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Corporate Income Tax Reform in Georgia

Corporate income tax (CIT) is one of the six taxes defined by the Georgian tax legislation. In 2014 CIT was 11.5% of all tax revenues and 2.8% of GDP.

Pursuant to the tax code of Georgia taxable profit shall be a taxable object of a resident enterprise. Article by Giorgi Kavelashvili: Managing partner of audit company ALTIDO LLC – exclusive partner of TBILISI BUSINESS HUB.

Introduction

It shall be determined as a difference between the gross income of a taxpayer and the amount of deductions. CIT rate is flat 15% and tax period is a calendar year.

In addition, Georgian Companies are liable to CIT on their worldwide income, subject to double taxation treaty reliefs. Foreign Companies are subject to tax on Georgian Source income only. Income subject to corporate income tax (tax base) is computed on the basis of International Financial Reporting Standards (IFRS) and modified by certain tax adjustments. The tax base may include trading income, gains from realization of assets, income from financial activities, dividend income etc.

However, the Georgian law has some significant differences from the IFRS including for deduction of expenses (depreciation, travel costs, allowances). Naturally, the person responsible for a company’s accounting, as well as the auditor, should be comprehensively aware of financial accounting system and corporate income tax calculation. Depending on the size and complexity of the taxpayer’s transactions, the process can be very complicated.

The relevance of funds for profit tax declaration mainly depends on the declaration forms and requested information by the tax authorities. According to the World Bank’s 2015 “Doing Business” data, in Estonia taxpayers need 20 hours each year to complete their corporate income tax declarations. In Ireland, the average is 12 hours, in Norway, 15 hours, while in Lithuania, 28 hours. In Georgia, the average time spent on CIT declaration is 191 hours, which means that the Government has to introduce changes to the regulations in order to decrease tax burden on taxpayers and make the tax administration taxpayer friendly.

Problem Definition

The Georgian economy currently is experiencing challenges requiring adequate measures from the Government to address. Access to credit for entrepreneurs is still restricted because of a higher interest rate compared to international rates. There is no significant positive tendency in regard to Foreign Direct Investment (FDI) inflows and domestic savings are also insufficient for boosting increase of stock for capital in businesses. As a result, the GDP growth rate has decreased in 2013 and 2014 compared to the tendency in the previous years. Economic slowdown is translated to a persistent high rate of unemployment and negative trade balance. The coincidence of the country’s economic problems with unfavorable international factors resulted as well in depreciation of Georgian Lari (GEL) compared to the US Dollar (USD).

New Model of CIT

Tax incentives are one of the significant stimulators for economic growth. In order to address these challenges, the Government considers abolishment of the retained earnings tax on companies, the reform that brought quite successful economic results in Estonia in 2000.

According to the bill, corporate income tax will only apply to distributed profit; undistributed profits, reinvested or retained, will not be subject to income taxation starting from January, 2017. After introducing the new tax regime it is presumed that budget revenue will decrease by 400-600 Million. It is critical to define how the Government will compensate the losses. Whether the Government will introduce new taxes, or increase the tax rates on existing taxes, or by reducing the budget expenditures.

General objective of the CIT reform is to improve economic growth prospects of the country through the nullification of the retained earnings tax on the companies. Specific objectives are to promote investments, create jobs, promote entrepreneurship, increase sustainability of companies in the economic downturn and improve GDP growth. 

Effect of the Reform on Tax Revenues

Pursuant to the USAID Regulatory Impact Assessment the CIT model has investment favouring effect. The stock of capital will increase by 3.23% within 1.5 years. This means that the net investment will increase. Economic agents will invest more than they used to invest. Real GDP will increase by 1.44% roughly within 1.5 years. Aggregate private consumption will increase by approximately 0.85% within 1.5 years. The reform will increase the government annual budget deficit by 3% at most. Current Account deficit will slightly decrease, implying some of dividends that were leaving the country will stay in Georgia due to investment favouring effect.

Graph 1: The Main Impacts of the Reform

graph
Source: USAID RIA; February, 2016

Overall, appropriate growth policies are always context specific. This is not because economics works differently in different settings, but because the environments in which households, firms and investors operate differ in term of opportunities and constraints.

Implementation of CIT reform in Georgia will have positive macroeconomic effects. Moreover, as seen in the last few years, the average economic growth rate has decreased and, therefore, this reform can be seen as a push for the economy not to stay in an economic growth trap. However, even though reform has a strong investment favoring effect, other developments in the economy, for example, the increase in ambiguity or institutional instability, might override the growth promoting incentives created by reform.

Furthermore, methodology of reform implementation and how changes in tax law will be formulated will definitely affect results of the reform. These factors are crucial and should not be discounted.

Conclusion

Along with macroeconomic benefits, implementation of the new CIT model in Georgia could bear some risks, which need to be considered and discussed.

Presently only Banks and large companies use IFRS – financial accounting/financial reporting, while smaller companies do simple accounting. Dividend can be properly counted only in IFRS (deduction).  This means higher cost for small and medium businesses. Taxpayers are familiar with the current system, hence imposing the new CIT model that also encourages capital accumulation, will probably cause distortion of taxpayers decisions and take time to adjust to a new system. Capital gains are not taxed separately – capital gains derived by companies remain exempt from tax until profit distribution occurs. This would obviate the need for complex capital gain rollover relief measures as companies churn assets for purposes of growing real investments.

In conclusion, the policy makers have to carefully analyze macroeconomic effect of a new CIT model, before introducing the new regulation. A model implemented successfully in one country does not necessary mean that it would work in another country, like Georgia.  One thing is clear, in the short term deficit will increase and it has to be balanced. Furthermore, adoption of a CIT model may take from a few months to several years to be properly implemented and followed. So, it remains to be seen if these changes would have “a boomerang effect” for the Government or not.ვ