The Russia Conundrum

The Tax Ministry, directed by the Kremlin, justified all the additional taxes and fines by inventing entirely new legal concepts, which were applied only to Yukos, and by misapplying Russian tax law, notably by retroactively assigning profits made by Yukos’s trading subsidiaries to the parent company at a higher tax rate. Yukos’s alleged back-tax bill for 2000 to 2004 ended up exceeding $30 billion. According to an analysis by the Parliamentary Assembly of the Council of Europe, published in January 2005, ‘the total tax burden for Yukos, including the retroactive reassessments, is indeed about triple that of its Russian competitors’ and ‘the tax burden for 2002 exceeds Yukos’s whole turnover for that year’.

In April 2004, Yukos was given just two days to pay all the ‘reassessed’ additional tax for 2000. But the tax authorities did not even bother to wait: they froze all the company’s assets, making it impossible for Yukos to pay even while simultaneously challenging the legitimacy of the reassessment. The spurious back-tax claims, asset- freezing orders and absurdly unrealistic payment deadlines ultimately led to the seizure of one of Yukos’s crown-jewel production assets, Yuganskneftegaz (YNG), in June 2004. In November 2004, the Russian authorities announced that an auction of YNG would take place the following month. This contravened Russian law, which requires the sale of non-core assets before core assets for the settlement of tax claims. Yukos had proposed to the tax authorities that the company would sell its shares in Sibneft, which would have allowed it to pay off most of the tax liability without affecting its core operations, but the tax authorities ignored the proposal.

At the time of its seizure, YNG was responsible for over 60 per cent of Yukos’s total output. It had been valued by management at between $16.1 billion and $22.1 billion, and by the Russian state- appointed evaluators Dresdner Kleinwort Wasserstein at between $14.7 billion and $17.3 billion. Nonetheless, the Russian Ministry of Justice announced that the value of YNG for the purposes of the auction would be no more than $10.4 billion.

In an effort to block the sale of YNG, Yukos filed for bankruptcy protection in December 2004, in the United States Bankruptcy Court for the Southern District of Texas. The Texas court agreed to issue a temporary restraining order, according to which, ‘the weight of the evidence supports a finding that it is substantially likely that the tax assessments of Yukos and the manner of enforcement regarding taxes were not conducted in accordance with Russian law’. The court also found that ‘the evidence supports a finding of the likelihood that the Plaintiff’s shares of YNG will be sold for approximately half the value estimated by two different investment bankers’.

In spite of the court order, the auction went ahead on 19 December 2004. The only bidder was a mysterious company called Baikal Finance Group, which was completely unknown in the industry and appeared to have been founded just two weeks earlier. Its total share capital was declared at $300 and its registered company address turned out to be a liquor store in the city of Tver. President Putin nevertheless gave Baikal Finance his enthusiastic endorsement, stating that its shareholders were ‘individuals who have been in the energy business for many years … and who intend to build relations with Russia’s other energy companies interested in this asset’. Despite its lack of capital, Baikal Finance Group was somehow able to put up the $1 billion deposit needed to participate in the auction and then another $8.8 billion to make good on its successful, uncontested bid to purchase YNG. The mystery was explained two weeks later, when it was announced that Baikal Finance Group was itself being purchased by the state- controlled Rosneft, chaired by Igor Sechin, for an undisclosed sum.

The chief Kremlin economic adviser, Andrei Illarionov, who was still in his post at the time, described the unlawful expropriation of YNG as the ‘scam of the year’, stating that there was ‘no free economic space remaining anywhere in Russia’ and that Russia now qualified as ‘a politically unfree country’. When he resigned 12 months later, he amplified his remarks. ‘Russia has become a different country,’ he said. ‘It is no longer a democratic country. It is no longer a free country.’ Illarionov confirmed that his resignation was in protest against the embezzlement of billions of dollars out of Rosneft’s profits by Putin’s inner circle. Russia, he said, was now run by an authoritarian, corrupt elite. ‘It is one thing to work in a country that is partly free. It is another thing when the political system has changed, and the country has stopped being free and democratic.’