UPDATE 3-Cuba plans big tax breaks to lure foreign investors

Wed Mar 26, 2014 4:56pm EDT

(Adds details from text of proposed law)

By Marc Frank

HAVANA, March 26 (Reuters) - Cuba's communist government has drawn up a new foreign investment law that will cut the profits tax in half and exempt investors from paying it for eight years in an attempt to attract desperately needed capital into the economy.

The National Assembly will meet on Saturday to approve the legislation that Cuba promises will offer investment security to foreigners and help further integrate the Caribbean island in the global economy.

But the proposed law appears to withhold many of the tax benefits from companies that are 100 percent foreign-owned, instead reserving those incentives for joint ventures with the Cuban state and between foreign and Cuban companies.

The proposed law includes a clause that bans expropriations except in cases of public interest previously established by the government, in which case investors would be compensated.

The new investment law continues the structural economic reforms under way in Cuba since President Raul Castro took over from his ailing brother Fidel in 2008. It has been anticipated since 2011, when Cuba enacted a 300-point overhaul of its domestic economy to encourage more private enterprise.

The law aims to address the lengthy and sometimes murky process to approve foreign investment deals and improve investment guarantees, two major concerns of potential investors and foreign governments.

It would also guarantee the free transfer of profits or dividends outside of Cuba without paying additional tax, and allows investment in any sector of the economy except education and healthcare.

Details of the proposed law were published on Wednesday in state-run media, and Reuters later reviewed a copy of the complete draft. The National Assembly was expected to approve the draft with little change.

Cuba is cut off from U.S. investment by a comprehensive trade embargo and has failed to meet its investment targets for each of the past five years.

Major foreign companies doing business in Cuba include Canada's Sherritt International, which has a joint venture with the Cuban state to mine nickel, and Spanish hotel group Melia Hotels International, among others.

Such companies will enjoy the new lower tax rates but not the 8-year tax holiday granted to new investors.

Cuba is promising legal protections to persuade foreign investors to risk their capital in the Soviet-style economy, and new incentives such as the dramatically lowered tax.

"The Cuban government has a major credibility gap to overcome with foreign investors. Investors will want evidence, not just legislation, that Cuba is prepared to allow investors to make money, employ Cubans they select and not move the goal posts when success seems to be too rewarding," said Paul Hare, a former British ambassador to Cuba who now teaches at Boston University.

Under the current foreign investment law, which went into effect in 1995, all tax breaks are negotiated and foreign firms pay a 30 percent profits tax and 20 percent labor tax. The labor tax was already being gradually reduced and now will be eliminated completely.

However, foreign ventures that mine natural resources, including oil, can be subject to a higher profits tax of up to 22.5 percent, depending on how those ventures are negotiated with the state.

Investors will still have to hire labor through state-run companies, a major complaint of foreign firms.

"The policy's impact will be known once Cuba starts negotiating deals with potential partners, but the new law's incentives and flexibility seem to be designed to bring in the capital needed to lift the economy and make the reforms succeed," said Phil Peters, who runs the Virginia-based Cuba Research Center. "Agriculture, sugar, and renewable energy are key sectors to watch for signs of a new attitude toward foreign investment."

MARKET-ORIENTED REFORMS

Under Castro's reforms, Cuba has proposed moving 20 percent of the state labor force to a non-state sector made up of farms, small businesses, cooperatives and joint ventures.

Greater foreign investment flows would "increase exports, the effective substitution of imports, (spur) high-technology and local development projects, as well as contribute to the creation of new jobs," according to the 300-point plan in 2011.

Yet to date the reforms have not led to fast growth. The economy is expected to expand 2.2 percent this year, compared with 2.7 percent in 2013.

The current law and new law allow for 100 percent foreign-owned companies and do not explicitly exclude Cubans who are citizens of other countries, but in practice Cuba has in most cases insisted on 51 percent ownership of joint ventures and has not allowed Cubans abroad or its own citizens to invest, except in small businesses.

There are currently around 200 joint ventures and other projects involving foreign investment in Cuba, compared with more than 400 some 12 years ago and the economy is considered one of the least investor friendly in the world. (Additional reporting by Nelson Acosta and Rosa Tania Valdes; Editing by Daniel Trotta and Kieran Murray)