Graham Stack in Kyiv -

Ukraine and agriculture should be a no-brainer, given the country's large swathes of famously fertile soil and its close proximity to Europe. The problem is the institutions. The financial results published March 1 from London-listed Landkom reveal just how hostile an environment Ukraine can be for the unwary.

Landkom's pre-tax loss of $27.2m for the first 10 months of 2009 - the financial reporting date was brought forward to October 31 from December 31 in order to better match the cropping cycle with the financial reporting cycle - was further exacerbated by two disasters that have cost the company millions and illustrate the difficulties of operating in Ukraine.

The first major blow was the failure to secure a $10m VAT reimbursement on imported goods from the Ukrainian government. Landkom is only one of many companies to have suffered from the reluctance of Ukraine's cash-strapped government to reimburse VAT. The state currently owes an estimated $3bn in VAT refunds to companies, especially exporters, which it is more or less openly refusing to pay. One of the country's largest metal companies, MMK Ilyich, has even threatened to send its 27,000 workforce home unpaid if the government doesn't return $12m in VAT refunds it owes the company.

The issue raises questions about Ukraine's investment climate. When the news first broke of Landkom's difficulties with VAT reimbursement last year, a company press release added that "Landkom is alarmed at the permanent interest of the police, [Security Service of Ukraine], Prosecutor General's Office, frequent checks and demands to show private, financial, economic and labour documents." Charismatic founder and former CEO, Richard Spinks, was quoted as saying that tax inspectors simply laughed at his refund request, saying the government had no money. Now the company has written off the sum in its 2009 accounts. According to a company statement, "although the Group intends to continue to seek reimbursement of the VAT, given the financial and political situation in the country, prudence dictates that there is a write-down of this receivable."

The new management under Vitaly Skotsyk is reluctant to take up swords with the government over the issue, preferring to put the blame on the previous management team. Its track record indeed left a lot to be desired, recording pre-tax losses of $53.3m in 2008 before being replaced in 2009.

The situation with Landkom, however, is worse than the government's general refusal to refund VAT, because in Landkom's case, the government doesn't even acknowledge most of the debt. According to Skotsyk, the former management was caught out by a change in the VAT rules, rather than singled out for rough treatment. "The company at that time was not even registered in the state's VAT system," Skotsyk tells bne.

Up to four years ago, imported agricultural machinery booked as capital assets was not liable for VAT, and management should have seen that this exemption was abolished, just as the company was importing masses of modern Western equipment in its investment phase following the 2007 IPO on London's Alternative Investment Market. "Our aim is now to return Landkom to the VAT system and then return the debt to Landkom. It is highly unlikely to be paid in cash, but could be offset against other taxes," hopes Skotsyk.

The general conclusion, Skotsyk says, is "that you need local knowledge to operate in Ukraine. Most problems faced by Landkom have been caused by the fact that it is the only 100% foreign-owned company in Ukrainian agriculture and also had 100% foreign management." The main problem has thus been "misunderstanding" the situation. "I have never had problems with VAT," says Skotsyk, who previously headed Amaco, one of the largest suppliers of agricultural machinery and inputs in the CIS. "It's just a case of knowing the right people and what to do."

According to CFO Stephen Pickup, there was a conscious decision on the part of board to choose a Ukrainian CEO this time round to replace former RAF pilot Spinks. Skotsyk's background in Ukrainian agriculture means he is well connected in the corridors of power. However, he himself admits that the current political mess means even good connections do not always help. Landkom as a London-listed company is additionally disadvantaged by its refusal to pay bribes to have VAT reimbursed, although "this might speed up the process," says Pickup. "We are not at the top of the queue."

Lost land

The VAT debacle wasn't the only disaster. The company's accounts published March 1 also exclude from its landbank 5,000 hectares (ha) of fields previously claimed by Landkom, because the company has lost control of them. This includes 3,000 ha of fields planted with winter crops in 2009, about one-eighth of the total area sown.

The issue touches on another institutional shortcoming: Ukraine has declared a moratorium on the sale of agricultural land initially privatized to villagers in the 1990s. This means agricultural companies have to lease land from individual small freeholders, with leases seldom running for more than 15 years, which is a huge handicap when it comes to raising capital and making investments. Apparently, the former Landkom management was conned by an individual who had accumulated a large number of leases and agreed to hand them to Landkom. A combination of leaky paperwork and bad faith mean that the individual is now demanding extra payment to continue the arrangement after Landkom has already planted the fields.

Skotskyk again blames former management. "I cannot understand how the company planted this land two years in succession while legally not having anything to do with the land. This was just gambling." At the same time, he says that Landkom is "using all tools" to show the individual in question that the company is serious about having the land returned to them, and puts the chances of returning the land at 80%.

Regarding the land sale moratorium, Skotsyk is pessimistic about the prospects of it being lifted any time soon. Newly-elected President Viktor Yanukovych and Prime Minister Yulia Tymoshenko both spoke out against its removal during their recent bitterly contested presidential race, and there is a majority against its removal in parliament. But for Landkom this may even be a blessing in disguise. "We don't currently have the money to buy out our land," says Skotsyk, "but there are other people who do."

Landkom produces chiefly rapeseed oil for export to Europe where it is processed into biofuel. A bright spark on the horizon for Landkom is new Ukrainian legislation stimulating domestic biofuel production, of which Skotsyk was one of the initiators. Ukraine imports most of its fuel needs, and the government is looking for ways of changing this for the sake of energy security. "This is a huge difference in strategy," he argues.

Alongside a number of tax preferences, the new legislation effective as of January 1, 2010, sees Ukraine's petrol producers obliged to mix 1% of bio-ethanol in their product, with the proportion set to increase by 1.5% each successive year. "This is the crucial thing," says Skotsyk. "You can imagine what this means in terms of volume."

Landkom is not intending to set up its own bioethanol production facilities yet, although Skotsyk has business partners with experience of such. "First of all we need to establish normal operations at Landkom, and then this will be the following step," he says.