The Baltic Course

Free zones on the fence

By Olga Pavuk,
Yelena Narushevich
(Ventas balss),
Gediminas Pilaitis
(Lietuvos rytas),
Tatjana Merkulova
(Delovie vedomosti)

Free zones are a good way to attract investments, and Baltic ports are well aware of it. Yet it's not easy to solve all contradictions arising in the establishment of duty-free zones while keeping in view aspirations to European Union membership

Latvia: equal rights for all zones?

Under the new law on taxation in free ports and special economic zones, uniform tax discounts will apply to all free zones as of January 1, 2002. It should be pointed out that discounts on direct taxes are effective on one condition - an influx of investments. No investments - no discounts on direct taxes. Another important point is that direct tax discounts under the new law are effective with discounts that do not exceed 50% o total investments made by the company. These changes apply to licensed companies that have signed agreements on doing business within a free zone.

Initially Latvia had two special economic zones (SEZ), one in port Liepaja in the south-west and in Rezekne, a city in the eastern part of the country, as well as two free ports -Ventspils and Riga where the free zone status was at first only assigned to part of the port's territory. Only in 2000 the entire Riga port territory was declared a free zone. Under the current law on the Liepaja SEZ, port Liepaja also enjoys the duty-free status but with arrangements different from those in Ventspils and Riga. Companies based in port Liepaja (to date there are 26 of them) are eligible to discounts on investments and taxes applicable to SEZ companies. Liepaja is the third largest port in Latvia and the most active of the SEZ. In recent years the port boasts the most rapid growth in handling - from 100,000 tons in 1992 to 3 million tons in 2000. Over a period of three years (from 1998 to 2000) SEZ companies have invested 31.6 million lats towards development. The average monthly salary in SEZ companies is 220 lats, compared to the overall city average of 133 lats.

Legislative amendments related to the new law in force as of the New Year were introduced by insistent recommendation of the European Union. Nevertheless, not all EU recommendations were included in the new law, in particular concerning the common deadline for closing all free zones in 2017, regardless of the region's development level. Yet, in October reports appeared in the press about a government decision (passed in great secrecy) to amend the bill once again before it has taken effect.

It should be noted that the EU has been pressurizing Latvia over organizing operations in duty-free business zones for several years, a fact that investors may find displeasing, as it is of utmost importance for them that the rules of the game remain unchanged for a predetermined period of time. By way of justification, one can say that Latvian laws governing free zones are far from clear-cut as they were written for each individual zone at a time when almost nobody spoke about joining the EU.

The adoption of uniform rules inspired the administration of free zones, each of them offering projects aimed at creating technological and industrial parks. Liepaja has developed a project for organizing an industrial park Karaosta in the territory of a former naval port, while Ventspils proposes to open a Baltic industrial park enjoying all exemptions due to a special economic zone. According to the Ventspils free port manager, Imants Sarmulis, «it can already be said that one investment has been implemented and two more are in the project stage. Thus, the Ventspils industrial park has already become a reality, a tangible outcome of the search for new directions in the port's operations. On the one hand, the port infrastructure and presence of a modern container terminal facilitate the port's growth. On the other hand, new businesses bring extra cargo to the port (raw materials, components, finished products).»

In May 2001 the Latvian Cabinet of Ministers reviewed a project on opening a financial center in the territory of one of the ports. The project is based on a concept used in in Dublin, Ireland. One of the initiators of the project, Juris Kanels, who is the deputy board chairman at Eirokonsultants and also an advisor to the country's special reform minister, told the BC that so far the Latvian parliament has failed to approve the inclusion of a provision on discounts to financial services in SEZ (80% off profit tax) in the above law. Latvian special tasks minister for public reform, Janis Krumins, explained to the BC that the financial center concept has been approved by the government and only some political will was now required. The project will be defended in Brussels. «The target audience of the Latvian international financial center are customers from Russia and other CIS states for whom Latvia can serve as a bridge to the West.» Krumins said that parties interested in the project included companies from the CIS, Israel, Iceland, Sweden, Norway, and others. The center itself could be located in Andrejosta, a part of port Riga, situated practically in the center of the capital.

Lithuania: free ports still a dream?

Lithuania has fallen behind Latvia where free ports have already been operating for a number of years. The idea of a free zone in Lithuania's only major port Klaipeda was kept on ice for quite some time by legislators for fear that the new status of the port would open the gates for smugglers and that Lithuania will not be able to meet EU requirements.

The law on Klaipeda national seaport, passed back in 1996, did not mention a word about free port status. Only last fall, after lengthy debate with lawmakers, amendments foreseeing the creation of a free port in Klaipeda were made to the law.

But there are still no free zones in the Klaipeda seaport as yet. It could be said that legislative prerequisites for free port operations have been created but there were no conditions precedent to the development of operations by stevedores and cargo forwarders. All customers of the port share the opinion that the mechanism for establishing a free port does not work.

«The law has many ambiguous provisions, and there are no other legal acts governing the free port operations,» said Benediktas Petrauskas, the director for development of KLASCO, the largest stevedore company in the port of Klaipeda.

The Lithuanian Stevedore Associa-tion president Aloizas Kuzmarskis also believes that that the legal mechanism for regular operations at the free port is too complicated, requires a number of various approvals and consents as well as double fencing and tight security around visa-free zones.

Under the said law, the security arrangements in the free port are the responsibility of the Klaipeda National Seaport administration. To assign security functions to the authority that has no direct liability for cargo in the port is seen by companies as an intention to set up an inefficient system of control at the expense of the state.

«Do we need another security department when the port premises are already controlled by the customs and the border guard police,» wondered Petrauskas. «We ourselves are interested in keeping cargo safe for our customers and making security arrangements. It is enough that we already pay customs some 2-5 million litas in guarantees each year.»

«The idea of free zones got stuck over fear from an overall increase in smuggling», said Algirdas Kamarauskas, the deputy head at the Klaipeda national seaport administration. «A great variety of restrictions has been imposed, an army of customs officers is already working at the port, and everybody expects help from the port administration.»

The seaport administration is unable to sign agreements on the establishment of standard plants in the free port as required under the law even if our clients agree to all conditions for the simple reason that the government does not approve to any such agreements.  Moreover, the list of business activities permitted within the free port has not been approved of either.

The convenience of free zones in ports lies in the opportunity to store cargos there for an indefinite period of time. Forwarders in Klaipeda are required to remove their goods within 60 days or request an extension from the customs. This is another obstacle on the way to a free zone port.

Private stevedore companies seek an 80% discount on profit tax applicable to the founders of the Klaipeda free port for a period of 5 years and also want full tax exemption for companies willing to invest 10 million litas in the port's superstructure and tax benefits on investments.

The port management and experts from other transportation branches feel quite skeptical about such exemptions as all participants of a free zone are supposed to compete on equal terms. So far there are not any exemptions for free zone founders in port Klaipeda.

Kamarauskas does not think that free port status carries any special importance in the transportation of metals and oil products. This year Klaipeda port lags behind its neighbors in the handling of such cargo. Stevedore companies are busy looking for new cargo and are trying to put all available territories in the port to use.

At the moment Klaipeda is only thinking about operations that would add value to cargo handled at the port through offering services such as re-packaging into smaller batches and other forms of processing. «The declaration on free port status was not used as a basis for making legislative acts for this kind of business,» said Petrauskas from KLASCO.

«The lengthy debate over the formation of free zones failed to reveal the advantages of Lithuania's only sea port or to polish its image in the eyes of its clients,» Kamarauskas said with regret, adding that «the initiative to open free zones should originate from the sea port administration and private companies.»

The Lithuanian Stevedore Associa-tion recently completed drafting a package of amendments to the free port law that was handed over to the Prime Minister Algirdas Brazauskas. The Lithuanian parliament may pass these amendments by the end of the year.

Estonia: imitating Europe? 

The term 'free zone' went on record in Estonia in 1997 under the law on customs. The latest amendments to this law were made in 1999 concerning regulations and the government's competence in setting these. Tax Policy Department head Marek Uuskula from the Estonian Finance Ministry told the BC that from the very start the law had been drafted on the basis of European experience.

Contrary to other free zones running in other Baltic states, Estonia will hardly have to change anything upon joining the EU. It does not have any discounts on land tax, income tax, social tax, investments, etc. Customs Department experts believe that, as far as tax discounts are concerned, Estonian zones are already operating under the same principles as are applied in the 30 European zones and only a few insignificant procedural changes will have to be made. 

Uusukula said that Estonian free zones offer only two kinds of discounts. First, they are exempt of export and import duties, value-added tax (VAT), tax on turnover, excise tax and certain customs duties on foods. Second, no customs clearance is required when a shipment is brought to the zone or removed from it.

These arrangements are most beneficial to container cargo because the exemptions are not of particular significance for oil or mineral fertilizers, for example, as these products are shipped in large batches and less paperwork is required anyway.

As to production within a free zone, in such cases VAT is levied only on services. The goods in storage are treated as if they do not exist - VAT, excise and other taxes have to be paid only upon removing them from the free zone.

Free zone principles in Estonia were elaborated in part already back in 1993 but people interested in establishing such a zone appeared only in 1997. It was decided to open a free customs zone in a port. The task of developing principles for operating the port in the new conditions was assigned to the experts from the Transportation and Communications Ministry, who based them on the model of a Dutch free port as a basis.

Initially it was planned that the entire port of Muuga, the largest cargo-handling port in Estonia, just by Tallinn, would operate as a free port. The project failed, however, as it turned out that neither the state nor most of the port operators cared to invest their money in fences and other security measures. As a result, the first Estonian free zone in Muuga port came into existence with only a few operators.

Later, in 1999, on the basis and initiative of a single company, Estreftrans-service, the government approved of opening a small customs free zone in the southern border town of Valga. Nevertheless, Uusukula doubts that this zone brings the state any material benefit. This free zone is more aimed at developing the remote region on the border to Latvia. Estreftransservice head Eduard Koger believes that the Valga free zone, fresh as it is, has nevertheless been very useful. «We got a license for ten years, and investments in the region's growth,» he said. The most recently founded free zone in Estonia is located in the industrial area of Sillamae on the Gulf of Finland. This was the initiative of the former Prime Minister, Tiit Vahi, director of Silmet, one of the biggest rare metal and rare earth metal producers in the region. Uuskula said this free zone was created with the purpose to boost a depressed region with growth. «It is too early to speak about any success, but not all resources have been put to use yet and the zone has the potential for growth,» said Uuskula. One of the most poignant problems is the shortage of qualified labor in the region. 

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