US embassy cable - 04ZAGREB1335

UNCLAS  ZAGREB 001335 
 
SIPDIS 
 
 
SENSITIVE 
 
STATE PLEASE PASS USAID FOR E&E/ACONVERY 
STATE FOR DRL 
TREASURY FOR VIMAL ATUKORALA AND OTA 
 
E.O. 12958: N/A 
TAGS: EAID, SOCI, PHUM, EFIN, PREL, HR, Trade 
SUBJECT: CROATIA HALTS VAT EXEMPTIONS FOR MOST NGOS 
 
SUMMARY 
------- 
 
1. (SBU) A recent change to taxation law means Croatian NGOs 
will again be required to pay VAT on purchases financed with 
foreign donations. Though some NGOs have raised alarms over 
alleged unfairness and lack of transparency, GoC efforts to 
clean up its tax policy are welcome steps. Although the 
government was completely within its legal rights to suspend 
VAT exemptions, its failure to adequately explain the 
decision to the NGO community has put the GoC on the 
defensive. USG assistance programs remain VAT exempt. END 
SUMMARY 
 
LET'S TAX LIKE IT'S 1997 
------------------------ 
 
2. (U) The April 30 national gazette published a Ministry of 
Finance decree revoking VAT exemptions for NGO purchases 
financed with foreign donations. The original 1997 law on VAT 
provided for narrow tax exemptions to humanitarian 
organizations. The GoC expanded these exemptions in 2001 to 
include human rights, minority rights, women's rights, and 
democracy-building NGOs. 
 
3. (U) As of May 8, VAT has been levied on in-country 
purchases of goods and services by NGOs financed with foreign 
assistance. NGO purchases financed with local assistance will 
continue to be assessed VAT. VAT will not/not be assessed on 
the receipt of foreign assistance itself. All existing 
bilateral agreements on VAT exemption, such as those with the 
USG and the European Commission, will remain in force. 
 
NGOS CONDEMN GOVERNMENT DECISION BUT IGNORE OLIVE BRANCH 
--------------------------------------------- ----------- 
 
4. (U) Three of the largest NGOs in Croatia -- BaBe (women's 
issues), GONG (democracy-building, election monitoring), and 
Green Action (environment) -- immediately and publicly 
criticized what they call the decision's harmful impact of 
civil society development. Two NGOs allege that the GoC 
attempted to bribe them with preferential tax treatment in 
exchange for dropping the issue. 
 
5. (SBU) GONG alleges government intimidation in the form of 
a June 1 audit by state tax inspectors. While all NGOs we 
spoke with expressed outrage at so-called retaliation for NGO 
protest, the Tax Administration has assured us audits are 
aimed only at the enforcement of tax laws and prevention of 
abuse. 
 
6. (SBU) Moreover, the Ministry of Finance accepted an NGO 
proposal to form a working group consisting of 
representatives from the Ministry of Finance, Tax 
Administration, NGOs, donors, and unions to brain-storm how 
best to support civil society without VAT exemptions. Since 
May 27, the GoC has attempted to work with key NGOs to 
establish public benefit criteria -- in line with European 
Union guidance -- that would allow for VAT refunds from the 
state budget for qualifying organizations. 
 
IT'S NOT ABOUT THE BUDGET 
------------------------- 
 
7. (SBU) No one claimed the VAT change was aimed at filling 
state coffers. BaBe and GONG told us that in their dealings 
with MinFin, the Ministry had no idea how much revenue the 
change would generate. In a separate meeting, MinFin 
officials told us that they are scouring tax regulations to 
close loopholes -- as much for tax policy reasons as revenue 
generation. 
 
8. (SBU) The GoC contributed 17 million kuna ($2.9 million) 
from its 2003 state budget to civil society development. The 
recently-created Foundation for Civil Society Development 
will work with the GoC, local administrations, and NGOs on 
increasing transparency in how state money is distributed to 
civil society organizations. 
 
TAX AGENCY HAS "NO INTEREST WAGING WAR WITH NGOS" 
--------------------------------------------- ---- 
 
9. (SBU) On June 30, Deputy Director of the Tax 
Administration Zlatko Fabijancic told us that charging NGOs 
VAT was in no way about increasing state revenues, but rather 
was about simplification of the tax code and eliminating a 
potential source of abuse. His agency hoped to insure that 
VAT exemptions are fully in accordance with the 1997 law on 
 
taxation. This measure would also combat tax evasion, as 
individuals have created or fabricated NGOs with the 
intention not just to evade VAT but also income tax. 
 
10. (SBU) Fabijancic explained that the Tax Administration 
feels that eliminating NGO VAT exemptions constitutes a 
much-needed correction to the 2001 change -- exemptions the 
Tax Administration long warned was out of step with EU norms. 
Correcting what he saw as a clear aberration from both 
Croatian and EU law is a necessary part of harmonization with 
EU tax law. 
 
11. (SBU) Fabijancic defended the GoC against NGO allegations 
of disinterest or ill-intent. He denied "bribery" 
allegations. Asked about allegations of intimidation, 
Fabinjancic declared, "We have no interest in waging war with 
NGOs." 
 
12. (SBU) In a separate meeting, a high-level contact in the 
Ministry of European Integration told us she personally does 
not/not see VAT exemptions for NGOs as inconsistent with EU 
policies nor does she believe EU harmonization demands taxing 
NGOs. She expressed hope that the GoC would be able to 
continue financial support for civil society while closing 
this tax loophole. 
 
COMMENT 
------- 
 
13. (SBU) Eliminating VAT exemptions for NGOs makes sense for 
Croatia's fiscal policy -- it simplifies the tax code, it 
closes a loophole, it eliminates a likely source of abuse, 
and it may even generate a modest amount of revenue. Based on 
our reading of the EC directive on VAT and discussions with 
the OSCE mission in Croatia, the GoC has done nothing 
inconsistent either with EU legislation or with best 
practices in EU member states. It has, however, failed to 
effectively explain its position to the NGOs. 
 
14. (SBU) Moreover, the GoC has shown a clear willingness to 
compromise with NGOs, offering to institute VAT refunds for 
organizations that meet public benefit criteria. Despite good 
faith efforts by the GoC to support civil society without 
manipulating the tax code, NGOs have stubbornly refused to 
discuss anything other than more exemptions. We are confident 
the GoC will continue to work with the NGO community to find 
a way to support civil society without resorting to 
manipulation of the tax code. 
 
15. (SBU) Discontinuing the VAT exemption looks worse than it 
is. In the assessment of large, internationally-funded NGOs 
we spoke with, NGO operations will continue despite a decline 
in purchasing power. In fact, the effectiveness of NGO 
pressure in generating MinFin's refund proposal is evidence 
that Croatian NGOs are alive, well, and not shying away from 
a fight. END COMMENT. 
FRANK 
 
 
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