Ben Aris in Berlin -

Hermitage Capital told bne that claims by the Russian tax police it has evaded taxes were groundless and stressed the tax authorities, rather than the tax police, have no problems with the fund's tax payments.

The business daily Kommersant reported Thursday that officials from the tax police had launched a probe into a number of Cyprus-registered investment companies linked to the fund on suspicion of paying too little tax. The investment companies were vehicles created to hold foreign investment into shares in major Russian companies, with the state-owned gas monopolist Gazprom being one of those named.

More worryingly, an unnamed official from the tax police told Kommersant that, "this is just the beginning of dealing with illegal schemes for Gazprom stock acquisition."

This latest probe into the firms linked to Hermitage reportedly began half a year ago and is being regarded by insiders as further "harassment" of the investment fund by the authorities. Hermitage was the biggest fund invested into Russia, until hundreds of millions of dollars were withdrawn after the fund's founder, Bill Browder, was refused a visa in November 2005. It is widely acknowledged that Browder's visa was pulled as a result of Hermitage's outspoken campaigning for better corporate governance in the companies in the fund's portfolio - pretty much all the blue chips in Russia.

The tax police are apparently looking into whether these Hermitage-linked Cyprus-registered companies should have paid a 15% withholding tax on dividends required by Russian law rather than the 5% that was actually paid under the terms of a double taxation treaty signed between Cyprus and Russia.

A spokesperson for Hermitage called the accusations "groundless" and noted that the companies in question do not even belong to Hermitage, but to a third party - an unidentified Western portfolio investor. Hermitage was only acting as an advisor to this investor and so is not directly liable for the tax payments, the spokesperson says.

The spokesperson also stressed that no charges have actually been levelled at Hermitage. Indeed, the tax authorities responsible for supervising tax payments - as opposed to the tax police, who are responsible for enforcing the tax authorities' decisions and requests – have said they have no issues with Hermitage.

"There is a difference between the police and the tax authorities," says the spokesman. "We contacted the tax authorities and they said they have no problems with Kameya's taxes nor do they have any questions about our tax payments."

The tax police are part of the Ministry of Interior (MVD) and usually come in at the end of the process rather than the beginning. They are not part of the tax authorities, which is a separate government organ.

Normally, the form that tax disputes take is that the tax authorities write to a company with questions about a certain tax payment. There will then be an exchange of letters and clarifications. If the problem persists, the tax authorities will call in the company for an audit in camera to see if the differences can be resolved. If that fails too, then a formal full audit is ordered. It is only at this point that the tax police is called in and then only if the company is resisting the implementation of the tax authorities' requests for information during the audit.

"This process usually takes about one and half years. The tax police have leapfrogged the whole process," says the Hermitage spokesperson.

Finally, the spokesperson says the investigation into the amount of withholding tax due seems farcical, as the law is very clear on the amount of tax due. Articles 3.10 and 3.12 of the Russian tax code and the double taxation treaty signed with Cyprus dated, December 15, 1998, state that the withholding tax on dividends paid to a Russian-registered company should be 15%, but those paid to a Cyprus-registered company with more than $100,000 invested in Russia are only 5%.

"In effect you have some low level tax police that are attempting to rewrite a sovereign tax treaty between states and implement the changes retroactively," says the spokesperson for the fund. "Some 21% of all foreign investment into Russia passes through companies registered in Cyprus precisely because of this rule on withholding taxes."

Grey schemes

Analysts argue it's highly unlikely that the terms of the double-taxation treaty will be changed as a result of this investigation and the probe is mere sabre-rattling. Rumour in Moscow has it that Browder has been making progress on getting his visa back and his opponents are looking for an excuse to keep him out.

The most worrying aspect of the story is the tax police comment on the possibility of an investigation into the "illegal schemes for Gazprom stock acquisition."

Until the so-called ring fence around Gazprom's domestically traded shares was removed at the start of last year - special rules that prevented foreign investors from buying these shares - "grey schemes" were widely used to dodge the proscription; while foreigners were not allowed to own the shares directly, there was no restriction on Russian legal entities buying these shares and for the foreigners to be shareholders in these firms. Billions of foreign dollars were invested into Gazprom shares in this way.

While these schemes are, on the face of it, completely legal as there is nothing in Russian law that bans them, they are clearly not in the spirit of the law. Should the Kremlin attempt to crack down on these schemes retroactively, it would further crack Russia's already battered investment climate, precisely at a time when it appears the Kremlin has started doing some damage control.

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