Putin Postpones Prohibitive Lumber Export Tax Regime

by Tatiana Smolenskaya, Tax-News.com, Moscow

10 December 2008

Vladimir Putin has recently announced that he will postpone the next step in his reform of the lumber tax regime designed to encourage domestic processing of timber. The proposed 80% export tax on wood will now be put off until the Autumn of 2009.

Putin said that his motivation behind postponing the tax measure came after Scandinavian lumber mills and manufacturers pleaded with the Russian leader to put off the prohibitive tax measures until they could make alternative arrangements. The export tax hike would have meant the collapse of many Finnish wood-processing businesses leading to as many as 16,000 redundancies and exacerbating the effects of the downturn in Finland. However it's more likely that Russia's plan to build the 1,200km long ‘Nord Stream’ natural gas pipeline connecting Russia directly with Germany may be closer to his actual motivation. Russia must gain permits from Finland, Sweden, Denmark and Germany to move ahead with plans. Russian workers will begin building the pipeline in 2010, with the aim of finishing the build by the end of 2011.

Finland has subsequently taken steps to decrease its dependence on Russian wood since the initial rise in export tax back in mid-2007 from 6.5% to 20% – the Finnish Forest Industry Federation has reported more than 1,000 redundancies at two of the largest papermakers in Europe as a result.

Anne Brunila, who heads the Finnish Forest Industry Federation, said “[Putin’s announcement] doesn't solve the problem, it only delays it, and gives more time for adjustments.”

The next move by Putin was as part of a three-year plan to transform the industry from one based on exports to one based on both harvesting and processing timber domestically. Putin has pushed for the wood to be processed locally thus taking full advantage of Russia’s expansive natural resources and maximising potential GDP.

The extra revenue generated by the 2007 tax hike was channelled into developing facilities within Russia with the aim of processing all of Russia’s lumber locally. The next rise on April 1 2008 saw duties increase by a further 5% to 25%. The increase in taxation was expected to bring increased foreign investment from foreign lumber mills to Russia with companies setting up shop in Russia and selling their processed wood locally in an effort to avoid the export tax. This would also increase Russia’s tax-take from companies who would be paying local income taxes. The Russian leader has also offered Scandinavian companies tax breaks to encourage them to relocate their operations within Russia.

Before the first increase in the export duty, when taxation was levied at 6.5%, Finland accounted for 16-18% of Russian timber exports with China buying between 53-60% annually. The increased levy has had a significant effect on trade between the three countries – Finnish imports between January and August of this year, when compared with last year, have decreased almost two-fold from 18.2 million cubic meters of lumber to just 9.8 million.

However the decrease in exports was not capitalised upon by Russian companies – holdbacks in the development of Russian processing factories, according to Russian experts, meant that the lumber, which would have previously been exported, lay rotting in Russia. Despite this, Putin refused to revoke the tax.

Although Putin’s tax regime is set to heavily damage the Finnish timber processing industry, Canadian loggers were delighted with the proposal as it would have led to a massive increase in demand for Canada’s growing lumber stockpiles. China, which is heavily dependent on Russian wood, is currently negotiating deals with Canadian loggers although the loggers will now have to wait until next autumn to reap the rewards.

Pat Bell, British Columbia’s (BC) Forest Minister, said that once the proposal is in place no Russian wood will enter China unless it is illegally harvested timber therefore leaving a gaping hole in supply. He said the Russian President's decision to postpone was ‘disappointing’ but by no stretch of the imagination the end of the world, adding that talks between BC and China had continued despite the Russian leader’s decision. He concluded that he expected trade between China and BC would increase from 2.3% of their total imports last year to at least double that figure this year. That figure is expected to rise rapidly after the 80% tax is enforced as law. He described the Russian decision to enforce a prohibitive export tax measure on wood as a welcome development that would increase investment and jobs in BC, and help Canada as a whole to offset the effects of the global economic crisis.

Finland has subsequently responded to the proposed punitive export tax regime by preparing countermeasures that will enforce taxes on Russian imports travelling through Finland. According to the Finnish Customs website one third of all Russian imports by value passed through Finland last year – equal to seven in every ten trucks travelling on Finnish motorways – a figure which grew by 25% year-on-year. The Finnish government plans to table a proposal early in 2009 which will charge vehicles a fee for bringing imports into Russia through Finland. It is hoped that this will offset the effects of the 80% tax on the Finnish economy.

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