Dechert OnPoint: Amendments to the Tax Code
Dechert Georgia, through the contribution of partners Archil Giorgadze and Nicola Mariani, joined by senior associates Ruslan Akhalaia and Irakli Sokolovski, as well as Ana Kostava and Ana Kochiashvili, is partnering with Georgia Today on a regular section of the paper to provide updated information regarding significant legal changes and developments in Georgia. In particular, we will highlight significant issues which may impact businesses operating in Georgia.
Georgia’s Parliament approved amendments to the Tax Code of Georgia (the “Tax Code”) on 12 May 2016, thereby introducing a new corporate profit tax regime (the “New CPT”), one of the most significant changes to Georgia’s tax system during the past decade.
The key difference between the New CPT and the corporate profit tax currently in effect (the “Current CPT”) relates to the taxable object and timing of tax payments. In particular, under the Current CPT enterprises determine their annual profit according to the tax accounting rules and pay the Current CPT on their profits whether or not these profits are distributed. In contrast, the profits under the New CPT are taxable only upon their distribution. In addition to distributed profits, however, the New CPT also applies to: non-business expenses and certain payments; the market value of free supplies or payments made; and representation expenses incurred in excess of the cap set out in the Tax Code.
DISTRIBUTED PROFITS
Under the New CPT, profit is taxable upon distribution only. Respectively, if the taxpayer does not distribute the profit, the taxpayer shall not be liable to corporate profit tax (provided, it does not make other types of payments or supplies which are subject to the New CPT).
In addition to the distribution of the profits, the non-arm’s length international transactions and non-market price transactions between the related parties may trigger the New CPT. Related party transactions trigger the New CPT if one of the parties to such transaction is: (i) an entity to which the New CPT does not apply; or (ii) an entity or an individual which is exempt from the corporate profit or individual income taxation. In such instances, the following amounts shall be deemed part of the distributed profit: (a) the portion of the income received or to be received in excess of the market price; or (b) the portion of the expense incurred or to be incurred in excess of the market price.
Importantly, under the New CPT the non-market price transactions between related parties shall not trigger the New CPT if both parties to the transaction are liable to pay the New CPT, which is one of the key positive developments.
Another important feature under the New CPT is that distribution of the profits by a Georgian enterprise to another Georgian enterprise (except enterprises exempt from profit taxes) do not trigger the obligation to pay the New CPT.
NON-BUSINESS EXPENSES OR PAYMENTS
Under the Current CPT, non-business expenses are not eligible for deduction. Under the New CPT, however, non-business expenses shall be immediately taxable notwithstanding the financial performance of the taxpayer. The non-business expenses include: (a) expenses which are not documented if the documentation of the expenses is required by the Tax Code; (b) expenses which do not relate to the generation of income, profit or compensation; and (c) interest payments made in excess of the cap set by the Minister of Finance.
In addition to this, certain payments (whether they qualify as an expense or not) are also subject to the New CPT. The payments which trigger the New CPT payment obligations include certain payments made to entities registered in the countries with preferential tax regimes (the “Offshore Persons”) or entities exempt from the New CPT. These include (among others): (a) Payments made for the purchase of debt instruments issued by the referred entities; (b) payments for contractual penalties under the contracts; (c) advance payments; and (d) the principal amount of the loan.
In the above listed instances, the New CPT shall be assessed on the full amount of the actual payment made. For instance, if the Georgian entity granted a loan to the Offshore Person, then the entire amount of the loan transferred to the Offshore Person would be subject to the New CPT.
In addition to the above stated, the following payments are also subject to the New CPT: (a) contribution to capital of or payment for the shares of the non-Georgian residents or the entities exempt from the corporate profit tax; (b) granting of a loan to any non-Georgian resident (both individuals and enterprises); and (c) granting of a loan to any individual (both residents and non-residents).
Notably, if the taxpayer which made an advance payment receives: (i) its advance payment back; or (ii) goods/services for which the advance payment was made, then the taxpayer may credit the New CPT paid on such advance payment against its future tax liabilities or claim back this tax from the state budget.
If the purchaser of debt instruments or shareholding received back its payment, then the taxpayer may credit the New CPT paid on such transaction against its future tax liabilities or claim back this tax from the state budget.
FREE SUPPLIES
The free supplies of goods and/or services or transfer of money are taxable under the New CPT. The tax is assessed on the market price of the free supplies or the amount of money transferred (as applicable).
For the purposes of the New CPT, free supplies include any supplies of goods and/or services the purpose of which is not receipt of income, profit or compensation. This definition implies that e.g. the gifts given to individuals or companies in the course of marketing activities should not trigger the New CPT. Besides, the free supplies with respect to which the taxpayer paid withholding tax shall not be further taxable with the New CPT.
REPRESENTATION EXPENSES
Representation expenses are expenses incurred by the taxpayer in the course of business activities in relations to representation or relationships with third parties (usually for business development or the support of business relationships). These expenses include the following: (a) costs of various business related events (e.g. presentations, receipts), including the costs of tea, coffee, mineral waters, juice, breakfast, dinner, supper and banquette, among others; (b) costs relating to sightseeing; (c) costs relating to the purchase of souvenirs; and (d) costs relating to serving guests, including, consular services costs (visa costs); transportation services (e.g. from airport); hotel services (booking, stay); and business event costs.
The representation expenses in excess of the cap established by the Tax Code are taxable under the New CPT. The cap is equal to the higher of the following two items: (a) one percent of the preceding year’s income; or (b) one percent of the preceding year’s expenses.
CONCLUSION
Thus, one of the key developments under the New CPT is that the profits of an enterprise shall not be subject to the New CPT, unless such profits are distributed or the taxpayer makes supplies or payments expressly specified in the Tax Code (e.g. non-business expenses, free supplies, etc.). Another important development is that the Revenue Service shall not have a right to make adjustment to the non-market price transactions between related Georgian enterprises to the extent such enterprises are subject to the New CPT. Lastly, the profit distributed by the Georgian enterprise to another Georgian enterprise shall not trigger the obligation to pay the new CPT. The new regulations, however, set a stricter approach with respect to certain transactions, e.g. payments to offshore companies or loans granted to individuals. Notwithstanding certain disadvantages of the new regulations, it is expected that overall the New CPT will have positive impact on Georgia’s private sector. These expectations are likely to be confirmed in the coming years.
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Note: this article does not constitute legal advice or tax advice. You are responsible for consulting with your own professional tax advisors concerning specific tax circumstances for your business.
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