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PP RUEHLMC RUEHVC
DE RUEHUM #0158/01 0670400
ZNR UUUUU ZZH
P 080400Z MAR 07
FM AMEMBASSY ULAANBAATAR
TO RUEHC/SECSTATE WASHDC PRIORITY 0889
INFO RUEHMO/AMEMBASSY MOSCOW 1708
RUEHBJ/AMEMBASSY BEIJING 5450
RUEHUL/AMEMBASSY SEOUL 2659
RUEHKO/AMEMBASSY TOKYO 2399
RUEHOT/AMEMBASSY OTTAWA 0399
RUEHML/AMEMBASSY MANILA 1317
RUEHLO/AMEMBASSY LONDON 0099
RUEHBY/AMEMBASSY CANBERRA 0107
RUEHVC/AMCONSUL VANCOUVER 0046
RUEATRS/DEPT OF TREASURY WASHDC
RUCPODC/USDOC WASHDC 1209
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHINGTON DC 0494
RHEHNSC/NSC WASHDC
RUEKJCS/SECDEF WASHDC

UNCLAS SECTION 01 OF 02 ULAANBAATAR 000158 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PASS USTR, USTDA, OPIC, AND EXIMBANK 
STATE FOR EAP/CM AND EB/IFD/OIA 
USAID FOR ANE FOR D. WINSTON 
MANILA AND LONDON FOR ADB, EBRD USEDS 
TREASURY FOR USEDS TO IMF, WORLD BANK 
 
E.O. 12958: N/A 
TAGS: EINV PREL ETRD EMIN ECON PGOV MG
SUBJECT: Tax Reform Creates Better Business Environment, But There's 
More to Do 
 
REF:  06 Ulaanbaatar 576 
 
¶1. (U) SUMMARY: As background for the upcoming Trade and Investment 
Framework Agreement (TIFA) talks, this report notes that major 
legislative changes in 2006 made a good start at reforming 
Mongolia's tax system, an area which has been one of the bigger 
problems for investors.  The old corporate income tax law in 
particular lacked loss carry forward provisions, arbitrarily limited 
deductions, induced businesses to split into multiple small entities 
to achieve lower tax rates, and prompted widespread tax evasion and 
corruption by tax inspectors.  Western investors less prone to 
engage in such shenanigans were at a disadvantage, and sought long 
tax holidays as a necessary part of large investments in the mining 
sector.  Tax holidays are no longer much possible, but new corporate 
and personal income tax, VAT and excise tax laws sharply lowered 
rates and created a more rational system.  Parliament is to consider 
changes to the customs and customs tariff law at its next session; 
there has been speculation that tariff rates might be raised from 5% 
to 10% to compensate for lower VAT rates.  High social welfare taxes 
remain a problem, and the World Bank notes that, to ensure an 
improved business climate, better tax laws must be matched by 
thorough reform of the dysfunctional and corrupt tax administration. 
 End Summary. 
 
The Old Law:  Not Business Friendly 
----------------------------------- 
 
¶2. (U) Major tax reforms in 2006 greatly improved the business 
environment in Mongolia for both foreign and domestic investors. 
Before the reforms, a World Economic Forum survey of Mongolian 
business executives cited tax rates and the complexity of tax 
regulations as two of the top five problems for doing business in 
Mongolia.  The tax reforms were the culmination of two years of 
technical assistance from USAID's Economic Policy Reform and 
Competitiveness Project (EPRC).  The reforms affected the Personal 
Income Tax (PIT) and Corporate Income Tax (CIT) codes as well as the 
VAT and excise tax codes. (Note: Reftel describes the details of the 
changes, and EPRC has a number of useful and informative guides on 
their website:  http://www.eprc-chemonics.biz.) 
 
¶3.  (SBU) The old corporate income tax system's lack of a loss 
carry-forward provision as well as arbitrary caps on deductions for 
business expenses discouraged investment; businesses could easily 
end up owing tax, even if they lost money.   The old law was so 
dismal and at variance with world norms that it was a prime reason 
why mining investors sought tax holidays under stability agreements. 
 (Comment: In turn, tax holidays, such as the one for Boroo Gold, 
helped pave the ground for populist anger on mining projects, since 
they set up arguments that foreign miners intended to reap huge 
profits from Mongolia's minerals while paying little or nothing to 
the government.) 
 
¶4.  (SBU) The old law created powerful incentives for avoidance and 
evasion.  Firms -- including most Western firms -- unwilling to 
engage in tax evasion were at a severe financial disadvantage to 
companies which were less scrupulous.  Large firms broke into 
numerous accounting entities to avoid the second tier of the CIT 
schedule, which doubled rates after 100 million MT (US$80,000) in 
income.  Such practices created duplicate boards and administrative 
staff, which drained human and material resources from cash-starved 
businesses.  The government dispatched tax inspectors to visit 
nearly 11,000 of the roughly 26,000 corporate taxpayers registered 
in 2004, and four-fifths of these visits resulted in fines being 
assessed for alleged violations of the complex tax code.  Corruption 
among tax inspectors has been rife, and businesses might negotiate a 
lower fine in exchange for something under the table -- or face 
higher fines if they refused to pay off the inspectors.  (Note:  One 
U.S. firm with a Mongolia office, for instance, is engaged in a 
bitter audit dispute with tax authorities, and has charged that the 
inspectors sought bribes.) 
 
ULAANBAATA 00000158  002 OF 002 
 
 
 
In With the New 
--------------- 
 
¶5. (U) The new laws became effective January 1 (except the new 
excise tax law, which went into effect last July 1).  In general, 
the new laws reduce tax rates, flatten the tax schedule, remove 
discriminatory loopholes and exemptions, and introduce appropriate 
deduction opportunities for corporate investment. By lowering the 
income tax rates, the Government of Mongolia hopes to encourage 
individuals and businesses to leave the "shadow economy," which has 
been estimated at half as large as the formal economy or greater. 
 
¶6.  (U) The new corporate income tax law allows firms to loss 
carry-forward for two years after incurring the loss, potentially 
encouraging investment and accommodating firms experiencing 
temporary negative shocks.  While most businesses approve of this 
provision, many note that the two year carry forward limit is 
insufficient for projects with long development lead times, as is 
typical of most large-scale mining developments.  The new law allows 
firms to deduct more types of legitimate business expenditures: 
training, business travel, cafeteria expenses, etc.  The new law 
levels the playing field between foreign and domestic investors, 
eliminating the majority of discriminatory tax exemptions and 
holidays (most of which favored international investors). 
 
Unfinished Business (Including Customs Rates) 
--------------------------------------------- 
 
¶7. (SBU) Parliament is scheduled to take up additional tax reform 
measures in its spring session, which begins in April.  These 
include revisions to the law on customs and customs tariffs.  There 
has been speculation, including some from Members of Parliament, 
that customs rates would rise from 5% to 10% in order to recoup the 
revenue shortfall from reducing VAT rates.  While the exact nature 
of the proposed changes in the customs law have been murky, Ministry 
of Industry and Trade counterparts aver that the changes will be 
consistent with Mongolia's WTO obligations. 
 
¶8.  (SBU) Parliament also is eventually expected to lower the 
current high social welfare levies on labor.  The high rates promote 
tax evasion, including through hiring illegal foreign workers 
(largely Chinese), an especially undesirable result in view of 
Mongolia's high unemployment rates.  Even legal foreign labor can 
sometimes have a cost advantage over locals, since no social welfare 
taxes are due, and this is a savings often greater than the foreign 
worker fee to the government (changes made in the mining law, 
however, make it much more difficult and expensive to hire large 
numbers of foreign workers in that sector). 
 
¶9. (U) The World Bank has warned that last year's legislative 
changes by themselves will not be sufficient to improve Mongolia's 
business environment.  Reform efforts, they urge, need to go beyond 
changes to the tax code or passage of anti-corruption legislation to 
restructure the operations of the key agencies - the tax department, 
the customs administration and the inspections agency - that 
directly interact with private firms and individuals.  The World 
Bank has embarked on a two-year program with the government to begin 
to reform the tax administration system. 
 
Minton