In the last decade, not withstanding certain slowdowns, Georgia has experienced a steady increase in foreign investment and economic growth. The increase in foreign investment and economic growth has been accompanied by an increase in cross-border activities on the part of Georgian companies and an influx of non-Georgian nationals into Georgia for entrepreneurial or work purposes. These economic trends have heightened interest in the Georgian tax implications of cross-border activities. Georgian legislators have recognized this and introduced a number of new tax regulations to facilitate and better organize such inflows of foreign direct investments.
These tax regulations, introduced in Georgia in recent years, have pursued two major goals. The first is boosting investor interest in Georgia by simplifying the Georgian tax system and introducing tax concessions. Some of these legislative incentives have been successful, while some have yet to yield the desired results.
The second goal of the Georgian tax policy was the prevention of abusive tax practices and the collection of more revenue from increased economic activities. This led to the introduction of special anti-tax avoidance rules, such as thin capitalization and transfer pricing rules. However, inevitably and as is the case in a number of countries, the first goal of simplifying the tax system and making it more attractive to foreign investors created tension with the second goal of preventing abusive tax practices and collecting more revenues.
Pursuit of the noted two goals has resulted in a relatively simple tax system. However, foreign investors must give careful consideration when choosing a business model before entering the Georgian market in light of the tax regulations. This article provides a brief overview of the key tax issues which foreign investors or individuals in Georgia for business purposes usually have to consider.
Taxation of Expatriates
In the past decade, the number of skilled professionals and entrepreneurs moving to Georgia for work or business purposes has increased dramatically. This influx of individuals into Georgia is likely related to certain tax issues.
Individuals moving to Georgia for work for a period exceeding 183 days in any uninterrupted 12-month period automatically gain Georgian tax residency status (“Expatriates”). Prior to the 2008 legislative review, individuals with Georgian tax residency status were taxed by Georgia on their worldwide income. However, after the 2008 changes, income received by Expatriates is taxed only on Georgian-source income.
Thus, if Expatriates receive non-Georgian source income, this income should likely only be taxed once, in the country of origin of the income; and the income Expatriates receive from a Georgian source, should likely only be taxed in Georgia. This system effectively mitigates the risk of Expatriates being taxed in two or more countries at the same time.
That said, the vast double tax treaty network of Georgia may help the Expatriates to legally reduce their tax burden on their non-Georgian source income to zero. This is especially true with respect to certain consultancy work performed by Expatriates outside Georgia. Furthermore, certain double tax treaties of Georgia exempt dividend and interest payments from the withholding tax of the source country. Respectively, Expatriates may get certain non-Georgian sourced dividends and interest payments free from any tax burden because: (a) a double tax treaty exempts these dividend and interest payments from taxation in the source country (i.e. the country from which the dividend and interest payments are derived); and (b) Georgia does not tax the foreign source income of Expatriates.
Notably, foreigners may acquire Georgian tax residency status even if they do not reside in Georgia for a long period of time. Under the tax code of Georgia (the “Tax Code”), a person having “significant wealth” may acquire Georgian tax residency status. In order to show “significant wealth,” the individual must prove that their assets exceed three million Georgian Lari or their annual income exceeds two hundred thousand Georgian Lari over the last three years.
Choosing Business Vehicles: Branch vs. Limited Liability Company
One of the preferred ways of doing business in Georgia for foreign corporations is either incorporating a Limited Liability Company (“LLC”) or a branch (“Branch”) of a foreign corporation in Georgia.
Incorporating an LLC or Branch is a simple process and it may be completed within one day of submitting the required documents to the National Agency of Public Registry of the Ministry of Justice of Georgia. The Tax Code treats LLCs and Branches in the same way in many respects. However, there are notable differences that investors must consider.
Both are taxed with a corporate profit tax on their net income (i.e. profit) at a rate of 15%, but LLCs pay corporate profit tax on their worldwide income minus related expense while Branches are only liable for the corporate profit tax on their Georgian source income and related expenses.
Another difference is that LLCs are required to withhold 5% of the Georgian withholding tax from the profits distributed (i.e. dividends paid) to their non-Georgian resident shareholders, while the distribution of profits of a Branch is not subject to a 5% withholding tax on dividends.
The third important difference in the tax treatment of LLCs and Branches relates to shareholder loans between the shareholders and their Georgian subsidiary. Interest payable on such loans, subject to certain conditions, is deductible from the gross income of the LLCs. However, loan contracts between head office and the Branch are not recognized for tax purposes; interest payments on shareholder loans are not recognized in the case of Branches and therefore these payments are not deductible from the gross income of Branches.
Since choosing a vehicle for doing business in Georgia may have important tax ramifications, investors sensitive to tax risks should assess Georgian tax rules carefully when deciding how to structure their business.
Georgian Withholding Tax
If a non-resident derives income from a Georgian source without having a registered Georgian permanent establishment, then the non-resident is taxed at the source of the payment of the income in Georgia. The applicable tax rate may vary depending on the type of income.
In particular, dividends and interest payments made by Georgian residents to non-Georgian residents are subject to a 5% withholding tax. Amounts paid by entrepreneurs or non-profit organizations for international telecommunication services or transportation services are subject to a 10% withholding tax. Income received by non-Georgian tax resident companies from oil and gas operations is subject to a 4% withholding tax.
The rent or salary paid to an individual is subject to a withholding tax of 20%, while other payments sourced in Georgia are subject to a 10% withholding tax. If these other payments and interest payments are made to persons registered in offshore or tax heaven countries, then the applicable withholding tax rate is 15%.
Non-Georgian Tax Residents Setting Up A Company in Georgia
Investors often opt to incorporate their business as an LLC. This choice inevitably raises questions regarding the preferred ways of financing the LLC from a tax perspective and the tax ramifications when distributing the profits of the LLC.
There are two primary ways for shareholders to finance an LLC: 1) contributing to the capital of the LLC; or 2) providing shareholder loans.
Cash contributions to the capital of the LLC do not trigger tax liabilities for the shareholder or for the Georgian LLC. A non-resident’s return on these contributions in the form of dividends is subject to a 5% withholding tax.
Unlike cash contributions to the capital, shareholder loans may result in certain tax liabilities for the parties. In particular, interest payments on these loans are subject to a 5% withholding tax. However, the interest payments are deductible (subject to certain limitations) from the gross income of the taxpayer. Dividend payments are not deductible from the gross income of an LLC, thus, shareholders loans usually reduce the tax burden for the LLC. For this reason, investors usually prefer to provide finances to their subsidiaries in the form of shareholder loans.
With respect to shareholders loans, it is also worth noting that the Tax Code limits certain deductions related to interest payments. Furthermore, shareholder loans fall within the scope of transfer pricing rules of Georgia. Therefore, shareholder loans require careful consideration and planning.
Georgian Transfer Pricing Rules
All Double Tax Treaties of Georgia have specific rules regarding international transfer pricing. The current Tax Code introduced these rules on 17 September 2010 but the Revenue Service was relatively passive in enforcing the rules because the rules lacked guidelines for the application of transfer pricing methodologies. The deficiency was corrected by Decree №423 (18 December 2013) of the Minister of Finance on the Assessment of International Controlled Transactions which provided guidelines for applying the international transfer pricing rules of Georgia.
Under the transfer pricing rules, the Revenue Service is authorized to adjust the commercial and financial terms (including the price of goods and services) of a transaction between two related parties if those terms differ from what would have been agreed between independent parties (the “Arm’s Length Principle”).
The Arm’s Length Principle essentially authorizes the Revenue Service to increase the price of the transaction and therefore requires Georgian companies to declare more income in Georgia. Alternatively, the Revenue Service may require a Georgian company to apply withholding taxes to the larger amount of income paid by the Georgian company to a non-Georgian resident. This authority creates tax risks for taxpayers with respect to related party transactions. Therefore, any transaction between related parties should be carefully considered and analyzed for all tax implications.
Transactions with Offshore Companies
Offshore companies have often been used by investors for tax planning purposes in Georgia. However, Georgian tax policy makers countered such practices by enacting special rules to deal with transactions with offshore companies. Furthermore, the Revenue Service has also increased its diligence in auditing such transactions.
As of the date of this article, the Tax Code states that any transaction carried out by a Georgian company with an offshore company is automatically subject to the Arm’s Length Principle. This means that taxpayers have to declare their tax liabilities on these transactions in reference to the Arm’s Length Principle. Otherwise, the Revenue Service is authorized to make adjustments to the prices or other terms of the transaction.
In addition, offshore companies’ Georgian source income is subject to a higher withholding tax. In particular, Georgian sourced payments in favor of offshore entities are mostly subject to a 15% withholding tax. The same types of payments by residents to other non-residents (i.e. non-offshore residents) are only subject to taxes varying from 5 to 10%.
For tax purposes, there is a list of offshore countries that are qualified as such by the Government of Georgia,1 including (but not limited to) the following: Hong Kong, Guernsey, British Virgin Islands, Cyprus, Cayman Islands, Lichtenstein, and Monaco.
Double Tax Treaties of Georgia
Georgia has entered into international treaties for the avoidance of double taxation with 47 countries.2These treaties provide important tax benefits for investors and individuals conducting business activities in Georgia. These treaties exempt certain types of income from taxation in Georgia or reduce the applicable tax rate. Furthermore, under some treaties an investor may deduct taxes paid in Georgia from the taxes an investor must pay on the same income in his own country of residence.
Investors usually prefer to enter Georgia from jurisdictions with which Georgia has entered into the treaty on the avoidance of double taxation. However, in light of the level of development of the Georgian legal system, investors should also take into account the relevant international instruments for the protection of foreign investments.
Such protection is usually availed to the investors under bilateral investment treaties (the “BIT”). The BITs provide material protection of foreign investments in Georgia. In particular, BITs offer investors the opportunity to submit any legal dispute with Georgia related to an investment in an LLC to the International Centre for the Settlement of Investment Disputes or other similar international dispute resolution organizations.
In recent years, the Georgian tax system has undergone major changes that have simplified some aspects while making the application of Georgian tax law more complex. Though the reduction in the number of taxes has made Georgia more appealing to investors, given the number of anti-tax avoidance rules and practices targeting offshore and related party transactions, investors should consult with an expert to fully understand the tax implications on their potential investment prior to investing in a business in Georgia.