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Russia's Largest Foreign Hedge Fund Accused Of Tax Dodge

by Tatiana Smolenskaya, Tax-News.com, Moscow

18 June 2007


The launch of legal proceedings by the Russian authorities against a company linked to a prominent foreign fund manager is focussing on the double taxation avoidance agreement between Russia and Cyprus. The case has also raised fresh concerns over Russia's deteriorating investment climate.

The case centres on a dividend payment to a Cypriot-registered firm by Kameya, a Russian company advised by Hermitage Capital, the largest foreign hedge fund in Russia which is owned by William Browder, a British citizen who rose to prominence through his shrewd investing in Russian energy companies.

According to the Russian Interior Ministry, Kameya failed to pay the correct amount of tax on the dividend, paid to the controlling shareholder of the Cypriot firm in May 2006. Under the Russia/Cyprus tax treaty, companies in Cyprus with investments in Russia that exceed $100,000 can withhold 5% of taxes on dividends, as opposed to the normal 15% for other foreign investors. The company has said that the correct amount of tax was paid on the dividend but the Russian authorities are insisting that Kameya should have withheld 15% rather than 5%, and therefore it owes the government some US$22 million in back taxes.

The Russian authorities are probing the exact nauture of the relationship between Hermitage and Kameya, but Hermitage insists that it is "completely independent" from Kameya and that it has no case to answer. "It's a nonsense case," a Hermitage spokesman was quoted as saying in an online report by Forbes.com.

The company also pointed out that the probe has been launched by the Interior Ministry rather than the tax department, as would be usual in such cases, suggesting that the authorities have hidden, and more likely political, motives for the probe. "The tax authorities, whose job it is to be concerned about this, never had an issue with it," the spokesman added.

The more likely reason for pursuing Hermitage, reports have speculated, is Mr Browder himself, who, like many outspoken business people in Russia, has seemingly fallen foul of the Putin administration's mistrust of investors who may be perceived as challenging its authority. These reports are likely only to reinforce fears that Russia is becoming too risky a place in which to invest.

Perhaps the most visible example of the Kremlin flexing its muscles against the growing power of business was the case of Yukos, which was forced into bankruptcy last year after being forced to pay around US$30 billion in back tax claims. Its former chief executive, Mikhail Khodorkovsky, who was a political oppoent of President Putin, was sentenced to nine years in a Siberian jail in 2005.

"Every single investor in Russia is going to run to their accountants and wonder if they are going to be next," a Hermitage insider told the Financial Times.

Mr Browder was banned from entering Russia in 2005 for unspecified reasons, but his expulsion was probably linked to his enthusiasm for upholding shareholder rights in Russian companies, particularly the formerly state-owned energy companies in which the Kremlin is taking an increasing amount of interest. His meticulous research into the companies in which he was investing also uncovered many instances of corruption and abuse of shareholder rights, it is said.

According to reports, prior to applying for his ban to enter Russia to be lifted in February 2007, Mr Browder was scaling down Hermitage's exposure to Russia, and is focussing on a new fund which is investing in other emerging markets in Latin America, the Middle East and Asia.

Another theory for the charges is that Mr Browder could have been involved in so-called "grey" trading schemes before shares in Gazprom were permitted to be bought by foreign investors. These schemes involved the use of companies set up in Russia by foreign investors to get around the rule that only Russians could buy shares in the firm prior to the liberalisation of the market in 2005. The Interior Ministry has denied this however, saying that the charges related to actions that took place in 2006, after the grey schemes were abolished.

Other reports have claimed that the tax case is being used by the Russian government to justify revisions to the tax treaty with Cyprus, from where a large percentage of foreign investment enters Russia, and force more foreign investors to pay higher taxes on their Russian gains.

"The dual tax treaty is a cornerstone of tax planning in Russia," the Moscow Times quoted Roland Nash, head of research at Renaissance Capital, as observing. "[The investigation] could set a precedent that calls the treaty into question," he warned.


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