Weighing the Possible Issues Involved in Exporting Chocolate to Russia - Research Paper Example

?To The Board of Directors Ultra-Educators Software Limited From 29 March WEIGHING THE POSSIBLE ISSUES INVOLVED IN EXPORTING CHOCOLATES TO RUSSIA Before the Ultra-Educators Software Limited makes its final decision whether or not to venture into the export of chocolates into the Russia Federation, there are several things to consider first. Engaging in a business in a foreign country is entirely different from conducting a business domestically considering that a foreign country may have laws material to the business that are conflicting to domestic laws. Moreover, there is the issue as to how the business is to be conducted, which comes after a determination of the viability of Russia as market for chocolates, considering the distance between the UK and the Russian Federation. Alongside this matter is the important consideration of the costs entailed in doing business in the Russian Federation. Possible Legal Risks Involved There are several legal issues, some of which take the form of risks, involved when entering a foreign market. Legal issues involved laws that affect the conduct of a particular business in a particular place. Laws that will be involved in conducting a business in Russia will be, necessarily, Russian commercial laws, international trade laws and international sales transactions and regulations. The risk, however, in conducting a business in a foreign state can be categorised into the following: effectiveness of the judiciary; rule of law; risk of contract repudiation; corruption, and; risk of expropriation.1 It is best to conduct business in a country that has a stable political condition and is known as business friendly. Although there is always risk, political risks of countries vary in degrees. Political risk is defined as “risk of loss when investing in a given country caused by changes in a country’s political structure or policies such as tax laws, tariffs, expropriation of assets or restriction in repatriation of assets.”2 Relevant to this discussion is the case of RosInvestCo UK Ltd v Russian Federation3 where a UK company has brought arbitration proceedings against the Russian Federation for invalid expropriation, which is contrary to the UK-Russian BIT. This case is thoroughly discussed on the UK-Russian BIT paragraph. In weighing the political stability of a country, its history might provide a good indicator of such a risk as countries with a history of stability and consistency are more likely to be less risky than those with opposing history.4 Unfortunately, Russia does not have a history of stability and consistency considering the number of political disarray it had in the past. The Best Form of Corporate Entity to Take There are, at least, four ways by which the Ultra-Educators Software Limited may engage in the business of selling chocolates in Russia. One is by selling directly by establishing its own branch or subsidiary; two, through retailers; three, through an intermediary or distributor, and; four, through a representative or agent company.5 Each of these methods has its own advantages and disadvantages. In making decisions about this matter, the following must be considered: the financial strength of Ultra-Educators; its connections; extent of its business commitments, and; the present state of its personnel, equipment, and status.6 If the Company intends to sell directly, it must set up an entity in Russia that will directly take charge of the business of selling the chocolates that the Company will be exporting to that country. It can either set up a branch or a subsidiary. A branch is a part or division of a company whilst a subsidiary is a separate entity independent from the company. Thus, the liability of a branch is that also of the main company, but not that of the subsidiary because it is deemed separate from the company.7 Moreover, if the branch has taxes owing to it by virtue of the business it is conducting in the foreign state, the main company is liable for such taxes. This is not so in the case of the subsidiary.8 However, since a subsidiary is considered a resident in the host state, it will be subject to unlimited taxes unlike the branch, which is subject only to limited taxes. Moreover, a branch is less costly to establish than a subsidiary because the latter will have to conform to all prerequisites procedures as well as everyday management. This is because a subsidiary is itself a corporation, although related to main company.9 A distributor is a merchant who buys merchandise from an exporter and sells them in the local market at higher prices. It does not usually sell the product directly to the marker but to retailers it has contact with. It usually carries other complementary merchandise either from other exporters or from other manufacturers. The distributor provides support and services for the merchandise. The company may engage business with one distributor on a trial basis and the relationship turns out, a longer contract term may be agreed. On the other hand, a retailer is one who sells products directly to consumers.10 The Company may also opt to export its chocolates directly to retailers, but since this will be is the first venture of the Company in Russia, it will be difficult to establish contact with retailers immediately. Finally, an agent is an authorised representative of a company, who does business and makes business decisions on its behalf.11 The Need for a Local Partner The advantage of local partner is that it is more attune to the business conditions of the domestic market considering its proximity to the place. Moreover, a local partner has more access to good local managers and human resources than a foreign entity conducting business locally. This is especially true if the local partner has already gained expertise in the import and export business through the years with other foreign investors. This means that the local partner has more superior knowledge, skills and values with respect to doing business in the domestic market than a foreign entity will ever have. 12 Double Tax Avoidance Agreement between the UK and Russia A double tax avoidance agreement between the UK and Russia was signed by the Parties on 15 February 1994. It became effective as to the UK on 1 April 1998 for corporation tax and on 6 April 1998 for income tax and capital gains tax. On the part of the Russian Federation, the Agreement came into force on 1 January 1998. According to Article 7 of the aforementioned Agreement, the profits of a business enterprise of a Contracting State can only be taxed in that State, except when the business entity is also conducting business in the other Contracting State through a permanent establishment located in the latter. In such a case, the profits obtained while conducting in the other state can also be taxed, but only up to the amount that can be attributed to that permanent establishment. The profits owing to that permanent establishment will be treated as if the latter is a distinct, separate and independent enterprise from the mother enterprise, for purposes of taxation. Deductible expenses are also allowed to that said permanent establishment. In practical application, this means that if Ultra-Educators establishes a permanent branch or subsidiary in Russia for the purpose of selling chocolates, its profits will be taxable in Russia, but only as much as such profit is attributable to that branch or subsidiary. Bilateral Investment Treaties between the UK and Russia A bilateral investment agreement (BIT) between the UK and Russia was signed on 6 April 1989 and came into force on 3 July 1991 (UNCTAD 2010). According to its provision, the BIT is valid is valid only for 15 years, but remains enforceable up to 12 months from the date any of the Contracting Parties has sent a notice of termination to the other. Since no notice of termination has been sent by any of the parties, the BIT is still enforceable today. The BIT contains the usual provisions that can be found on other standard BITs such as the fair and equitable treatment provision, the national treatment and Most Favoured Nation clauses, compensation for losses, currency convertibility and profit repatriation, prohibition against expropriation except in certain cases, subrogation and settlement of disputes. There are provisions, however, that are specific to this particular BIT, such as the agreement on the choice of the arbitration body where a future dispute between the Contracting Parties may arise. The Parties in this case agreed to submit the case, in the event of an international arbitration, to the Institute of Arbitration of the Chamber of Commerce of Stockholm or an international or ad hoc arbitrator to be appointed under the Arbitration Rules of the UN Commission on International Trade Law. A third option is when the Parties agree in writing to modify this particular provision (Art 8, UK-Russia BIT). In addition, the Parties made an exception to the National Treatment and Most Favoured Nation principles and compensation for losses under Articles 3 and 4, respectively. Article 7 provides that the aforementioned provisions have no application to existing or future customs union or any international agreement or domestic legislation relative to taxation. Some of the provisions of the UK-Russia BIT were tested in the case of RosInvestCo UK Ltd v Russian Federation (SCC arbitration V [079/2005]), where the claimant, a UK corporation, submitted a claim for arbitration on the ground that the Russian Federation has expropriated its assets in violation of Article 5 of the BIT. In 2004, the claimant brought shares in a Russian oil company, whose assets were eventually seized by the Russian government and auctioned for failure to pay its taxes. The Russian company went bankrupt and was subsequently left with no assets. In accordance with Article 8 of the BIT, the claimant initiated arbitration proceeding under the rules of the Stockholm Chamber of Commerce (SCC). Article 8, however, included only disputes arising under Articles 4 and 5 where the amount of payment or compensation is in issue but not the issue of expropriation per se. Nevertheless, it was held that although the tribunal had no jurisdiction to try the issue of expropriation, since Russia objected to the claim that there was expropriation against the claimant considering that the claimant was not a beneficial owner, but only a nominal owner, at the time of the expropriation, its jurisdiction can find basis in Article 3 on the Most Favoured Nation clause. The BIT between Denmark and Russia was made the third party component because it had a wider dispute arrangement since the BIT did not limit the issues that could be settled in the Stockholm arbitration, only referring to it as “any” unlike that the of the UK-Russia BIT. The fact that the claimant was merely a purchaser of shares of a Russian company was also an issue as the Russian government denied the claimant’s status as an investor that could be protected by the UK-Russia BIT. The Tribunal held that under the wide definition of the term “investment” in the UK-Russia BIT, a UK company purchaser of assets of a Russian company is deemed an investor and therefore protected by the treaty. Employment Issues/Immigration Restrictions A foreign employee may be hired, but only upon prior authorisation from the Federal Immigration Service and only if he obtains and is granted a work permit by the said agency. In addition, there is a quota that limits the number of foreign individuals that may be hired to work within the Russian Federation. Employment is governed by the Russian Labor Code, which is underpinned by the principle of social partnership between employee and employer.13 References: Arnold, B & McIntyre, M (2002) International Tax Primer 2nd Edition, Kluwer Law International. Czinkota, M & Ronkainen, I (2007) International Marketing 8th Edition, Cengage Learning. Dahlberg, M (2005) Direct Taxation in Relation to the Freedom of Establishment and the Free Movement of Capital, Kluwer Law International. Fengxiang, W (2006) Elements of International Business. Tsinghua University Press. KPMG Doing Business in Russia http://www.kpmg.ru/russian/supl/library/taxlegal/Doing_business_in_Russia.pdf Luo, Y (2002) Multinational Enterprises in Emerging Markets, Copenhagen Business School Press DK. RosInvestCo UK Ltd v Russian Federation (SCC arbitration V [079/2005]). Schaffer, R & Agusti, F & Earle, B (2008) International Business Law and Its Environment 7th Edition, Cengage Learning. UK-Russia Double Taxation Convention, 15 February 1994. UNCTAD (2010) ‘Country Specific Lists of BITs’ United Nations Conference on Trade and Development, http://www.unctad.org/Templates/Page.asp?intItemID=2344&lang=1. Read More