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Taxes New policy designed to attract investment for start-ups and venture capital projects

Major tax breaks in the pipeline for innovation investors

The government is planning to exempt investors from long-term capital gains taxes to attract private equity and venture capitalists.

DMITRY KAZMIN

VEDOMOSTI

Special focus was put on boosting innovation during a meeting on tax policy over the coming three years, chaired by prime minister Vladimir Putin last week. Mr Putin agreed with a pro- posal to exempt the sale of not publicly traded shares from the 20pc tax on capital gains, a move intended to in- crease long-term investment in innovative companies and entice investors to conduct their deals within Russia’s legal jurisdiction, two offi- cials told Vedomosti. According to a copy ob- tained by Vedomosti, the proposal by the ministry for economic development sug- gested the tax break would apply to stakes of at least 10pc held for at least five years. Shares traded on the MICEX Market for Innovations and Investments or not traded on any organised exchange would be covered under the plan. Final proposals should be fi nished by April, said an of- fi cial taking part in the dis- cussion of the tax code amendments. Cancelling the capital gains tax for legal entities has essentially al- ready been approved, but extending the benefi t to pri- vate investors is still being discussed, the source said. There are currently no dis- counts on the capital gains tax, although until 2007 in- vestors holding securities for at least three years were ex-

Banking & Finance

MOSCOW BLOG

Crime and punishment

Ben Aris

RUSSIA NOW

The hope is to attract venture capital and private equity to businesses within Russia’s legal jurisdiction

The goal is to stimulate investment beyond blue-chips and into start-ups and venture capital projects

empt from it, said Dmitry Kostalgin, a partner at Tax- advisor.

The goal is to stimulate an infl ow of investment beyond blue-chips and into start- ups and venture capital projects, deputy economic

development minister Stan- islav Voskresensky told

Vedomosti.

Kirill Dmitriev, president of Icon Private Equity, said he thought it was the right ap- proach, since a dispropor- tionate amount of invest- ment in Russia goes into blue-chips. Tax breaks on capital gains would make Russia more attractive for private equity investment, investors told Vedomosti. Investors will start to look more closely at a business’s fundamentals and not just its stock price, said Alexei Panferov, managing partner

at New Russia Growth Cap- ital Advisers.

Rusnano managing director Dionis Gordin said the pro- posals were a positive indi- cation of changes in the sys- tem as a whole, but the time limits and the size of the stake were a bit harsh for venture capitalists, adding that these kinds of fi nancial operators are more used to frequent purchases and sales with a timeline of three to fi ve years. The proposals by the minis- try for economic develop- ment are also intended to en- courage investors to conduct

their business in Russia, Voskresensky told Vedomo-

sti.

Capital gains taxes are a major argument for selling shares somewhere else – in Cyprus, for example – said Giedrius Pukas, a partner at private equity fund Quadro Capital Partners. But taxes aren’t the only rea- son, said Konstantin Dem- chenko, a managing director at Everest Asset Manage- ment. Foreign jurisdictions are favoured also because of problems with Russian law enforcement and courts. An- other reason for offshore

transactions is a reluctance by certain parties to disclose end benefi ciaries, said Finam general director Arsen Aiva- zov.

Additionally, from 2011, tax exemptions will be simpli- fi ed for dividends being paid into Russia from abroad, said Alexander Zakharov, a partner at Centre USB. The minimum investment of 500m roubles (£11.3m) will be lifted, and the discount will apply to owners of stakes of 50pc for more than a year, excluding countries in the fi nance ministry’s list of tax havens, he said.

pretty grim reading. The article was spurred by comment from Alexandra Wrage of NGO TRACE Inter- national who ran workshops in Russia for Western compa- nies on how to avoid bribery. She lambasted the “rampant, endemic” corruption in Rus- sia, saying it was much worse than in other big emerging economies. There is no denying corrup- tion is both a big problem in Russia: some economists say that the cost of graft has shaved about 2pc off GDP growth rates. Berlin-based NGO Transparency Interna- tional, which produces the global yardstick for corrup- tion perception, rates Russia at joint 146th on the 180-strong list, and reckons bribe-taking is worth about £200bn a year – or nearly one third of Russia’s entire eco- nomic output. However, while Russia gets the most attention on this score it is not alone. All the countries in the CIS are fac- ing the same challenge. For example, Ukraine, which is arguably the only true de- mocracy in the CIS, scores even worse than Russia. And Kazakhstan, which is run by president-for-life Nursultan Nazarbayev, whose children control huge swathes of the economy, scores better than Russia (120th in Transparen- cy’s list). At least Russia has a real and functioning private sector and the nepotism is not quite so blatant.

I

Something needs to be done about corruption in the re- gion. And that is the point: fi - nally, Russia has begun tack- le one of the most difficult re- forms to make for a transition country. When Vladimir Putin was president he called for a

Money ETFs and index-trackers lead the way as investment floods back into the country

High-water mark for Russian funds

With a rebounding economy, resurgent commodity prices and a strengthening currency, foreign investors are seeing Russia as an attractive proposition.

PETER FRANCE

THE MOSCOW TIMES

A total of $411m fl owed into Russian funds over the week ending March 11, the high- est level since October 2009, far outstripping investment flows into Russia’s BRIC peers, according to fund tracker EPFR Global. In the same period, Brazil attract- ed only $47m, India $67m and China $83m. “Investors are warming to the Russia story rather than to any particular market themes… especially with the price of oil now hugging the $80 per barrel level and with rouble appreciation

also expected to continue,” said Chris Weafer, chief strategist at leading Rus- sian financial corporation UralSib.

“Most of that new Russia money was invested into ex- change-traded funds (ETFs) and index-tracker funds rather than to actively man- aged funds,” he added. According to EPFR Global, about $191m, nearly half the total investment into Russian funds, fl owed into ETFs tracking Russian in- dexes. ETFs are rapidly growing in popularity for foreign investors who want to increase their exposure to emerging-market equities. Getting in on the increasing fl ows of cash into Russia-fo- cused funds, State Street Global Advisors unveiled a new Russia-focused SPDR, S&P Russia ETF, which aims to compete with Mar-

ket Vectors Russia ETF, cur- rently the only other US- traded ETF tracking Rus- sian stocks. The fund will at- tempt to track the performance of the S&P BMI Russia Capped Index, which focuses on fi rms dom-

ETFs are popular for investors wanting to increase their exposure to emerging-market equities

iciled in Russia with a mar- ket capitalisation of $100m or more. “The driving force behind the development of this new, emerging-market SPDR ETF was increasing investor demand for more precise ex- posure to the BRIC coun- tries,” said Anthony Rochte,

senior managing director at State Street Global Advi- sors. The renewed interest has pushed Russia from under- weight to overweight in terms of fund investment compared with its BRIC peers, Brazil, India and China. Total Russia holdings as a percentage of the average emerging markets fund was 7.66pc at the end of January, slightly above Russia’s weighting in the MSCI emerging markets index, Weafer said. That’s up from its nadir in January 2009, when the country was heav- ily underweight, averaging about 5.16pc. And foreign investors’ eyes are being increasingly drawn from companies op- erating in the commodities and oil and gas industries toward the retail and bank-

ing sectors. Compared with the MSCI emerging-mar- kets index, industry giants Gazprom, Lukoil and No- rilsk are all underrepresent- ed in the average portfolio, while Sberbank, VTB and VimpelCom are all overrep- resented.

The bump in investment flows helped domestic bourses snap a week of treading water to fi nish the week positively. The MICEX Index gained 1.4pc on Fri- day to fi nish up 0.1pc, while the RTS Index rose 2pc, up 1.8pc on the week.

n March, The Moscow

Times ran a piece head- lined “Corruption may force Western firms to quit Russia.” It made for

crackdown on corruption in every one of his state-of-the- nation speeches, and absolute- ly nothing happened. Dmitry Medvedev also regularly talks about corruption, and has started acting on it, too. The Interior Ministry has set up an anti-corruption unit and the Prosecutor’s Office (Rus- sia’s top policeman) set up an investigative committee last year to examine more than 40,000 cases. The government says it exposed a total of 439,000 crimes in 2009 of which 173,000 were serious and caused a total of 1tr rou- bles (£23bn) of damage. You can choose to believe the actual numbers of crimes solved or not, but an attack on the problem has clearly begun.

05

Every week, a high- ranking official from across the spectrum of government is either sacked or jailed

Every week, some high-rank- ing official from across the spectrum of government has been either sacked or jailed. In all, some 800 members of Rus- sia’s administrative elite were sent to prison in 2009. Of course, the numbers of those punished are tiny compared to the million-plus strong bu- reaucratic army, but the strat- egy is a warning shot across the bows of every branch of gov- ernment to say “change is com- ing, mend your ways”. More recently, Mr Medvedev has taken things up a gear and started to legislate. A police re- form bill was passed in Febru- ary; the interior ministry was given a shake-up in March; a bill to better defi ne blue-collar crimes was passed the same month. More are on their way, although it will take years if not decades to make a real dent in the problem. “Our task is to create justice of high quality that helps our cit- izens,” Mr Medvedev said, add- ing that it would not be an easy process.

Bureaucracy or corruption? Two sides of the same coin

Stephen Dalziel

EXECUTIVE DIRECTOR OF THE RUSSO- BRITISH CHAMBER OF COMMERCE.

W

Investment Privatisation and modernisation lead the way in quest for foreign cash

Going for growth: race to recapture FDI

With Russia’s post-crisis economic recovery proving slow, the Kremlin is targeting foreign direct investment in the drive to modernise the economy.

BEN ARIS

BUSINESS NEW EUROPE

The recovery of the Russian economy continues to lag be- hind others around the globe, according to the latest man- ufacturing and infl ation fi g- ures. This is threatening to dampen the return of invest- ment from overseas, whether on equity and debt markets or in foreign direct invest- ment (FDI). It’s the latter that is the focus of the govern- ment’s programme to steer the Russian economy follow-

ing the crisis, as it looks for long-term cash and partner- ships to help develop and di- versify away from natural re- sources, increase productiv- ity and rebuild ailing Soviet- era infrastructure. However, Russia has a fairly poor record in attracting FDI. Although levels sky-rocket- ed in the boom years prior to autumn 2008, volumes were still modest compared with other Brics, and tethered to natural resources for the most part. This is the result of commonly acknowledged is- sues (corruption, poor legal protection and, frankly, abys- mal PR for the most part), against which president Medvedev is leading a charge, under the all-encompassing banner of “modernisation”.

A major factor in this cam- paign is to improve the coun- try’s image as a safe invest- ment target. The eventual goal is to lever foreign invest- ment and expertise to help create the hi-tech economy about which the president so often eulogises. As prime minister Vladimir Putin said recently, a key focus in the fu- ture is to locate long-term in- vestment in scientifi c sectors independent of budget fund- ing. That, however, won’t happen until Russia’s basic infrastructure is updated. It adds up, then, that this year’s privatisations are tar- geting strategic or project- based investors in transport. Not only are highly publi- cised privatisations of ship- ping and port companies on

the cards, but deals to push forwards stalled projects, such as the Western High- Speed Diameter in St Peters- burg (a highway connecting the city port to the ring road), or the development of that city’s Pulkovo Airport, for which VTB Capital has re- cently put together an invest- ment consortium. FDI is key to the political leadership’s vision for Rus- sia’s future. For now, the ori- gin of the bulk of direct in- vestment remains offshore fi - nancial centres, such as Cy- prus, through which Russian corporations route what is in effect domestic investment, due to the preferential treat- ment available to “foreign” investors. That said, the push to attract

infrastructure investment proved reasonably successful in 2009, with transport and communications sectors leading the way in attracting FDI, according to state sta- tistics service Rosstat. Mean- while, the leading role of re- tail last year indicates that foreign investors now believe that the country is genuinely starting to see additional drivers to the hydrocarbon roadhog. Russia attracted $15.9bn in FDI in 2009, 68pc below the 2008 record of $49bn, but a fall in line with global levels. That means that Russia now faces serious competition to secure a share of the interna- tional investment fl ows – par- ticularly from fellow Brics, Brazil, Cina and India. Of the

four, the Russian economy was the hardest hit, and its growth is widely expected to lag over this year and next. As Mr Putin noted in February, “In the post-crisis period, the competition for attracting this investment will be tough.” Meanwhile, fi nance minister Alexei Kudrin suggested last month that it could take until 2013 for FDI to return to the level seen in 2008. The details released thus far on the latest privatisation drive are there- fore only likely to prove the tip of the iceberg: the author- ities hope to create a virtuous circle, with additional FDI speeding structural reform and growth of the economy, in turn spurring further in- vestment.

hen I ask members of the Rus- so-British Chamber of

Commerce what the biggest problem is doing business in Russia, the most frequent answer is “bureaucracy”. You have to have forms for this, forms for that, stamped and signed by the right author- ity, often in triplicate Russians seem to have thought up rules and regula- tions just for the sake of it. Two years ago, I thought I had hit on a sensible economy measure. The Chamber runs two major events in the year: the Business Forum in Lon- don in June, and RussiaTALK in Moscow in October. Why, I suggested did we not produce double the number of delegate bags for the Forum, bearing the Cham- ber’s logo, then send the sec- ond half to Moscow for Rus- siaTALK? Staff agreed this was a good idea; but when we went to ship the bags to Moscow, we were told there is a special tax slapped on imported goods which are made of cloth and bear a logo. If anyone can see the sense in this, I should be delighted to have it explained to me. The problem with such non- sensical rules is that they in- evitably lead to corrupt prac- tices. We were lucky; we had another event in the UK where we could use our bags, albeit a year later. But a com- mercial company under time pressure may have been tempted to try to come to “an agreement” with the Russian authorities, avoiding the tax but reaching a compromise fi gure which may have gone into an individual’s pocket in- stead.

This is the real danger of petty bureaucratic rules. Rather than going through an ex- haustive and possibly costly

legal process to ensure that all the rules have been followed to the letter, there will often be the temptation to bypass them by placing money in a brown en- velope which benefi ts only the recipient. So, although our members may put “bureaucra- cy” rather than “corruption” at the top of their list of problems doing business in Russia, these things are really two sides of the same coin. There has been much hand- wringing over the years about the problem of corruption in Russia. Read Russian literature from the 19th century and you’ll see that it is deeply in- grained in the Russian way of doing things. Sadly, the Soviet system did nothing to improve this. The centrally planned economy produced what the

Read Russian literature from the 19th century and you’ll see that corruption is deeply ingrained

Politburo dictated, not what the country needed. One word which you quickly learned if you visited the USSR in the Seventies and Eighties was de- fi tsit (shortage). And where you have “defi tsit” you have a breed- ing ground for a black market – and corruption. The Russian president, Dmitry Medvedev, has openly recog- nised the problem of corrup- tion in today’s Russia. Modern Russia is a consumer society without the problems of defi t- sity. But the country is still plagued by nonsensical pieces of bureaucracy. There’s a wonderful line in the classic Monty Python comedy fi lm, Life of Brian. When Brian asks his mother why women aren’t allowed to go to watch stonings, she replies: “Because it’s written, that’s why!” Un- fortunately, much of Russian bureaucracy can be summed up in the same way. And until it’s sorted out, any battle with corruption will be an uphill struggle.

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