I.Tax Incentives for Offshore Countries

Corporate Income Tax in Georgia and the so-called "Estonian Model"

Before January 1, 2017, Georgia operated under a standard corporate income tax model, whereby Georgian companies paid income tax on their net profit. Specifically, according to the tax code in effect before 2017, the corporate income tax was levied on "the difference between the taxpayer's total income and the amounts deductible under the code."[1]

Starting from January 1, 2017, the law changed, and a new corporate income tax system, the so-called "Estonian Model," was introduced. The core idea of this model is to defer corporate income tax until the company distributes the net profit to an individual founder or a non-resident entity.[2] With the help of the "Estonian Model" of corporate income tax, a Georgian company can avoid paying corporate income tax if it reinvests the profit it receives back into the business. Therefore, if the company does not distribute the net profit as dividends to the shareholder, it will not pay corporate income tax. However, when the company decides to distribute the accumulated profit, it will have to pay tax at the same rate as under the standard model (15%).

The "Estonian Model" of corporate income tax does not apply to all taxpayers, and in this regard, the tax code establishes several exceptions. Notably, financial institutions (banks, credit unions, microfinance organizations, and loan-issuing entities) and non-resident companies remain under the standard model of corporate income tax. Specifically, financial institutions and non-resident enterprises typically pay corporate income tax on their net profit, which is the difference between the total income received and the amounts deductible in relation to earning that income.

Additionally, the income received by non-resident enterprises may be taxed either under the general rules (for example, income from the supply of goods) or under special rules (for example, dividends, accrued interest, or royalties for the use of intellectual property).

In the case of active income, such as income from the supply of goods, foreign enterprises use the standard model. Specifically, in the case of the sale of property located in Georgia, the object of corporate income tax for the foreign enterprise is the difference between the total income and the amounts deductible as established by the tax code.

Low-Tax Jurisdictions, or So-Called “Offshore” Countries

Georgian legislation does not use the term "offshore." Instead, what is commonly referred to as "offshore" is designated in the Georgian Tax Code as a "low-tax jurisdiction." The Tax Code outlines the criteria that a state must meet to be classified as a low-tax jurisdiction under Georgian law. Specifically, a country is considered a low-tax jurisdiction if:

• There is no corporate income tax imposed on the profit received by a legal entity;
• A legal entity is exempt from corporate income tax;
• The corporate income tax rate does not exceed one-third (i.e., 5%) of the corporate income tax rate in Georgia.[3]

The list of low-tax jurisdictions, considering the aforementioned criteria, is determined by the Government of Georgia[4] through Resolution No. 615 of December 29, 2016.[5]  This list includes territories such as the Virgin Islands, the Cayman Islands, Andorra, Uruguay, Kuwait, Belize, Chile, and others (a total of 64 countries/territories).

In this regard, it is noteworthy that the income received from Georgia by enterprises from low-tax jurisdictions is taxed similarly to the income received by residents of other countries, with minor differences. Specifically, for passive income, interest and royalties paid to a low-tax jurisdiction are taxed at a rate of 15%, instead of the standard 5%. However, dividends in this case are still taxed at 5%. As for income received from the sale of assets, there is no difference in taxation. Specifically, if a resident enterprise of a low-tax jurisdiction purchases shares/stocks of a Georgian company and later sells those shares/stocks at a higher price, its net profit will be the difference between the sale price and the purchase price, and 15% of this profit will be paid to the state budget of Georgia.

Legislative Changes in the Tax Code Regarding "Offshore" Companies

Members of the Georgian Parliament, Paata Kvizhinadze, Anton Obolashvili, Irakli Kirtzkhalia, Bezhan Tsakadze, Zaal Mikeladze, Irakli Zarkua, and Gogi Meshveliani, presented a bill concerning "offshore" companies to the Georgian Parliament on April 10, 2024. Furthermore, the Parliament reviewed the bill concerning "offshore" companies under an expedited procedure and passed it on its third reading on the ninth day after its registration, April 19.

On May 2, 2024, the President of Georgia returned the bill to the Parliament with motivated remarks, suggesting the removal of tax benefits from the bill related to companies registered in offshore jurisdictions. [6] The Finance and Budget Committee of the Georgian Parliament (the lead committee) issued a conclusion on May 21, 2024, not supporting the President's motivated remarks.[7] Subsequently, on May 29, 2024, the Parliament overrode the President's veto in a plenary session and supported the original version of the bill. [8]

According to the legislative amendment, Article 309 (Transitional Provisions) of the Georgian Tax Code is supplemented with Paragraph 146, with the following wording:

"Where the ownership rights to all assets (including shares) of a foreign enterprise registered in a low-tax jurisdiction are transferred to a Georgian enterprise by January 1, 2028:

1. a) The income/benefit received from this transaction by the foreign enterprise and its partner individual, considered as income from a Georgian source for the purposes of this Code, is exempt from profit/income tax;
2. b) The import of the asset/goods into Georgia is exempt from import duties. The rules and conditions for applying this subparagraph 2 shall be determined by the Minister of Finance of Georgia;
3. c) The Georgian enterprise is exempt from property tax on the asset received within the framework of this transaction until January 1, 2030.

Note:

1. This part applies if:
2. a) 100 percent of the shares of the foreign enterprise registered in the low-tax jurisdiction and the Georgian enterprise are owned by the same individual (group of individuals);
3. b) The transfer involves an asset that was owned by the foreign enterprise registered in the low-tax jurisdiction as of the effective date of this part.
4. In cases covered by this part, the value of the asset for the receiving party is the same as its value for the supplying party at the time of transfer."

Results of the New Law

Explanatory note of the law

The explanatory note accompanying the bill on amendments to the Tax Code concerning "offshore" companies states that investments in Georgia are often made by foreign enterprises registered in low-tax jurisdictions (offshore), which operate in Georgia through their subsidiary companies. This involves risks of tax evasion and hinders efficient tax administration. Given this, it is important to facilitate the process of transferring assets from companies registered in low-tax jurisdictions to Georgia to prevent tax evasion, ensure business transparency, and simplify tax administration.

The explanatory note also mentions that the process of transferring all assets to Georgia by an "offshore company" may be hindered by the tax obligations that arise during the transfer of these assets. The aim of the legislative change is to encourage the process of transferring assets from a foreign enterprise registered in a low-tax jurisdiction to Georgia by establishing temporary tax benefits for these operations.

Accordingly, the authors of the law state that the main objective of the law is to facilitate the transfer of ownership rights of assets from offshore companies to Georgian companies by establishing tax benefits. To share this logic, we need to determine at least two things:

• Transferring assets from offshore companies to Georgian companies is currently not possible without taxation;
• With the help of the new amendments to the Tax Code, it will become possible to transfer assets without taxation.

We previously noted that in the case of an offshore company selling an asset located in Georgia, the object of corporate income tax is the difference between the selling price of the property and its purchase price (capital gain). According to the legislative amendment, if the ownership rights to all assets (including shares) of a foreign enterprise registered in a low-tax jurisdiction are transferred to a Georgian enterprise by January 1, 2028, the income/profit received by the foreign enterprise from this transaction is exempt from profit/income tax. In other words, within the framework of the new law, if the criteria specified by the law are met, the offshore company will no longer have to pay profit tax on the aforementioned capital gain to the state budget of Georgia.

However, it is noteworthy that even without this legislative amendment, an offshore company can transfer its assets to a Georgian company without taxation, for example, by transferring assets free of charge, contributing these assets to the capital of a Georgian company, or liquidating the offshore company and transferring the assets it owns to the individual founder.

Accordingly, the only novelty of the law is the exemption of an offshore company from corporate income tax in the case of asset transfer through a sale.

Additionally, it should be noted that the legislative amendment does not create any real motivation or incentive for transferring assets from an offshore company to Georgia. Specifically, the benefit is provided only for the operation of transferring the assets. After the assets are transferred, the tax regime remains essentially the same.

In summary, the law does not effectively achieve the goal outlined in the explanatory note. Firstly, it is already possible to transfer assets from offshore jurisdictions to Georgia without taxation even without this amendment. Secondly, the amendment fails to create a genuine incentive for transferring assets to Georgia, as the tax regime remains unchanged and only the transfer operation itself is exempt from tax.

The real outcome of the law - tax-free profit extraction from Georgia

According to the legislative amendment, the tax benefit applies to the transfer of assets by an offshore company to a Georgian company, where the income from the sale of these assets is considered income from a Georgian source for the purposes of the Tax Code.

Income from a Georgian source is defined by Article 104 of the Georgian Tax Code. According to this article, income from a Georgian source includes income from the sale of goods if the supply of goods (transfer of ownership) occurs within the territory of Georgia. Income from a Georgian source also includes income from the sale of shares/stocks of a resident company.

Accordingly, the tax benefit regarding corporate income tax does not apply to the supply of assets located abroad or shares of a foreign company. An offshore company will benefit from these tax exemptions if the asset it transfers to a Georgian company is located in Georgia—such as real or movable property in Georgia or shares of a Georgian resident company. Therefore, the tax benefit regarding corporate income tax applies not to the transfer of assets from abroad to Georgia, but to the change of direct ownership of assets already in Georgia, provided that the beneficial owner of the assets remains the same individual or group of individuals.

It is important to note that when a Georgian company purchases an asset from an offshore company, the Georgian company pays the corresponding purchase price to the offshore company. Due to the amendments to the Tax Code, this payment will be transferred from Georgia to the offshore company without incurring any taxes.

In this way, the legislative amendment enables the accumulated profits of a Georgian enterprise, which would have been taxed if distributed to the shareholder, to be transferred out of Georgia tax-free as a purchase price. Specifically, a Georgian enterprise that accumulates profits can, instead of distributing these profits as dividends, purchase property located in Georgia from its own offshore shareholder. Through this mechanism, the accumulated profit of the Georgian company is transferred to the offshore company as a purchase price, which, under the legislative amendment, is exempt from profit tax.

Consequently, the indirect result of the legislative amendment is that profits extracted from businesses in Georgia, which were previously taxed at 19.25%,[9] can now be transferred without any tax liability. This process merely requires a restructuring of the business without changing the ultimate beneficial owner, allowing the accumulated profit to be transferred as a purchase price rather than as a dividend.

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