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Country Commercial Guides FY 2000: Azerbaijan Report prepared by U.S. Embassy Baku, released July 1999 Note*

CHAPTER VII. INVESTMENT CLIMATE

Of all companies in Azerbaijan, local companies comprise 54%, while joint ventures comprise 46%. Because of unsuccessful test wells prompting the withdrawal of two of the consortia, the interest among foreign companies to conduct business activities in Azerbaijan has decreased over the last year. Of the 3.5 thousand joint-ventures registered in Azerbaijan, only 1.2 thousand are active. Joint-ventures currently produce 2 -3% of Azerbaijan's GDP.

A. Openness to Foreign Investment: It is the policy of the Government of Azerbaijan (GOAZ) to encourage and welcome foreign direct investment. One of the first legislative acts adopted in Azerbaijan after it became independent was the 1992 Law on Protection of Foreign Investments. This law guarantees equal treatment to foreign and Azerbaijani investment regardless of nationality. Foreign participation is possible through joint ventures with local companies, wholly foreign owned enterprises, and representative offices. Participation of foreign investors in certain areas, such as the energy sector, requires prior approval of the Cabinet of Ministers (and in some cases, President Aliyev). According to the privatization law passed on September 29, 1995, foreign investors may participate in Azerbaijan's mass privatization by acquisition of state privatization options. On July 16, 1996, Azerbaijan's parliament passed a land law, which allows for private ownership of land but precludes ownership of land by individual foreigners.

Officially, U.S. and other foreign firms are able to participate in government-financed or subsidized research and development programs on a tender basis. In fact, preference is given to local firms whenever possible.

Valid visas and registration of the company/firm are necessary requirements for the foreign investors to start operating activities. Also, effective May 1999, foreign entities, companies or individuals, conducting business activities in Azerbaijan and employ foreign nationals are required to obtain a license from the Ministry of Labor and People's Social Protection. This can be accomplished by submitting the following documents:

• Application letter. Applications for legal bodies should show the name of the legal person, the legal and organizational form, legal address, type of activity, settlement account number and name of bank. Applications for individuals should show the name of person in full, plus detailed information contained on their identification document (Serial No., date and place of issuance and address)
• Official copy of establishment documents
• Official copy of a state registration certificate
• Official copy of a tax registration certificate
• Payment order (receipt) confirming payment of State Duty (license fee) in amount of 500,000 AZM per license. The fee is to be remitted to the Operational Department, National Bank of Azerbaijan and referred to Account Number: 360201, Correspondent Account Number: 501004, Tax Identification Number: 170013678
• Copy of lease agreement or office ownership certificate
• Document justifying the need for attracting foreign employees

The Ministry is to issue its permission within 15 days of application. A license is valid for 5 years. Note: Information has been received that indicates a possible revision to this regulation that will require each foreign entity to pay a fee in this amount for each foreign national employed.

The time required for the GOAZ to process a straightforward business registration varies from a few weeks to over a year. De-registration can also be a lengthy process.

A cause for concern among foreign investors is they may find that the high-ranking officials who run GOAZ regulating agencies are one and the same as their toughest business competitors

B. Right to Private Ownership and Establishment Azerbaijani law provides for private ownership of land and businesses by foreign investors. In addition, a move toward privatization began in 1996. The program calls for the privatization of 70% or more of all state-owned enterprises (SOEs). Implementation of the privatization effort is the responsibility of the State Property Committee

Successful privatization of state enterprises, combined with new capital investment, modern management practices, and a favorable overall commercial environment could stimulate additional economic growth. To assure success, favorable laws were enacted to encourage and protect foreign investors. In accordance with the Law on Protection on Foreign Investments enacted in 1992, foreign investors are protected against nationalization or requisition except under certain specified conditions. Should nationalization or requisition become necessary, compensation will be paid according to the real value of the investment at the time the nationalization or requisition occurred. In addition, with the exception of taxes, should legislation take place that puts the foreign investor in a position less favorable than the previous legislation, there's a grandfather provision that extends the previous legislation for an additional ten years.

Foreign investors in Azerbaijan may establish a presence is one of three ways: through joint venture with local partners; by opening a branch office of a foreign entity; or by creating a foreign owned Azerbaijani corporate entity. Depending on the method selected, different tax regulations will apply. In addition, joint ventures and wholly foreign-owned Azerbaijani legal entities may benefit by their ability to obtain certain licenses or consents.

Presently, foreigners cannot buy land, though the State Property Committee appealed to the Special Presidential Commission on Privatization to improve the situation and to allow foreigners to take part in the process of privatization. However, foreigners participating in joint ventures with Azerbaijani partners can purchase real estate jointly. Azerbaijani citizens can buy, sell, and trade apartments.

In accordance with the Land Code of the Azerbaijan Republic adopted in 1992, joint ventures may rent land for an infinite term. Foreign investors may acquire the right for utilization of natural resources on the base of concessions.

C. Protection of Property Rights: Modern Copyright legislation was enacted in 1996. New Patent (1997) and Trademark (1998) laws are in place. They were prepared with assistance from the World Intellectual Property Organization (WIPO) of which Azerbaijan is a member. Azerbaijan is also a member of the Paris Convention for the Protection of Industrial Property, the Berne Convention for the Protection of Literary and Artistic Works, and the Universal Copyright Convention. The bilateral trade treaty between the United States and Azerbaijan contains intellectual property protection provisions. Although these rights are protected by law, in practice there is little enforcement. Pirated software, audiotapes, and videotapes are widely available.

D. Adequacy of Laws and Regulations Governing Commercial Transactions: Although Azerbaijan became independent in 1991, and subsequently adopted a democratic form of government, its shift to a free-market economy has been slow. This is partially because many of its laws and regulations are hybrids and still reflect numerous aspects of Soviet laws. Foreign investors may find signed contracts ignored by local partners and by GOAZ authorities that are used to less formal business dealings. Changes are occurring, but are often in conflict with other laws still to be changed. Often times, new legislation is not promptly published so implementation is sometimes lagging. In addition, there are inconsistencies in how legislation is implemented. Pursuing a court case can be a lengthy, expensive, and unpredictable process. Because the U.S. government has not ratified the Bilateral U.S.- Azerbaijani Investment Treaty, U.S. investors do not have automatic recourse to the convention on the settlement of investment disputes. Collection of payments can be frustrating in the absence of effective legal redress.:

Another source of frustration is that the application of customs duties varies widely. Importers of bulk items report different customs duties for virtually every shipment. Corruption among customs officers is common.

E. Foreign Trade Zones/Free Ports: There are currently no Foreign Trade Zones or Free Ports in Azerbaijan.

F. Major Taxation Issues Affecting U.S. Business: Foreign investors in Azerbaijan are subject to two different forms of taxation, depending on the type of business or investment. If the investor has entered into a Production Sharing Agreement (PSA), the PSA will stipulate the tax protocols that will pertain to that particular investment. Each one may be different and for that reason will not be discussed here. Investors operating outside of PSAs are subject to a Statutory Tax Regime. This regime includes the following taxes:

• Profit Tax - A Profit Tax of 32% is assessed against a firm's taxable profits (gross receipts less VAT, excise taxes, and expenses included in the cost of production.
• Dividend Withholding Tax - A Dividend Withholding Tax of 15% is assessed at the time dividends are distributed outside Azerbaijan.
• Value Added Taxes (VAT) - Goods and services are subject to a 20% value added tax. This applies to imported goods as well.
• Personal Income Tax - Income taxes ranging from 12% to 40% are assessed progressively based on gross income.

Note: If the employee is a foreign citizen (expatriate) and is physically present in Azerbaijan for 183 days or more during a calendar year, he/she is considered to be a permanent resident of Azerbaijan and, therefore, his/her entire worldwide income is subject to Azerbaijan income taxes. If they are actually present in Azerbaijan for less than 183 days, they are considered to be a non-resident and only that portion of their income derived from Azerbaijani sources is subject to Azerbaijan income taxes.

• Social Insurance Fund - Employers are required to pay an amount equal to 35% of an employee's gross salary to a Social Insurance Fund. The employee pays an additional 1%.
• Employment Fund - An amount equal to 2% on an employee's gross salary must be paid by the employer to this fund.

Tax authorities tend to use Azerbaijan's complicated and often contradictory tax laws to pursue relatively trivial infractions. New tax legislation, now under preparation, will take affect in January 2000.

G. Performance Requirements and Incentives:

-- Performance Requirements: None.

-- Incentives: A Presidential decree of January 18, 1997, called back almost all tax privileges previously available to foreign investors, effective January 1, 1997. This does not apply to international oil PSAs ratified by the parliament, which have the power of a law and supersede any subsequent legislative changes.

Investors are free to choose sources of goods, services and labor. Enterprises with foreign participation exceeding 30% foreign capital have the right to export their goods and services without a license. All foreign investors have the right to import without license goods used in their business.

Legislation does not require that nationals own shares in enterprises with foreign investment, nor does it require that the share of foreign equity be reduced over time or that technology be transferred.

Legislative acts may specify geographical areas with restricted or prohibited activity of foreign investors for the reasons of national security and defense.

H. Transparency of Regulatory System: Azerbaijan is a relatively new republic that is still making the transition to a market economy. The legal framework inherited from the Soviet Union is gradually being replaced by new rules and procedures. Weak administration and a lack of transparency characterize regulation. Although necessary new laws are being adopted under the guidance of the World Bank and IMF, Azerbaijani laws are often vague and take on meaning only through implementing decrees and regulations. There is no official gazette. Decrees are usually published in leading newspapers, but accompanying regulations usually are not. There are often differences between policies established by the GOAZ and procedures followed by executive agencies. The latter frequently lag behind the former. The Baku City tax authority regulates tax payments by foreign investors. Payments to Azerbaijani physical persons are subject to withholding at the source of payment.

Foreigners have invested approximately $500 million in the privatization process, but the value of privatization vouchers has declined by 75% from its January 1998 level. The GOAZ's second-phase privatization program, scheduled to be in place in January 1999, has not been submitted to parliament. As a result, there is no clear process for privatizing Azerbaijan's potentially profitable, large-sized state enterprises.

I. Corruption: Corruption is perhaps the greatest single problem foreign investors' face in Azerbaijan. Although state leaders have repeatedly proclaimed the struggle against corruption the most urgent task, the situation has not improved. According to the local criminal code, both giving and accepting a bribe is a criminal act..

J. Labor: Most Azerbaijani labor unions depend on the GOAZ. The right to strike exists and have occurred sporadically in the industrial sector. Azerbaijan is a member of the International Labor Organization. A nationwide minimum wage exists, but is currently less than $2 per month. Provisions for the payment of a "13th month" and bonuses for workers with long-term service in the oil sector may often be written into their contracts. The legal work week is 41 hours. Health and safety standards exist but are not enforced. Local employees of U.S. companies in the energy sector enjoy significantly better working conditions than exist elsewhere in the economy. U.S. employers report that the Azerbaijani labor force is well educated and motivated, but -- as a result of their Soviet training -- may be reluctant to take responsibility and initiative.

K. Efficiency of Capital Markets and Portfolio Investment: The Azerbaijani banking system is small, weak, and plays a minimal role in the economy, which mostly functions on cash. There are four state-owned banks, seventy private Azerbaijani banks, and twelve foreign-owned banks. Many western businesses use either of two banks for their local business - the International Bank of Azerbaijan (IBA), the healthiest state-owned bank which is scheduled for privatization in the second half of 1999, or the British Bank of the Middle East Baku branch. Both have correspondent relationships with U.S. banks. Western businesses generally use local banks only for the payment of local transactions. Of the four state-owned banks, only IBA is a fully-functioning commercial bank. The other three are technically bankrupt and going through a World Bank-designed restructuring program and, consequently, unable to lend money. Private banks are small and weak. Some of the stronger ones do business with foreign companies and may have correspondent relationships with U.S. banks.

The Baku Interbank Currency Exchange holds interbank auctions of foreign exchange. It also has conducted auctions of Treasury Bills for the Ministry of Finance. Development of a secondary market in T-bills has been prevented by the GOAZ's reliance on thirty-day bills. There is no stock exchange or other capital markets.

Bank supervision is rudimentary. Relatively few Azerbaijani businesses maintain bank accounts, perceiving that banks cannot protect the confidentiality of deposits. The deposits of Azeri citizens in the International Bank of Azerbaijan total $14 million, representing approximately 1/3 of all deposits made in the country and ranks it first over "Sberbank" and HSBC British Bank. The total amount of all bank deposits of Azeri population exceeds $50 million. Although many banks offer short-term trade financing services, longer term loans and mortgages are not available. Repatriation of profits is an onerous and bureaucratic process.

There is a lack of standard international accounting practices. Foreign companies are required to maintain accounts according to Azerbaijani standards, which are inconsistent with international standards. Three of the "Big Five" U.S. accounting firms have offices in Baku.

L. Conversion and Transfer Policies: There are no restrictions on converting or transferring funds associated with an investment into a freely usable currency and at a legal market clearing rate. There is no difficulty in obtaining foreign exchange. The manat (national currency) is freely convertible at hundreds of foreign exchange shops throughout Baku.

Enterprises with a foreign capital share may freely transfer profits from their business in Azerbaijan to their home country with no charges. The average delay for remittance of investment profits is two to three banking days. However, repatriation of profits can be an onerous and bureaucratic task.

Foreign investors may be required to put 15 to 25 per cent of their operating capital into a "reserve fund" which cannot be withdrawn from the country while operations are ongoing in Azerbaijan. The GOAZ has frozen bank accounts of companies that have not met all their tax obligations.

M. Expropriation and Compensation: The law prohibits nationalization and expropriation of property, except where national interests are endangered, and then only with full compensation. No acts of expropriation have occurred in recent years. In addition, the Overseas Private Investment Corporation (OPIC) is active in Azerbaijan and new investments can be covered by insurance. Refer to Sub-Section Q.

N. Dispute Settlement: There are no effective means for enforcing property and contractual rights. Officially the GOAZ does not interfere in the court system, but in practice courts are not independent. The Economic Court, which has jurisdiction over commercial disputes, is weak and corrupt. There is a new bankruptcy law, but it remains untested. Local courts do not accept judgments of foreign courts.

Azerbaijan is a party to the World Bank Convention on the Settlement of Investment Disputes between States and Nationals of Other States. However, the application of the World Bank convention is limited since it only governs disputes arising from investments between contracting states and nationals of other states. Azerbaijan is also a member of the Multilateral Investment Guarantee Agency (MIGA). It is not a member of the International Center for the Settlement of Investment Disputes (ICSD), also known as the Washington Convention. Nor, is it a member of the New York Convention of 1958. Azerbaijan is also not a member of the CIS Arbitration Court. Bilateral agreements on legal assistance with Russia and Turkey have been signed, though the agreement with Russia does not cover commerce.

O. Political Violence: While political instability has been a problem since independence, the political situation has been relatively stable since a coup attempt in 1995 was suppressed.

Since the late 1980s Azerbaijan has been in a state of conflict with neighboring Armenia over the Nagorno-Karabakh enclave. Ethnic Armenians from Nagorno-Karabakh now control that area and several adjacent regions of Azerbaijan. A cease-fire has been in effect since May, 1994. However, localized fighting broke out briefly in the spring of 1997 and summer of 1999. There is a process for negotiating an end to the conflict under the auspices of the OSCE (Organization of Security and Cooperation in Europe) Minsk Group, in which the U.S., Russia, and France are co-chairmen.

P. Bilateral Investment Agreements: Azerbaijan signed a bilateral investment treaty with the U.S. in July, 1997. Azerbaijan also has bilateral investment protection agreements with the United Kingdom, Germany, Turkey, China, and Pakistan.

Q. OPIC and Other Investment Insurance Programs: An OPIC treaty is in effect between the United States and Azerbaijan. The Caspian Finance Center was established in Ankara in 1998 to facilitate OPIC, EXIM and TDA services in the Caspian Sea area. U.S. firms interested in OPIC financing or insurance programs in Azerbaijan should contact OPIC directly. The World Bank's Multilateral Investment Guarantee Agency (MIGA) may issue certain types of insurance to private companies investing in Azerbaijan. Interested U.S. firms should contact MIGA in Washington, D.C., directly. (See Chapter XI, Appendix E for contact details.)

R. Capital Outflow Policy: Although legislation provides that companies are free to take capital out of the country, in reality, there are some restrictive handles regulated by the National Bank. They are mostly related to the transfer of money to offshore accounts. Currency convertibility is not generally regarded as an impediment for doing business in Azerbaijan, but restrictions remain on larger amounts.

Note: Additional information on investments can be obtained from the USACC Investment Guide to Azerbaijan published by the U.S.-Azerbaijan Chamber of Commerce (See Chapter XI, Appendix E)