Russian Federation are to fi nance welfare benefits of the social groups as follows: retired persons with long term ser vice record (labor veterans), citizens who were unlawfully retaliated for alleged political disloyalty, and persons who were employed in the period between June 22, 1941 and May 9, 1945. The RF Ministry of Finance expressed its readiness to allocate RUR 510 billion in 2005 to assist the regions in transition under the new welfare law. Such funds will be allo cated from the Reserve Fund which totals RUR30 billion.

As of January 1, 2005, the Stabilization Fund totals nearly RUR522,3 billion. Accord ing to the draft federal budget, contributions to the Stabilization Fund in 2005 are esti mated to be RUR387,7 billion, with estimated utilization capacity being RUR242,6 billion, including RUR74,7 billion scheduled to cover budget deficit of the RF Pension Fund, and RUR167,9 billion to repay the Russian foreign debt.

All in all, in the nearest 2 years, the RF Ministry of Finance plans to finalize the tax re form. As a result, the main outcome could be a released tax load and simplified taxation system of the Russian Federation. For example, in 1998, the number of taxes amounted to 52, while it is expected to be reduced down to 15 by 2006. According the estimates of the RF Ministry of Finance, transfer pricing remains one of the key issues of the upcoming re form.

2.2.5. Federal Budget for the year of Tax revenues of the federal budget for 2005 have been determined in the total of RUR2 trillion 232 billion 700 million (11.93% of GDP or 10.05% of GDP without considera tion of single social tax), which is less almost by 3.5 percentage points of GDP than that under the budget law for 2004. The reduction is due mostly to the changes in classification of incomes, which in 2005 enables the revenues from tax duties to be attributed to non tax revenues which used to be reflected in the item representing foreign trade tax and foreign economic operations (Foreign economic activity revenues). In addition, from 2005, aggre gate income tax revenues are to be transferred to the local budgets.

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