ALROSA’s decision to abandon, starting from 01.01.2008, the VAT exemption when selling diamonds in the domestic market produced a very lamentable reaction on the part of Russian diamond cutters. In the opinion of the Leviev Group’s spokesman, “if this intention will be effected it will mean an end to the Russian diamond-cutting industry”; the Yakutia workmates are particularly woebegone, “because this one-sided decision of the ALROSA management will lead the already half-alive diamond-cutting workshops in Yakutia and in Russia to their death.” The implication of such “obituaries” is simple – from 2008, the price for rough diamonds will go up by 18% (this is the VAT rate). Although these expenses will be later reimbursed from the federal budget, the diamond cutting companies will have to find additional working capital somewhere, which is a big problem in Russia taking into account the refinancing rate and the bankers’ reluctance to credit the risky diamond-cutting business operating at a low margin of 10-15%.
At the same time, ALROSA’s move is void of any revolutionary essence and is just bringing the situation back to the 90s of the last century, when Russian diamond-cutting enterprises buying rough paid VAT even at a higher rate of 20%. It should be remembered that the law, which relieved diamond import to Russia and diamond turnover in the domestic market of VAT, was passed in July 2000. The lobbyists’ motivation backing this decision was highly decent. They argued that this law would give access to the world diamond resources for Russian diamond-cutting companies and in this way would facilitate their complete workload, since their floating funds would not be deviated for VAT payments and might be used to buy additional rough, thus significantly increasing the total output and diamond export from Russia. The long-term experience proved these expectations hollow. Few of Russian diamond-cutters rushed in to use this opportunity of untaxed import – only Kristall of Smolensk became a De Beers sightholder, but is buying from this corporation not more than 5-7% of the needed amount of rough. The import supplies of rough diamonds grew by whole percents, but the diamond-cutters were as always complaining about chronic shortage of raw materials. The problem of floating funds was also not solved by this law – one may include or exclude VAT when selling diamonds, but the refinancing rate made and makes credits in Russia several times as costly as in Belgium, Israel, the U.S.A. and India. This is why companies having Russian capital and working with Russian credits are non-competitive a priori, as compared with their counterparts in traditional diamond-cutting centers. They were staying afloat due to the commodity credits from ALROSA and funds received from the Republic of Sakha (Yakutia) budget and other similar non-market measures.
Exemption of Russian domestic diamond turnover from the VAT actually solved only one task making diamond rough in the home market cheaper as compared with the world market. This is why tolling and grey and black exports in Russia are flourishing – these “paths” of the national diamond-cutting business give the highest profit rate. It should be noted that such a result of the appropriate legislative initiatives was predicted as far back as 2000. At the plenary session of the Russian Federation Duma on June 23, 2000, Vitaly Basygysov, Deputy from the Republic of Sakha (Yakutia), pointed out that relieving domestically sold diamonds of VAT would mean to support “Israely and Belgian capital”, i.e. the diamond-cutting companies belonging to foreign owners, and proposed an amendment to the bill replacing the “VAT exemption” with a “zero VAT rate”. This is an important matter deserving to be considered in detail.
The “zero VAT rate” means that all the expenses in terms of VAT payments, when buying goods and services needed by a company to do its business in line with its articles of incorporation, will be completely reimbursed from the national budget, i.e. the difference between the VAT payments and the VAT reimbursements from the national budget is equal to zero. Exactly this rate is applied when ALROSA ships its diamonds to the external market. The “VAT exemption” means that a company may attribute VAT payments to costs, thus decreasing its tax base. This is what happening to the diamonds, which ALROSA is selling in the domestic market. It is quite evident that to export diamonds is much more profitable for ALROSA. Indeed, today the actual losses of ALROSA due to the VAT exemption introduced for domestic diamond turnover amount to about $50 million per year, according to some estimates. This is well known to the management and experts of the diamond mining and diamond cutting industry of Yakutia; this is why starting from 2000 and actually every year since, the Republic of Sakha (Yakutia) put forward a legislative initiative to replace the “VAT exemption” with the “zero VAT rate” in the domestic rough diamonds market. In this case, ALROSA will not charge VAT from diamond-cutting companies, but instead of attributing incoming VAT payments to diamond mining costs it will have an opportunity to be completely reimbursed from the federal budget. The regular efforts of the Republic Sakha (Yakutia) in this direction stumble across a grounded rejection of federal legislators backed by the argument that, firstly, there are no extra $40-50 million in the federal budget for this purpose and that, secondly, the current legislation (in particular, the Tax Code) allows for a tax payer to abandon the inexpedient VAT exemption, i.e. in this case, the VAT exemption for diamonds sold in the domestic market. This is the opportunity, which has been used today by ALROSA.
The persistent and unsuccessful attempts by the Republic of Sakha (Yakutia) to introduce the “zero VAT rate” into the appropriate article of the Tax Code serve to be a convincing illustration of that singular trap, which may catch a diamond mining country careless enough to set up a government controlled diamond mining industry. Yakutia owns 40% of the ALROSA stock, and this company was, is and in the foreseeable future will be the major source to fill in the budget of this republic. At the same time, in the Republic of Sakha (Yakutia) there were set up many government-owned diamond-cutting companies. The interests of the diamond miner and those of the diamond-cutter in the market are opposite: the miner is striving to sell at a higher price, while the cutter is striving to buy at a lower price; if both of them belong to the same owner, the situation is fraught with conflicts, which may be described only in medical terms. It is favorable for Yakutia diamond-cutting companies when ALROSA is not charging VAT for sold rough diamonds, but it is unfavorable for the Yakutia budget when ALROSA is losing tens of millions of dollars due to this practice. Evidently, the amiable invitation extended to the federal budget to pay for this extraordinary show is not appreciated.
The experiment with the Russian (Yakutia included) national diamond-cutting industry is going on already for almost 15 years. Within its framework there were many eye catching events including the sale of longstanding stocks of the State Depository for Precious Metals, deft lobbying, tax rate equilibristics, well-honed patterns of tolling and grey export, many bankruptcies, written off debts and bad credits. The main result of this experiment, for the sake of which it was actually run, brought about hundreds of large, tens of very large and several transnational personal fortunes made on Russian diamonds by way of “experimental” methods. In this regard, the experiment was highly successful.
Today ALROSA is passing over to underground mining and the cost of rough diamonds will be increasing exponentially. The current foreign exchange rate has an adverse trend for the company. Geological prospecting requires more and more funds – the epoch of relatively easy discoveries has long passed. The company bears colossal social responsibility not only for the fates of 40 000 employees and their families but, in the long run, for the well-being of the Republic of Sakha (Yakutia). This is why the decisions aimed to stabilize the company positions are quite timely, fair and adequately appreciated by market professionals able to view the situation objectively. Thus, M. Shkadov, General Director of Kristall, commenting on the ALROSA decision to abandon the VAT exemption said, “Under such circumstances ASLROSA is doing absolutely right as any business entity fighting down its costs.”
Vladimir Semenov exclusively for Rough&Polished from Yakutsk
