Despite the problems detailed in this report, most U.S. companies in Russia believe that opportunities justify the risks, uncertainties and considerable bureaucratic obstacles. Few established foreign companies are leaving and many continue to demonstrate an interest in Russia's rich geological and human resources, world-class high-technology and vast potential market.
Russia enacted an investment law in 1991 which defines the permissible forms of foreign investments as well as the rights and obligations of the government and investors. Also in force are laws on enterprises, on joint stock companies and on the privatization of national assets, as well as various presidential decrees. In 1994 the government was preparing for review by the legislature draft laws on concessions, free enterprise zones, production sharing (for oil exploitation) and a revision of the 1991 investment code.
The 1991 Investment Code defines foreign investors as foreign legal entities, citizens, states or international bodies. Foreign investments may be made in all kinds of property (including intellectual), or placed in entrepreneurial projects and other activities to derive profit. Investments may be in the form of wholly-owned companies, joint ventures, portfolio investment or in (limited) rights to use land or other natural resources.
Russian foreign investment regulations regarding permissible activities, prior authorization and notification requirements are confusing and contradictory. The Ministry of Finance, local authorities and/or various central government bodies all register foreign investments. Prior approval is required for investment in new enterprises using assets of existing Russian enterprises, foreign investment in defense industries (which may be prohibited in some cases), investment in the exploitation of natural resources, all investments over 50 million rubles, investment ventures in which the foreign share exceeds50 percent, or investment to take over incomplete housing and construction projects. Additional registration requirements exist for investments exceeding 100 million rubles. Projects of foreign enterprises may also be subject to expert examination for ecological considerations or where a large-scale construction or modernization is envisaged.
The 1991 Investment Code guarantees foreign investors rights not less favorable than those of Russian investors.
The Russian post voucher (cash) privatization program adopted by presidential decree in July of 1994 explicitly grants foreign investors the right to participate in auctions and tenders and to purchase shares in privatized firms, although the Ministry of Finance must be informed of such action. Some restrictions do apply. For example, the federal government can limit foreign access to enterprises in strategic sectors such as defense, the energy sector, mining and minerals, transportation and communications. However, the federal government plans to exempt entirely a list of firms engaged in the sale or production of "strategic commodities and products" from further privatization at least for the remainder of 1995. Federal State Property Committee (GKI) Chairman Belyayev has repeatedly stated that foreign investors will play a key role in cash privatization and that they will be given national treatment. Belyayev recently said that foreigners purchased 10 percent of all shares offered during the first (voucher) phase of privatization in Russia and that a higher level of foreign participation is desirable in the cash phase. GKI reports that although Russian law does not yet allow foreigners to own land, foreign investors can take majority ownership in enterprises which own land. The first such example has recently taken place in St. Petersburg. As to municipal and oblast level enterprises, the local state property committees and administrations have substantial autonomy and foreign investors will need to work closely with such authorities.
Traditionally, all research and development in Russia was financed by the government and occurred in government-owned or controlled institutes and organizations. The entire system is now in a state of transition. The government is providing considerably less funding for research that in the past and individual institutions are actively soliciting international participation in research projects (although some of the projects in which American firms have begun active cooperation still receive significant Russian government funding). The legal basis for such cooperation is not yet firmly established, however, and the rights and obligations of all private parties (foreign or Russian) participating in government sponsored or subsidized research and development are spelled out in the specific contract and agreements reached by the parties involved.
Russian law offers few incentives to foreign investors. Those set out in the 1991 investment law, including certain tax benefits, have never been implemented, or have been largely eliminated or superseded by subsequent laws and decrees.
Russia is well along in reforming its foreign trade regime in line with market standards. Very few non-tariff elements remain. The country has applied for accession to the World Trade Organization (WTO), has submitted a memorandum of foreign trade regime, and is preparing for the first meeting of its working group scheduled in 1995.
Russia has raised import tariffs in several stages beginning from zero when the Soviet Union collapsed. In July 1994 import duties were raised across the board, increasing the average weighted tariff to 11 percent from 7-8 percent, with some duties reaching 50 percent. In March 1995, by presidential decree, these rates were revised to raise the floor (except for a reduced list of zero-duty goods) to five percent and lower the ceiling (except for a few luxury goods) to 30 percent; this raised the average weighted tariff further to 15-16 percent. A 1995 presidential decree provided for reducing or waiving import duties for investment projects of USD 100 million or more of which at least USD 10 million is direct foreign investment.
Inherited Soviet-era qualitative restrictions on imports were initially limited to security and health requirements, but Russia's July 1993 customer protection law stipulated official certification (by GOSSTANDART) of imported products for conformity to Russian technical, safety, health and quality standards. Requirements are still evolving, and are based on a combination of international (mostly European Union) and Russian standards. U.S. companies have complained of costly procedures and arbitrary certification requirements. A joint Russian-U.S. communique of December 1993 pledges cooperation on improving and simplifying certification, testing and quality assurance. Russia is establishing reciprocal standardization with the U.S. and with other countries and is reciprocally accepting foreign certification by accredited institutions. Import licenses are required on the normal range of dangerous and harmful materials and goods.
The U.S. Government has imposed antidumping duties on Russian ferrosilicon (June 1993), titanium sponge (August 1992), and urea (June 1992). Investigations are underway concerning alleged dumping of Russian pure magnesium, ferrovanadium and nitrided vanadium. Antidumping duties imposed on Russian uranium in 1992 were suspended in 1993 in exchange for a matched sales agreement.
Banking operations in Russia by foreigners, though improved, remain problematic. A November 1993 presidential decree imposed a two-year moratorium on foreign bank operations with Russian residents. This decree conflicted with a September 1993 decree sheltering foreign investors from adverse legal changes for three years and violated the principle of nonretroactivity of law since it applied to foreign banks licensed in october 1993. A June 1994 decree eased the November 1993 restrictions for existing European banks and an April 1995 decree lifted the restrictions on the two existing American banks. A pending Duma bill "On Banks and Banking Activity" contains a statute that extends until January 1, 1996, a moratorium on foreign banks' dealing with Russian residents, and introduces the policy of reciprocity for any foreign bank seeking to obtain an operating license.
The banking bill also allows Russian authorities to set limits on the total amount of foreign banking capital as a percentage of overall banking capital. Currently, that limit stands at 12 percent, and the capital of all operating foreign banks is considerably below this figure. The Russian insurance industry is also lobbying for protection. Increasingly, foreign insurance companies may follow the example of a major American insurance firm, which entered the market via a 50/50 joint venture with a large Russian bank. Measures to limit foreign attorneys not licensed in Russia from providing legal counsel on Russian laws have had little effect on the foreign law firms, which continue to rely largely on foreign lawyers.
Major changes have occurred in the oil and gas sector during the past 12 months. In October 1994, seven foreign joint ventures obtained oil export tax exemptions for three years for the purpose of capital recoupment. An additional seven joint ventures received exemptions in February 1995 on similar terms, while another group of companies hopes to have its request approved by the end of June 1995. The benefit to the companies, however, may prove ephemeral, as the government has announced that it will eliminate the export tax altogether by the end of 1995, replacing it with an excise tax on production to which exemptions may not apply. In the meantime, the export tax has been reduced from 30 to 23 ecus, with another decrease to 20 ecus expected in June 1995.
In February 1995 President Yeltsin signed into law a bill amending the 1992 sub-surface resources law. The amendments make it easier to obtain and transfer oil and gas production and exploration licenses, and substitute more modest royalties for the 10 percent mineral replacement tax. In June 1995, the Duma passed legislation which would allow foreign oil companies to enter into production sharing contracts rather than rely exclusively on existing joint venture provisions in the foreign investment law; this legislation awaited the approval of the Federation Council and the President at the time this report was written.
Another important development was the elimination of oil export quotas in January 1995. Producers are now allowed to export their oil without prior approval from the Ministry of Foreign Relations. Nevertheless, their ability to do so remains subject to their allocation of access rights to the oil pipeline system by the Ministry of Fuel and Energy and the state-owned pipeline company Transneft. Under current rules, this means that roughly one-third of a company's production is given access to pipelines serving hard currency export markets. Those established joint ventures which qualified for oil export tax exemptions have been given priority access to the pipeline system for the entirety of their production.
The ruble is fully convertible within Russia and CIS countries which remain in the ruble zone. There are currently no restrictions on profit repatriation. In January 1994 commercial banks became responsible for monitoring the repatriation of export earnings.
Foreign and domestic companies may acquire, hold and sell foreign exchange freely, though hard currency cash transactions for goods and services within Russia are prohibited. Russian enterprises are required to convert 50 percent of foreign currency earnings into rubles by selling such currency on either the currency market or to the Central Bank of Russia.
Without special permission it is illegal for Russian companies or citizens to maintain a bank account outside of Russia for purposes other than operating expenses. Licenses are required for offshore accounts and can be difficult to obtain. Non-residents can open individual and commercial ruble accounts for servicing import/export operations (referred to as "T-accounts") and for investment (referred to as "I-accounts"). However, ruble balances in T-accounts many not be converted back to U.S. dollars.
While the domestic political situation remains ambiguous, the current central leadership is unlikely to nationalize foreign investment or engage in expropriation. However, local government interference in several cases appears tantamount to expropriation; arbitration or legal proceedings are pending in some of these cases.
Most western attorneys still refer their western clients who have investment or trade disputes in Russia to international arbitration in Stockholm or to courts abroad. However, a foreign arbitration award can only be enforced in Russia if there is a reciprocal treaty between Russia and the country where the order was made, or, if no such treaty exists, if a Russian court reviews the procedures which led to the granting of the award and agrees that it was properly made and can be enforced.
It is therefore worth considering the alternatives available in Russia. One choice is the Arbitration Court of the Russian Federation, which is part of the court system. It has special procedures for seizure of property before trial, so property cannot be disposed of before the court has heard the claim, as well as for the enforcement of financial awards through the banks. Additionally, the International Commercial Arbitration Court at the Russian Chamber of Commerce and Industry will hear claims if both parties agree to refer disputes there. Applications can be made by parties to foreign trade agreements and by companies with foreign investments.
The weakness in the system is the lack of differentiation in outcomes. All awards and orders are enforced by the officials of the district court whose procedures have not been modernized to take account of changes in business. There is hope that a draft law on enforcement will result in more effective litigation.
Russia is a member of the International Center for the Settlement of Investment Disputes and accepts binding international arbitration.
Investors are not required to disclose proprietary information to the Russian government as part of the regulatory process.
In 1992-93 Russia enacted laws strengthening the protection of patents, trademarks and appellations of origins, and copyright of semiconductors, computer programs, literary, artistic and scientific works, and audio/visual recordings.
The Patent Law, which accords with the norms of the World Intellectual Property Organization, includes a grace period, procedures for deferred examination, protection for chemical and pharmaceutical products, and national treatment for foreign patent holders. Inventions are protected for 20 years, industrial designs for 10 years, and utility models for five years. One must wait four years before applying for a compulsory license. The Law on Trademarks and Appellation of Origins introduces for the first time in Russia protection of appellation of origins and provides for automatic recognition of Soviet trademarks upon presentation of the Soviet certificate of registration.
The Law on Copyright and Neighboring Rights, enacted in August 1993, protects all forms of artistic creation, including audio/visual recordings and computer programs as literary works for the lifetime of the author plus 50 years and is compatible with the Bern Convention. The September 1992 Law on Topography of Integrated Microcircuits, which also protects computer programs, protects semiconductor topographies for 10 years from the date of registration.
Russia has acceded to the Universal Copyright Convention, the Paris Convention, the Bern Convention, the Patent Cooperation Treaty, the Geneva Phonogram Convention, and the Madrid Agreement. Under the U.S.-Russian Bilateral Investment Treaty (not yet ratified by the Russian side) Russia has undertaken to protect investors' intellectual property rights. The U.S.-Russia Bilateral Trade Agreement mandates protection of the normal range of literary, scientific and artistic works through legislation and enforcement.
While the Russian government has successfully passed good laws on protection of intellectual property, enforcement of those laws has been a low priority. Russian authorities are engaged in a comprehensive revision of the Russian criminal and civil codes, including sections pertaining to intellectual property rights which would provide strengthened penalties, the establishment of specialized courts, particularly a patent court, with trained and experienced judges and attorneys, and trained police and customs officers. Until these measures become reality, however, there is widespread marketing of pirated U.S. (and other) video-cassettes, recordings, books, computer software, clothes and toys. Losses to manufacturers, authors and others are estimated to be in the hundreds of millions of dollars.
The Russian Intellectual Property Agency, established in 1992 with direct accountability to the Russian president, was given responsibility to develop and coordinate state intellectual property policy, promote copyright protection, and collect and distribute royalties. It was replaced in October 1993 by the revived Russian Authors Organization (RAO), asemi-of ficial agency combining supervisory functions with advocacy of authors' commercial interests. Rospatent is the official body responsible for registration and protection of patents and trademarks.
Legal requirements may be less burdensome than reaching final agreement with local political and economic authorities; registration can be a lengthy, bureaucratic process, particularly where natural resources or defense production are involved. Corruption is widespread and the fears of some Russian officials that foreigners will purchase Russian assets at below-market rates can impede bureaucratic approval.
The Russian government is in the process of establishing a procurement regime. So far that regime consists of a single law passed in December 1994 and several implementing regulations currently in preparation. Russian officials have sought to make the law compatible with WTO standards and note that it does not prevent market access by foreign enterprises. However, it also gives preference to domestic suppliers and allows the federal government to dictate supply in certain cases. Officials also say that Russia is considering signing the WTO procurement code as part of WTO accession.
A major complaint of foreign business is the tax system, in particular the number of taxes, the stability of the system, transparency and due process. Russia imposes numerous taxes including profits, excess wage, dividend,withholding, payroll, road use, property, VAT, import and export tariffs, excise and local taxes. These taxes may total more than a company's profit - proving a very real disincentive to both Russian and foreign businesses. In addition to high rates, taxes have been changed frequently and radically, often with no warning and sometimes with retroactive effect. Businesses are unable to rely on a particular tax regime and may suddenly find themselves unable to make a profit. Finally, businesses complain about the lack of due process -tax penalties are high and do not distinguish between inadvertent and criminal errors and the appeals process is cumbersome. The Duma is beginning to address these problems. It passed a new profits bill, signed into law, which repeals the excess wage tax beginning January 1, 1996. In mid-1995 the Duma was deliberating changes to the basic tax law to address the due process, stability and transparency problems. Finally, the Finance Ministry in 1995 was drafting a basic tax code which should be introduced into the Duma in the fall of 1995 and take effect in 1997.
Nevertheless, major portfolio investors are eyeing the Russian market with anticipation. A Federal Commission on Securities and Capital Markets was created in November 1994 to oversee market regulation. In May 1995, the Duma passed a long-awaited bill on the securities market; the bill may be signed into law by President Yeltsin by mid-summer 1995. Investors are also encouraged by the recent establishment of western-style registrars and custody services, and the entry into the Russian market of major western market players.
Crime has become one of the most frequently cited concerns of foreign (and Russian) business, particularly those involved with large amounts of cash and goods. While organized crime is not new to Russia, recent years have seen an increase in the range and frequency of criminal activity. Unfortunately, legal and judicial reforms have not kept pace with criminal advances. Much crime is tied to commercial activity, with one half of all entrepreneurs in a recent survey reporting that they must pay kickbacks and protection to stay in business. Failure to make these payments can be fatal and may generally prove a disincentive to the creation of new businesses. President Yeltsin and his government acknowledge that crime and corruption are major problems and have asked the Duma to speed adoption of needed legislation. Meanwhile, Prime Minister Chernomyrdin announced that the government will spend two trillion rubles to fight crime in 1994-95, and adopt tougher measures against official corruption.
Russia is a member of the Multilateral Investment Guarantee Agency (MIGA).
Labor-management relations in Russia are strained. Economic restructuring has caused rising anxiety and unrest among Russian workers, and trade unions are generally weak and ineffective. Most of the "official" labor unions, formerly the Communist trade unions, operate in a subservient role to enterprise management, in much the same way they did in Soviet times. Workers have little confidence in trade unions and most feel powerless to challenge management. The independent unions are much more effective at the enterprise level, but because they represent a small percentage of total workers their national clout is very small.
The Russian government generally adheres to ILO conventions protecting worker rights, but enforcement is inadequate. Perhaps the most troubling worker issue in present day Russia is the abysmal state of worker safety. Employers have generally reduced spending on safety equipment and government enforcement of safety regulations is very poor.
Capital flight is a significant problem, with an estimated USD 40-50 billion having left the country in recent years; including some USD 17 billion in 1994. The only true method to curb capital flight will be to stabilize the Russian economy, reduce inflation and make it a more attractive environment in which to invest.