Cablegate: Ukraine: Cba Special Representative Mermoud Meetings On

DE RUEHKV #1335/01 1520733
P 010733Z JUN 07





E.O. 12958: N/A
SUBJECT: UKRAINE: CBA Special Representative Mermoud Meetings on
Business and Investment Climate

1. (SBU) Summary: Special Representative for Commercial and Business
Affairs Frank Mermoud met on May 17-18 with government officials and
U.S. business in Kyiv to discuss business climate and economic
policy issues. The tone of the meetings with the State Customs
Service, and the Ministers of Fuel and Energy, and Transportation
and Communications was generally very positive, with the Ukrainian
officials offering assistance and support on most of the issues
Mermoud raised. State Tax Administration chief Andriy Brezvin,
however, seemed more focused on fighting tax fraud than in helping
improve conditions for businesses. End Summary.

Business Breakfast: Same Old Problems

2. (SBU) Special Representative Mermoud met with executives of U.S.
businesses before embarking on his official meetings. Attendees
agreed they were interested in, but not vitally concerned by,
Ukraine's current political instability. Instead they were focused
on specific problems their companies faced -- most of which predated
the present crisis, and some even the present government. The
discussion touched on a range of topics:

-- Vanco sought a clear statement of support from Fuel and Energy
Minister Boyko for its production sharing agreement on exploration
and development in the Black Sea.

-- Marathon Oil wanted Boyko to approve its proposed joint study
agreement with Ukrainian state natural gas company Naftohaz.

-- Cargill and Bunge noted that the GOU had announced a lifting of
the export ban on wheat, but neither had yet learned details. The
GOU owed both unprecedentedly high levels of VAT refunds. They saw
the cause of their problem as their refusal to pay fees to "brokers"
to secure refunds.

-- Pratt and Whitney said its business of coating aircraft engine
parts for international customers was severely hampered by the
onerous customs procedures necessary to get the parts in and out of
the country.

Tax Administration: Same Old Answers

3. (U) Head of the State Tax Administration, Andriy Brezvin, made
clear to Special Representative Mermoud that his top priority was
combating tax fraud. The STA had refused payment of $40 million of
fraudulent VAT refund claims in 2006, and had already refused the
same amount in the first four months of 2007. He said that in the
future, companies which had used sham intermediaries to process
payments would be excluded from the refund system. Through a minor
change to the tax code, the STA would be able to eliminate VAT
refunds to companies found non-compliant. Compliant companies would
have no problems with refunds, he said. The STA would refund to
exporters all VAT that had been paid to the budget by a taxpayer.
Mermoud suggested that while it was appropriate for the Tax
Administration to be concerned with fraud, it was also important to
focus on customer service. Mermoud suggested the creation of a
working group involving businesses to explore ways of improving tax

4. (SBU) Mermoud raised the GOU's large and growing arrears in the
payment of VAT refunds to U.S. agricultural firms Cargill and Bunge.
According to the companies, Mermoud explained, the STA was overdue
on $64.5 million owed to Cargill and $34.4 million owed Bunge.
Brezvin responded that the STA had on 1 May approved refunds of 34
million UAH ($6.8) to Cargill. This would clear all arrears to
Cargill UA itself, but not the more substantial claims of Cargill's
subsidiary, Barge. He would issue an instruction to accelerate the
examination of Barge's accounts. As for Bunge, Brezvin noted that
it conducted transactions involving so many third parties that it
was difficult to verify them all. He said he had issued
instructions for all audits of grain traders to be completed by July
1. After that date, the STA would switch over to an "automatic"
electronic system of VAT refunds.

5. (SBU) Mermoud asked about a criminal investigation of Cargill by
the tax police now underway in Donetsk. Brezvin said that Cargill
had done business in 2004 with a sham middleman company that was
apparently engaged in tax fraud, and the tax police were
investigating. Brezvin assured Mermoud that the investigation would
be fair, and promised that the tax police would meet with Cargill
the following week to share information on the investigation.
(Note: That meeting took place on May 24, and is reported septel.
End Note.)

KYIV 00001335 002 OF 003

Boyko Sounds Cooperative Note

6. (SBU) Minister of Fuels and Energy Yuriy Boyko emphasized his
interest in cooperating with U.S. firms. He noted the Holtec
project was now underway. Special Representative Mermoud informed
him that Vanco would submit a counterproposal on the PSA to the GOU
soon, Boyko acknowledged he expected Vanco to suggest some changes
to the PSA, and pledged to pursue talks with them. He hoped Vanco
would find "another Shah Deniz" in the Black Sea. Boyko also said
NaftoHaz would sign a joint study agreement with Marathon after June
4, noting the agreement was similar to the one with Shell but more
far-ranging. Boyko also noted his ministry was working with
Cardinal to resolve their issue of required sales of gas at domestic
prices. He committed to work with Westinghouse on projects to
provide alternative fuel supplies but pointed to problems
Westinghouse had with the Temelin reactor in the Czech Republic,
noting these had to be resolved.

7. (SBU) Boyko expressed support for efforts to increase energy
efficiency and for holding a U.S.-Ukraine energy dialogue in the
fall. In response to Mermoud's question about the recent
Russia-Kazakhstan agreement on pipelines, Boyko claimed the pact
worked to Ukraine's advantage, as Ukraine would gain more transit
fees for gas shipped to Europe. Mermoud raised our concerns about
RosUkrEnergo and a lack of transparency. Boyko shrugged and noted
Ukraine needed to keep gas prices low for at least three years, and
to achieve that that meant not dealing directly with Gazprom. He
said he was optimistic that Ukraine would face only a 7-8% increase
in gas prices for 2008.

Customs Wants to Help

8. (U) Ruslan Cherkassiy, First Deputy Chairman of the State Customs
Committee, appeared eager to be helpful on Pratt and Whitney. He
understood the potential that current procedures--requiring the
company to file promissory notes in order to bring in parts
temporarily--could be time consuming. He speculated that the basis
for P&W's activities could be changed from the "tolling" scheme
requiring promissory notes, to a more simple regime of temporary
import. He offered a meeting between P&W and relevant customs
officials to discuss the options.

9. (U) Mermoud told Cherkassiy that the U.S. had proposed to several
GOU officials, including First Deputy Prime Minister Azarov, to
create a business/government working group on Customs reform. The
purpose would be to explore ways of simplifying procedures in order
to encourage high-tech investment. Cherkassiy was receptive, but
asked that the U.S. side submit more details on the proposal in a
letter to him.

10. (U) Mermoud asked about Ukraine's plans to reinstitute SEZs.
Cherkassiy said that the SEZ regime in place before the GOU
cancelled it in March, 2005, had not been effective in encouraging
new exports, innovation, or jobs. The current draft law fixed the
shortcomings of the old system, he maintained. The new law would
not permit customs privileges for goods produced in the zones but
sold on the customs territory of Ukraine instead of being exported.
In response to a question by Mermoud, Cherkassiy confirmed that
five firms that had operated in the SEZs before April, 2005, had won
court cases to have their privileges restored. He pointed out,
however, that the privileges for all but one of these companies were
due to expire in 2007 or 2008. The one exception was a meat
processing operation in the Donetsk region, whose privileges were to
last for 60 years. Cherkassiy noted that most of the imported
inputs for this company's products came from the U.S.

11. (SBU) On IPR protection, Cherkassiy confirmed that customs now
had ex officio authority to seize contraband, but that Customs
lacked detection equipment to enforce the law properly. The service
had, for example, only one portable x-ray machine. Ukraine had a
very good registry of protected goods, but he stressed that the
cooperation of the rights holders was the key to effective

Business Prospects in Transportation and Communications
--------------------------------------------- ----------

12. (SBU) Minister of Transportation and Communications Mykola
Rudkovskiy gave Special Representative Mermoud an overview of his
agency's chief priorities, and said he would like to travel to the
U.S. this summer to meet with businesses. Stressing that the

KYIV 00001335 003 OF 003

participation of U.S. firms would be welcome, Rudkovskiy listed the
Ministry's main priorities as follows:

-- New toll roads and bridges. The traffic that would be generated
when Ukraine co-hosts with Poland the 2012 European soccer
championship made such infrastructure improvement urgently
necessary. Ukraine would open eight new border crossings.

-- Modernizing airport runways and terminals. The Ministry would
oversee renovation of passenger terminals and runways at seven
airports. The state would guarantee loans for the regional
airports, but Kyiv's Boryspil would be able to find financing on its
own, he said. He estimated the total cost of the program at $800

-- Upgrading the railway system. Working with Citibank, the state
railways would seek $2 billion in loans to improve the railways and
rolling stock. He said he thought Caterpillar could cooperate in
supplying locomotive engines. Mermoud noted that U.S. firm Rail
Runner was very interested in helping Ukraine railways upgrade.

-- Port Infrastructure. Rudkovskiy expected a new law on the ports
to pass very soon, whereupon private infrastructure investment,
including from the U.S. would be permitted.

-- Aviation: Mermoud and the Minister both welcomed Aerosvit's
choice of Boeing aircraft to replenish its fleet. Rudkovskiy said
the GOU was now looking to purchase personal jets for both the
President and Prime Minister. Mermoud suggested the Boeing Business
Jet and said he anticipated close cooperation between Boeing and the
Ukrainian aviation sector, especially Antonov. The Minister noted
that Antonov was interested in Pratt and Whitney engines for its

13. (SBU) Special Representative Mermoud raised two additional
issues of interest to the U.S. First, he pointed out that Ukraine's
reluctance to participate in the International Air Transport
Association's Billing and Settlements Plan (BSP) could create
problems for airlines operating in Ukraine. Second, he noted that
the U.S. was waiting for Ukraine's action in informing Eurocontrol
to exempt the U.S. from fees for overflights by USG state aircraft.
Rudkovskiy said he would look into both issues.

Kyiv's "Science Park": State-led High-tech Initiative
--------------------------------------------- --------

14. (U) On May 17 Special Representative Mermoud attended a
presentation of the Science Park at Kyiv Polytechnical Institute
(KPI) at the National Technical University of Ukraine. The rector
of KPI, Mykhailo Zgurovskiy, explained that the GOU had created the
Science Park to serve as a link between the University's research
institutes, foreign high-tech companies, and investors. The Park
was focusing on information technology, energy efficiency, new
materials, and urban planning while preserving KPI's traditional
role of working with Ukraine's military-industrial complex. The
presentation was well-attended by members of government and local
and American business, including Presidential advisor Oleksandr
Zinchenko, Head of State Agency for Innovation and Investment
Ivchenko, Regions MP and titanium magnate Hrihoriy Smityukh, Head of
the MFA's Economic Cooperation Department Serhiy Korsunskiy, and
representatives of Cisco Systems, Microsoft, and APC.

15. (U) Following the presentation of Science Park projects, Special
Representative Mermoud expressed his optimism for the future of the
Ukrainian high-tech sector. Ukraine, Mermoud believed, would be
well served to study the experience of NASA-led research and
development as an example of a public-private sector partnership
that gave a boost to American high-tech industry. Mermoud also
stressed the importance of commercializing research as a next step
of economic development. Through the lens of transformational
diplomacy, Mermoud noted that Ukraine has successfully moved to
democracy, now it must focus on commercial and economic
transformation. Mermoud concluded by touting the International
Fulbright Science & Technology Award as a way to advance
U.S.-Ukrainian scientific ties and encouraged university officials
to have their brightest students apply before the June 1st

16. Special Representative Mermoud has cleared this message.


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