US embassy cable - 05YEREVAN1074

UNCLAS SECTION 01 OF 02 YEREVAN 001074 
 
SIPDIS 
 
DEPT FOR EUR/CACEN, EUR/ACE 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON, EAID, ETRD, AM 
SUBJECT: U.S. INVESTORS WIN IMPORTANT VICTORY AGAINST GOAM 
TAX SERVICE 
 
REF: Yerevan 52 
 
1. (U) Sensitive but unclassified.  Please protect 
accordingly. 
 
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SUMMARY 
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2. (SBU) On June 16, Armenia's court of appeals ruled in 
favor of a group of American investors who have been trying, 
for over two years, to collect USD 2 million in taxes that 
they had overpaid to the GOAM during the privatization and 
renovation of the Marriott Hotel Armenia.  As the largest 
U.S. investment in Armenia backed by the Overseas Private 
Investment corporation (OPIC) and the International Finance 
Corporation (IFC), the case was the best known example of a 
problem common to nearly all foreign investors in Armenia: 
the GOAM's failure to repay overpaid Value-Added Tax (VAT). 
In this case, as in the many other claims against the Tax 
Service, no one seriously disputed that the tax was 
overpaid.  The Tax Service has been notoriously loath to 
part with cash, even ignoring previous court judgments.  For 
the first time, it appears that the tax service is prepared 
to honor the court's verdict in this case, a move that could 
lend confidence to other businesses with large outstanding 
VAT refund claims.  End Summary. 
 
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RELUCTANT JUSTICE 
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3. (SBU) The Hotel Armenia's dispute with the GOAM is a 
familiar one for foreign investors in Armenia.  As part of 
their privatization and investment agreement, they were 
entitled to VAT refunds on all capital investments as part 
the 2001-2003 renovation of the Hotel Armenia.  (Note:  By 
law, foreign capital investment and exporting industries are 
entitled to VAT exemptions.  End Note.)  Nevertheless, the 
GOAM never returned USD 2 million in overpaid VAT claiming 
that tax laws and other bureaucratic barriers denied the Tax 
Service "a mechanism" to return the money that they 
acknowledged they owed.  In 2003, the investors sued the tax 
authorities, winning both in lower court and on appeal.  The 
Tax Service never honored the judgment.  The parties then 
reached a settlement in 2004 whereby the hotel could offset 
other tax obligations against the VAT overpayment.  The 
government backed out of that agreement, leading to the 
present proceedings.  After postponing the court hearings 
twice, the court has ruled against the Tax Service a second 
time.  Following the ruling, the Tax Service still will not 
refund the tax in cash, but has agreed to honor the earlier 
settlement to offset the amount, an acceptable outcome for 
the investors. 
 
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A STEP FORWARD FOR ARMENIA'S VAT ARREARS PROBLEM 
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4. (SBU) Shortcomings in Armenia's revenue services (in 
particular their failure to return overpaid VAT) are among 
the greatest scourges to Armenia's business climate.  By the 
end of 2003, outstanding VAT refund claims amounted to 1.3 
percent of GDP and 10 percent of annual tax revenue. 
Recognizing this problem, the GOAM in 2004 promised as an 
IMF conditionality not to accrue new VAT arrears to 
businesses and to pay back the old arrears.  The GOAM also 
made similar pledges to us during the Fall 2004 and Spring 
2005 meetings of the U.S.-Armenia Task Force (USATF). 
According to U.S. businesses, the tax service has since done 
a good job not accruing new arrears:  one company had more 
VAT returned to it during 2004 than in six years of prior 
business.  The GOAM had not yet started to pay back the 
stock of larger arrears like those owed to the Hotel 
Armenia.  Deals like this, allowing companies to offset 
these arrears against current tax liabilities could be a 
hopeful sign that the GOAM is ready to confront this 
problem. 
 
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U.S. ENGAGEMENT KEY TO POSITIVE OUTCOME 
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5. (SBU) The Hotel Armenia case was the focal point for 
Armenia's problem in VAT administration.  We raised this 
case and the general VAT refund problem repeatedly at the 
ministerial level and with the head of the State Tax 
Service.  The Ambassador raised this specific case at two 
meetings of the U.S. - Armenia Task Force (USATF), and 
Embassy EconOff along with representatives from the IFC and 
Marriott Corporation conspicuously attended all court 
hearings. 
 
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COMMENT:  TAX ENVIRONMENT IMPROVING--TOO SLOWLY 
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6. (SBU) While the experience of the Hotel Armenia may sound 
discouraging to future investors, the fact that the Tax 
Service seemingly intends to honor a judgment of the court 
against them (and the fact that the investors were able to 
get the court to rule against the powerful tax service) is a 
hopeful sign.  Two years ago the VAT regime was so bleak 
that many foreign businesses had stopped claiming VAT 
refunds and simply wrote them off as expenses.  In line with 
President Kocharian's January 2005 call for reform of the 
Tax Service (reftel), foreign companies are now reporting in 
many cases that they are getting their current VAT refunds 
on schedule.  While we acknowledge the fact that this 
outcome might not have been reached without our engagement, 
it is another sign that Armenia's tax environment may be 
becoming more friendly, and that the impunity of Armenia's 
Tax Service is waning, albeit reluctantly and too slowly. 
EVANS