The government of the Azerbaijani Republic was not happy with the level of participation of Azerbaijani organizations in the AIOC contracts for 1995-1997. According to the Azerbaijani side, the AIOC had to adopt the international practice of giving preferences to the services of local contractors and locally-produced goods, and provide the implementation of competitive conditions for international tenders in terms of quality, cost and execution of work.
There are a great many examples of laws about preferences of local companies. Under these laws, preference is given to local products and services, provided that they are not more expensive than a fixed amount in percentage compared with competing foreign products of the same quality and execution of work. Products are considered local if they are produced locally by a company at least by 51% owned by local owners, and if their added value in the same country is no less than 40%. In the UAE, Saudi Arabia and Malaysia this system effectively facilitated the development of their national oil industries.
The management of the AIOC explained the inequality between local and foreign contractors by contradictions in a number of legal acts. They put local companies and joint ventures at a disadvantage compared with foreign subcontractors who performed work for the AIOC. There were significant discrepancies in terms of taxation (income tax, value added tax, withholding tax rate on tax and tax returns).
Foreign currency transactions had certain limitations; there were rules that restricted the export of capital abroad. Accounting which became mandatory for Azerbaijani companies and joint ventures did not meet international standards. All these differences put local companies and joint ventures at a disadvantage compared with foreign subcontractors who conducted work for the AIOC. To demonstrate the unequal position between local and foreign companies, let us look at some taxation rules of the Azerbaijani Republic.
Below are the main differences between the taxation of foreign joint ventures (FJV) and subcontractors, Azerbaijani legal entities (ALE) according to an audit company «Price Waterhouse»:
1. In accordance with the protocol of taxation of the FJV, 5 % tax is levied from their payments at the place of the source of income. Retention of 5% corresponds to the compulsory taxation of the FJV. Starting from January 1, 1997, a 32 % tax on profits was established for the ALE. According to foreign experts, it was an obstacle to the success of companies. Tax experts explained it in the following way: the calculation of taxable profits was based on accountancy common in Azerbaijan. According to this, certain costs are not subject to income tax, such as training costs, business trips, insurance, interest payments, etc.
2. The useful life of an asset. This period was extremely long and because of that, the depreciation rates were very low. Income tax for Azerbaijani legal entities thus increased from non-deductible costs. Accordingly, the income tax paid by the ALE was much higher than it would be in the western taxation system.
3. It is possible for Azerbaijan subcontractors to pay VAT at 20% for purchased goods and services, but without a VAT refund for export and sale of goods to compensate for these expenditures. This is due to the fact that any services provided by the AIOC, both by the FJV and Azerbaijani subcontractors, were subject to VAT at zero rate under the agreements on joint production sharing. This problem, according to Western experts, could be eliminated, since the Azerbaijani subcontractors' contractor would be entitled to compensation of the paid VAT on purchased goods and services, provided that the state is able to recover these amounts from the budget.
4. The exchange rates for foreign companies were more profitable than for local companies. Since the FJV were considered residents, subject to a certain foreign exchange regime, they were allowed to provide services on the territory of the Azerbaijani Republic in foreign currency. Subcontractors ALE could provide services in Azerbaijan only in manats, except in cases when they obtained a license from the National Bank of Azerbaijan to perform work in foreign currency. The ALE had another major constraint. They were allowed to have bank accounts only in the Republic of Azerbaijan, except when they received permission from the National Bank to open bank accounts in other countries.
The AIOC proposed to the government to remove all the restrictions and adopt Western standards of accounting and taxation for the whole financial system in order to provide the FJV and ALE with equal opportunities. The Cabinet, against the suggestion of the AIOC, proposed including the foreign contractors in the national system of taxation, based on the example of the Karabakh field. Under the contract there was a 32% profit, in accordance with the law. But it was impossible to introduce changes ratified in an international agreement ratified by the government, the validity of which prevailed over domestic law.
Thus, the solution was delayed, and it was naive to think about a possible increase of the share of local companies in the AIOC project against this background. The operating committees understood this and, in fact, having no interest in increasing the proportional participation of the Azerbaijani legal entities in the contracts, were going to continue to use the imperfect legislation. Nevertheless, it is wrong to talk about the full stagnation of the economy of the country and, in particular, about the absence of positive aspects in the tax system of the Azerbaijani Republic.
