A Critical Comparison of Georgian Corporate Income
Tax Model with its EU Analogues,
primarily Estonian
By
Giorgi Tsaguria
Abstract
The following work is related to the last years reform of corporate income tax (CIT) in Georgia(2016-2017), which was intended to be based on the Estonian CIT model, which is unique andpreviously had no analogues in the world.A subject of the following Master’s Thesis is to compare and criticize existing Georgianincome tax model. A comparison has been made with Dutch income tax model, which is takenas an example of typical EU corporate tax model and with Estonian CIT model as a “parent”model of Georgian CIT system. As the result of such comparison, major weaknesses ofGeorgian CIT model have been identified.The aim of this research is to define all major differences of new Georgian corporate taxationmodel, comparing it to the respective approaches used in the European Union. The researchhas been made from both, the theoretical and practical perspectives.In this research, you will find six main issues of the current Georgian CIT model that have beendetected and assessed as important to be noted and amended if possible. Respective adviceregarding the amendments for these issues are also provided.
81. IntroductionThe changes that the CIT model adopted in 2016-17 was probably the most challenging inGeorgian modern Tax Code, because it was solely based on the CIT of just one country -Estonia. Therefore, Georgian new CIT model, based on 2016-17 tax reform (GCITM) is almostunique and have a very poor practice in Georgia, as well as in Estonia. This fact also excludesobservations of any court practice or of any other tax dispute platform effective in Georgia.Although the GCITM has important strengths, based on its practical usage – number ofimportant mismatches have been detected and discussed in this article. Based on the restrictionsof the format - only problematic/unclear issues related to GCITM are observed. The article alsoproposes ways to improve GCITM, mainly adopting the approaches used in Dutch andEstonian CIT models. This analysis is not related to the economic consequences, but to theincentives and legal logics.2. General Overview of GCITMGCITM has taken all of the taxable objects that the Estonian Corporate Income Tax Model(ECITM) envisages, giving them slightly different formulation. The main document for theGeorgian CIT base is a factual economic performance of the company, based on InternationalFinancial Reporting Standards.
9However, substantial differences exist in the interpretations and further explanations, whetherthe specific transaction falls under the respective taxable object definition or not.With such an approach the regulations on a thin capitalization, an accrual method of taxaccounting, liquidation, reorganization and transfer of asset rules, numerous tax norms areeliminated as no more applicable for the persons subject to GCITM.
3. Unresolved Issues/Practical Negative Effects of the Existing Model. Proposed Ways ofSolution.3.1. Legal VehiclesGeorgian Law on Entrepreneurs lists the types of entities defined as enterprises and there areno Collective Investment Funds (CIFs) and trusts. Therefore, most likely, this is the reasonwhy regulation of Tax Code of Georgia (TCG) with respect to accumulated pensions andinvestment funds is very narrow and provides exemptions for operations related to investmentsand pensions provided by a legal entity which obtained a status of an international financialcompany only.1Comparing to the EU Countries Classical CIT Model (EUCCCM) and ECITM, Georgian taxlegislation lacks CIT regulation regarding the specific types of entities. Entities like CIFs(“funds for joint account”2 as in the Netherlands) and trusts are widely used in the Westernworld for the specific investments and/or savings purposes. Such entities are mostly (inEUCCCM, as well as in Estonia3) exempt from CIT or have other specific tax regimes.1 Tax Code of Georgia 2010 (Georgia) s99 (1.n)2 Law on Corporate Taxation 1969 (Netherlands) s2 (1.f)3 Income Tax Act 1999 (Estonia) s2 (5)
10Additionally, according to the EU/Georgia Association Agreement,4 Georgia has an obligationto regulate such investment vehicles as UCITS (Undertakings for Collective Investment inTransferable Securities) in accordance with a Directive N2009/65/EC of the EuropeanParliament and of the Council of 13 July 2009. Respective regulatory changes shall be madebefore 2022.5 This should most likely mean implementation of respective tax regulations aswell.If the respective amendments were done in TCG, as well as in the Law on Entrepreneurs, givingpossibility for creation of the CIFs (including UCITS) and trusts, with respective CITexemptions, it would create an incentive for creation of pension/saving funds, which wouldalso have a huge impact on Georgian economic growth, which was the goal of the new CITmodel.In addition, it is noteworthy that the partnerships are not differentiated in GCITM for taxpurposes, comparing to EUCCCM, where different kind of partnerships might be taxeddifferently. In case of GCITM, all the partnerships are taxed in the same manner; they are allinter alia CIT subjects in Georgia and taxed respectively.64 Chapter D of Annex XV-A of EU/Georgia Association Agreement5 Ibid6 Tax Code of Georgia 2010 (Georgia) ss21 (1.c), 97 (1)
113.2. CIT on Profit Distribution of PE Acting in GeorgiaTCG defines distributed profit of permanent establishment (PE) as a distribution (the profitattributable to PE taken away by the non-resident enterprise) either in monetary or non-monetary form made to the non-resident out of the profit gained as a result of the activity ofthe PE.7 At the same time, distributed profit is a profit distributed by an enterprise to its partneras a dividend in a monetary or non-monetary form.8Based on the definition of a dividend, it may be distributed only between two separate legalentities.9 Thus, because a PE and its head office do not form distinct legal persons and representa single legal entity,10 PE is unable to distribute its profit in a form of dividend. Therefore, themoment and an exact transfer of funds that should be regarded as distribution of profit subjectto CIT is unclear.The Georgian Tax Authorities keep silence regarding this issue, whereas more than 1900 PEs11of non-residents are left with this uncertainty and each makes its own interpretation on thesubject.In order to make the abovementioned clear, TCG could choose an approach used in ECITMand Estonian Tax Board. The dividend distribution of PE could be directly connected to the7 Tax Code of Georgia 2010 (Georgia) s981(3)8 Tax Code of Georgia 2010 (Georgia) s981(1)9 Article 8.12 of the TCG.10 Law on Entrepreneurs of Georgia 1994 (Georgia) s16 (1)11 Official web-site of National Agency of Public Registry < https://enreg.reestri.gov.ge > (accessed 16 July 2018)
12tax period i.e. a fiscal month and the transfer of funds could be considered the moment whenthe assets are not under the control of a PE or a PE has not received a remuneration at a marketprice for its activities.3.3. Uncertainties Related to Taxation of Specific ExpensesTCG specifies that expenses, which have been incurred without a purpose to gain profit, incomeor compensation, shall be deemed as expenses not related to economic activity, thus subject toCIT.12The main issue related to this norm is connected to the penalties and fines. ECITM directly saysthat the fines and penalty payments (including payments in kind), imposed on the basis of law andinterest paid for late payment of tax and bribes are subject to CIT,13 GCITM lacks such provision,leaving space for taxpayer’s interpretation. Additionally, most criminal fines and tax penalties arenot deductible in EUCCCM,14 as it is per today applicable in Georgia with respect to the companiesnot transitioned to GCITM yet.Per my opinion, levying CIT on the penalties/fines should be subject to CIT, as not levyingCIT might trigger unequal treatment of the taxpayers transitioned to GCITM and of nottransitioned. Regarding the bribes, I do not think it is correct to levy CIT on giving a bribe - asthe taxpayer giving a bribe will be charged in a form of penalty for such a bribe, whichaccording to my previous argument should be subject to CIT.12 Tax Code of Georgia 2010 (Georgia) s982 (1.b)13 Income Tax Act 1999 (Estonia) ss51 - 5214 Marnix Schellekens, Netherlands Corporate Taxation Country Surveys, 17 May 2018, Amsterdam, 1.3.3.2. <https://online.ibfd.org > (accessed 16 July 2018)
13In addition, I think that introducing assumption that the penalties/fines are deemed to be relatedto the economic activity, therefore not subject to CIT would not be correct from the perspectiveof GCITM general approach:• GCITM’s aim seems to be taxation of all the finances that leave the GCITM subject;• Special assumptions are not provided for the expenses not related to the economicactivity.3.4. Determination of CPTRsGCITM levies CIT on the specific transactions with entities registered in country withpreferential tax regime (CPTR).The rules determining the CPTRs and referring to the respective Ordinance of the Government ofGeorgia15 is mentioned in the article regulating expenses not related to economic activity.16 Thefirst rule states that a country shall be considered as CPTR if under the tax legislation of thecountry and/or of separate territories of the country:• a legal person is exempt from CIT; or• CIT is not imposed on profit gained and/or distributed by a legal person, or the CIT ratedoes not exceed 5%.171815 Ordinance of the Government No 615, 2016 (Georgia)16 Tax Code of Georgia 2010 (Georgia) ss982 (5), 982 (6), 982 (10)17 Based on the current Georgian CIT rate (15%)18 Tax Code of Georgia 2010 (Georgia) s982 (5)
14The second rule states that if the tax legislation of foreign country or its separate territory envisagesany of the abovementioned tax implications to a company registered on its territory – such countryor its separate territory shall be deemed as CPTR with respect to such implication.19Further, TCG states that the list of countries and/or separate territories of countries that areconsidered as CPTRs for the purposes of TCG shall be determined based on the rules mentionedabove by ordinance of the Government of Georgia.20Therefore, we have three interconnected rules, which determine whether a country shall beconsidered as a CPTR. A company registered in UAE should fall under the first rule based on thefact that UAE does not impose CIT on supply of computers, however it might not fall under thesecond rule in case if we take a profit of oil company which is taxed in UAE, and therefore, it alsodoes not fall under the third rule – as although UAE is in a list of CPTRs, but only for the purposesof the second rule. Thus, in this event, an oil company registered in UAE is a company registeredin CPTR based on the first rule, but it is not a CPTR based on the second and the third rule.Notably, some countries mentioned in the list do not exist anymore. This might be issue in somecases. For example – the Netherlands Antilles. This country is dissolved.In order to avoid all the above mentioned, GCITM could take an approach used in the ECITM,where the rules for CPTRs are determined similarly to Georgian second rule only.2119 Tax Code of Georgia 2010 (Georgia) s982 (6)20 Tax Code of Georgia 2010 (Georgia) s982 (10) referring to Ordinance of the Government No 615, 2016 (Georgia)21 Income Tax Act 1999 (Estonia) s10 (1)
15Most importantly, EITA do not refer to the territories, which should be considered as CPTRs, butto the territories which should not be considered as CPTRs and moreover, this list do not prejudicethe rules determining CPTR.22 Thus, the CPTR in case of Estonia is the country satisfying thealternative to Georgian rule N2 mentioned above. Leaving only the second rule, GCITM wouldalso be clearer and probably avoid uncertainties.3.5. Possible Increase in a Burden of Tax as a Result of New CIT ModelAccording to the Constitution of Georgia, a new type of common-state tax may be adopted or theupper limit of the current rate may be increased only through a referendum, except for the casesprovided for by the Organic Law.23 Additionally, introduction or change of a tax shall not bedeemed as introduction of a new type of common-state tax or an increase in the marginal rate ifthe introduced or changed tax represents an alternative to the current tax or replaces the current taxand at the same time does not increase the tax burden.24The reforms of 2016-17 were not carried out based on the temporary increase of taxes, which couldbe legitimate in accordance with the Organic Law.25 Therefore, the Government did not executeits right mentioned in the Organic Law.Thus, the referendum was required if the actual tax burdenhas raised based on GCITM changes.22 Income Tax Act 1999 (Estonia) s10 (3)23 Constitution of Georgia 1995 (Georgia) s94 (4)24 Constitution of Georgia 1995 (Georgia) s94 (5)25 Organic Law of Georgia On Economic Freedom 2011 (Georgia) s1 (6)
16Deferred tax assets are the amounts of income taxes recoverable in future periods in respect ofdeductible temporary differences, the carryforward of unused tax losses, and the carryforward ofunused tax credits.26 Deferred tax assets might be deemed as the tax relief, as they are artificiallycreated by the tax legislation and do not coincide with the real accounting situation of the company,thus creating a possibility for the company to delay payment of CIT.Let’s assume that a big international company providing taxi services has entered Georgia in 2014.It knew that TCG provides a tax relief in a form of deferred tax assets. It predicted that the taxrelief would be applicable also in the future. The company has bought cars on amount ofUSD10mln. Company has a financial profit since its establishment in Georgia. It could deduct thisamount at once or deduct an annual depreciation of cars (both represent a tax relief). The TCGenvisaged 20% annual depreciation for cars. Thus, the company deducted USD2mln in the firstyear, USD1.6mln in the second year and intended to deduct USD1.28mln in the third year (2017).However, in 2017, the new GCITM has been enacted and the right of the company to deduct further20% was cancelled. Furthermore, nor a right to correct/clarify declarations for previous years hasbeen granted to the taxpayers that have used an annual depreciation method for tax purposes.Alternatively, if the company chose a one-time deduction method and intended to carry lossincurred in 2014 – such a right is not applicable in 2017, based on the GCITM. As the result - acompany is liable to pay CIT on the distribution of dividend in 2017 and it cannot carry lossanymore for further years.26 International Accounting Standards 12: para. 5 — Income Taxes
17As might be ascertained from the abovementioned arguments – transition to the new GCITM dorepresent a cancellation of tax relief. Cancellation of tax incentives according to tax scholars makethe tax burden heavier and entail more tax risks.27As the companies are no more allowed to carry loss incurred initially – transition to new GCITMmight be considered as increase of a tax burden, especially for the big international companiesmaking a long-term investment in Georgia, which require a purchase of expensive assets. Thus,the constitutional claim would at least have a solid based to be satisfied.3.6. Lack of Effective Incentive to Reach the Aim of the ReformGCITM was intended to create a new incentive – to reinvest sums in the enterprises. However,when we check the ECITM, which was the base of GCITM, it contains specific incentive, whichis not provided in GCITM. The companies did not have an actual financial incentive to retain theprofits within the company. As the result, the aim of the reforms carried out most likely was notreach. Furthermore, as discussed in previous chapters, many uncertainties take place, whichcertainly do not create an incentive to even enter the Georgian market.One of the most interesting incentives that GCITM could take from ECITM is that in Estonia, aprofit distributed in the calendar year, equal to or less than the income distributed in the previousthree calendar years from the average profits distributed by the resident company, is taxed at the27 Causes of Tax Risks and Ways to Reduce Them, European Research Studies Journal, Volume XX, Issue 3B, 2017, p.456
18reduced rate.28 Such a regulation shall most likely create an additional incentive for company toreinvest more and not to withdraw finances from the business for the years.
4. ConclusionThe aim of the work to show all the major problematic issues related to the GCITM is achieved.During the research, numerous complex issues have been detected and observed, comparingGeorgian tax legislation with its analogues in EU.Although there is almost no cases observing GCITM, the article has successfully provided thepossible tax dispute subjects and proposed the ways of elimination of such issues (whereapplicable) before serious tax disputes has arisen. The main problems of the GCITM detected anddiscussed in this work are related to:• Tax subjects;• Distribution of profit by PE;• Taxation of penalty/fine payments;• Determination of CPTRs;• Incentive to reach the aim of the reform;• Increase in a burden of tax.To summarize, I believe that this work will be useful, based on the fact that GCITM has beenenacted recently and there are very few works related to the weaknesses of GCITM, especiallyfrom the perspective of its practical implications
