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If you overtax it, they won’t come

By Nathan Greenhalgh. 26.02.2009

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The development of the tourism sector in Lithuania and Latvia, both relative newcomers on the European scene for attracting foreign visitors, could be nipped in the bud by a value-added tax (VAT) hike on top of an economic downturn.


The hotel associations of both Lithuania and Latvia are crying foul about their respective countries’ VAT increases, which took effect January 1 as part of their governments' anti-crisis plans. In Latvia, the VAT on hotel room sales has gone from five percent to 21 percent and in Lithuania from five percent to 19 percent.
"It will be a very sad situation," Evalda Šiškauskienė, president of the Lithuanian Hotel and Restaurant Association, said. "I think the government is just cutting the branch we are sitting on."
The association has asked the government to reduce the VAT rate on guests coming from abroad to zero percent, but no answer to this request has been given yet.
"They did not promise 100 percent but at least the talks are started," Šiškauskienė said after a January 30 meeting with Prime Minister Andrius Kubilius and other government officials. "We had about a three-hour discussion. They got the message.”
In the meantime, both Šiškauskienė and her counterpart in Latvia predict that a wave of hotel bankruptcies will result from the double-punch of recession and tax increase.
"Forty percent of the hotels, guest houses and other lodgings will be closed," Santa Graikste, executive director of the Latvian Association of Hotels and Restaurants, said. "Especially hotels in the regions and the countryside."
In addition to these difficulties, Lithuanian hotels could lose a substantial amount of business from the shutdown of flyLAL, the country’s national airline, which ceased operations on January 17. Meanwhile, over the last two years airBaltic, the Latvian national airline, has cut many of its routes from Vilnius International Airport.

These two events have caused Vilnius airport to lose numerous direct flights from European capitals, including Budapest, Brussels and Madrid – just in time for Vilnius' year as the European Union Capital of Culture, which hotels owners had hoped would bring an increased amount of visitors. With this reduction of flights, flying into the country has become more inconvenient and expensive, two traits that don't attract tourists.
"Reducing our numbers of flights, it's not the most perfect of things," Šiškauskienė said diplomatically. "We can't compete with anything. We are a new destination ... it's killing tourism."

Robbing Peter to pay Paul
Both Lithuania and Latvia are increasing the room stay VAT as part of their anti-crisis plans passed in December. Both plans are designed to curtail national budget deficits by cutting public sector expenditure and increasing VAT and excise taxes.
Both governments are keen to avoid larger deficits that would harm their credit ratings and delay integration into the Eurozone. Latvia has gone so far as to accept International Monetary Fund loans to stave off red ink.
Hotels are just one of many sectors of the economy facing VAT hikes. However, they are affected more than most because instead of a one-percentage point increase like other Lithuanian businesses or a three-percentage point increase like other Latvian businesses, hotels' tax is going up about 400 percent.

This will mean that Lithuania’s and Latvia’s VAT rate on room sales will be uniquely high in Europe.
    "The saddest thing is that 20 states in the European Union have VAT below 10 percent," Šiškauskienė said.
In order to compete with other European countries, Šiškauskienė said she expects Lithuanian hotel owners to try to keep the same prices and said that if tourism drops off significantly the government may not see much more revenue from the VAT increase.
"Another sad thing is that owners cannot put prices up because it will be impossible to compete with other countries. It won't happen. Owners will probably be keeping the same prices and taking money from their own personal income," she said.

"Because nobody is going to increase prices and income will be lower than we expected, that means taxes will also be lower than expected. If you collect less, than you pay less tax."
Some hotel owners argue that instead of creating more revenue for the government, the new taxes will actually decrease revenue by causing hotels to fail and employees to be laid off at a time when many businesses aren't hiring, forcing more people to receive unemployment benefits.
"I don't believe that in such a way they can increase. I am sure that it will be not increased but decreased," Dace Stezkina, general director of Riga's four-star Avalon Hotel, said. "They will have to pay much more people who are not employed."

    Unemployment rates in both countries are already skyrocketing   because of the economic slowdown.
An increase in grey market activity by hotels seeking any means possible of relief from the new tax burden could be another consequence of the new VAT rate.

More expensive, less options

Latvian hotel owners fear that Riga, the county's primary tourist destination, will become more expensive and have less lodging options to offer visitors as the VAT increase kicks in and potential bankruptcies occur.
"If the tourist who comes to Riga by plane inside of an hour can go to Estonia or Lithuania where accommodation is substantially cheaper, why stay in Latvia?" Graikste said.
Stezkina lamented that the Avalon may be one of those hotels that goes under: "It's not possible to manage it. I will lose my business." But she added that Avalon would not be alone.

"I'm very sorry to say this, but it won’t only be my company. It will burn down, all the tourism industry in Latvia," she said.
The Avalon is considering cutting breakfast and increasing its marketing to try to stay in business. Meanwhile some of the hotels that stay afloat may increase their room rates to make up for the increased chunk of change sent to the government.
"If you look at Estonia and Lithuania there is less VAT so they can keep prices a little bit lower," Iveta Linina, sales and marketing manager of Riga's five-star Royal Square Hotel, said. "Probably guests will opt for a place that's a little bit cheaper. Now Riga's a little more expensive."
Linina echoed Stezkina’s fears about staying solvent.
"All these expenses, everything is going up," she said. "It's still very, very low profit and it's very difficult to survive."
Stezkina said the government should consider spending more on advertising the country and easing the tax burden on hotels, arguing that this could bring in more revenue than a higher VAT rate by bringing in more tourists. However, with state budgets being slashed everywhere, this is unlikely to happen.
She added that a fall in guest numbers would not just affect hotels.
"People don't just stay in the hotel," she explained. "It will not be only hotels that will lose out, it will be the food and entertainment industries too, and you can understand how many workplaces that is."
Kārlis Čakste, general manager of the three-star Hotel Valdemars, agreed that the VAT increase will stifle the future growth of Latvia's tourism industry.
"By doing this it's not only a slap in the face to the hotel industry, it's a slap in the face to the tourist coming to Latvia," he said. "It will decrease the number of people coming to Latvia in the long run."

Low-budget optimism
However, some of Riga's lower-budget lodgings, such as the Valdemars and the Dodo Hotel, expect to weather the storm intact because their services cost less. As budgets tighten, more customers than before are looking for lower prices.
"We already have very good cost management," Eric Larcheveque, president of the three-star Dodo, said. "We are not afraid that we could go out of business or go bankrupt."
Larcheveque admitted that Latvia will probably see less tourists in the next few months, but asserted that by keeping its prices down the Dodo would not be driven to extinction like its namesake.
"It’s possible that other operators will not be able to compete with us in price," he said.
In January, the Valdermars became a Clarion Choice franchise, which Čakste said would help.
"We are a bit lucky in that a lot of our clients are Scandinavian corporate clients," he said. "My belief is that we can handle the situation. Clarion Choice is an international hotel chain and we're connected to the system in Scandinavia."
Not all lower-priced hotels are so sure of themselves, though. Brigita Veinberga, director of sales and marketing at the three-star Hanza Hotel, considered the VAT increase a palpable menace.
"Yes, of course, it's a big threat for us because all of the operating costs are growing. Heating, electricity, everything costs more. Breakfast costs more because VAT has increased also for food and beverages," she said.
Hanza's survival strategy, she added, is to cut costs without decreasing the level of service, among other measures.
"We work more with the Internet, looking for new partners. We are not increasing prices," Veinberga said."I think the hotels that work hard will survive."

Promises honored?
One of the biggest inconveniences Latvian and Lithuanian hotels have faced is paying increased VAT on reservations and travel agency contracts that have already been signed with a five percent rate expected.
"This impacts very strongly because we plan our rates and sign contracts a year in advance," Veinberga said. "We have promised everybody the rates with five percent VAT and we work with a lot of travel agencies in the Baltics and abroad."
The Lithuanian government has promised to give tax credits on room stays in 2009 that were booked in 2008 to keep the rate on those purchases at five percent, while the Latvian government is considering such a proposal.
"Reduced VAT rate is still being discussed; we hope that soon, at a meeting of the Cabinet of Ministers, we will get a more favorable decision," Graikste said. "Compensation for the difference in VAT between 21 and five percent for contracts signed before December 12 is one of the possibilities; this could help recover some lost revenue."
However, given the financial difficulties both governments are in, some hotel owners are skeptical that they'll ever see that money.
"There are some discussions but we are still not really convinced we can get it back. But we do have some hope," Veinberga said. "At the moment we have to pay it. Maybe we'll get it back later – who knows?"


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