1% personal income tax applicable in Georgia What to know and consider?
Under article 90 of the Georgian tax code, an individual with an earning up to 500 000 GEL (approx. $150 000) yearly obtaining a certificate of “small business” can enjoy 1% personal income tax in Georgia.
We see that 1% is a super low tax, highly beneficial for many freelancers and individual entrepreneurs worldwide. You cannot find many jurisdictions offering such tax incentives; however, that is not as simple as it sounds.
Here is what you should consider before enjoying the 1% taxation in Georgia:
Positive side: The 1% taxation is available without being a tax resident in Georgia
Yes, you do not need to be Georgia’s tax resident to benefit from the “small business” status. When Georgia’s Revenue Service issues this certificate, the authorities do not ask if you are a Georgian tax resident, but about the business activities you carry out.
On the other hand, if you are not a tax resident of Georgia but a tax resident of another country, 1% taxation might not be fully beneficial for you as, most likely, the income form services invoiced from Georgia and taxed by 1%, will be taxed again under the law of the jurisdiction of your residence (worldwide taxation).
Such a problem (worldwide taxation in other jurisdictions) may also arise when you are a dual tax resident: of Georgia and other countries (even if the tax treaties are in place, they do not always ensure full protection). It is a long story with many details, but in short, the most effective way to thoroughly enjoy the tax benefit is relocation to Georgia. You can see my article about the Georgian tax residency rule here.
Negative side: “Small business” status does not apply to all business activities
For example, consultation service and employment contracts (and some other business activities) do not qualify under the 1% taxation in Georgia. A list of activities for are qualified for “small business” status is given in decree #415 of the Georgian government.
The mentioned decree #415 provides the list of:
- Economic activities that are allowed for “Small Business” entrepreneurs and are taxed at 1% (or 3% above 500,000 GEL, if applicable);
- Economic activities that are allowed for “Small Business” entrepreneurs and taxed at the regular rate of 20%;
- Economic activities that are not allowed for small business enterprises, meaning that in the case of performing such activities, the status of “Small Business” will not be granted or will be revoked.
Thus, you should find out if there is a risk of a Georgian tax authority to re-qualify your service, for instance, as a consultation service (forbidden business activity).
Notably, for qualifying under the 1% taxation, it is not decisive what title you give to your contract, but contractual conditions should be in line with the reality. Otherwise, Georgian tax inspectors might apply the so-called General Anti-Avoidance Rule (GAAR) and change the qualification of your business transactions for tax purposes.
According to the Georgian tax code article #73.9:
“To determine tax liabilities, a tax authority has the right:
- a) not to take into account business transactions of no substantial economic impact;
- b) to change the classification of a business transaction based on its form and substance if the structure of the transaction does not correspond with its substance”
You see that Georgia’s tax authorities are entitled to change the transaction’s qualification regardless of a contract. For example, if a contract says “IT service” or “management services,” a tax authority might qualify it as consultation on IT or consultation on management issues; as a result, that revokes the “small business” status retrospectively.
Thus, please, make sure that the contract terms are well-worded and comply with the real activity.
The same problem might arise regarding qualifying a contract as service provision or employment. (Employment income is taxed by 20% in any case). If you work as an employee and change your contract and name it “service agreement” to enjoy the 1% taxation, make sure that other conditions of the contract and actual conduct also change, otherwise, only changing the name might lead to the application of GAAR.
Several factors make an employment contract different from a service provision. For example, when a service provider has only one client for a long time, it might create doubts that the contractual relationship is employment and not the service provision. Of course, that is not the only decisive factor in this analysis but they might start with that.
For your information, there have been several cases when Georgia’s tax authorities challenged the “small business” status, claiming that based on the facts, a person was an employee and not a service provider and the only purpose of naming a contract a “service agreement” was to benefit from the 1% tax.
Positive side: If your income exceeds 500 000 GEL per annum, it is not the reason for the “small business” status annulation
If your income exceeds 500 000 GEL annually, it is not a legal base for revoking the “small business” status as long as the 500 000 income threshold is not exceeded in 2 consecutive years.
Besides, you pay 3% above 500 000 starting from the month when you exceed the threshold. If you receive 600 000 GEL by one transaction and it is your recognized income, you pay 3% on the full amount of 600 000 GEL. On the other hand, if you receive 60 000 GEL during 10 months, and exceed the threshold in the 9th month, you will pay 1% during the first 8 months on 480 000 GEL and 3% on 120 000 GEL.
Note: tax reporting period for “small business” is a month.
Negative side: Ownership of a certificate of “small business” does not mean the guaranteed 1% rate. It still can be challenged by tax authorities (e.g., revoking the status and applying 20% retrospectively)
You cannot enjoy the 1% taxation without a “small business” certificate issued by Georgia’s Revenue Service. However, when you have the certificate, it is not a legally binding document for the Georgian tax authorities, as they still can challenge the status and claim you not to be taxed by 1%, but – 20% regular rate.
The procedures work as follows:
You visit a service center of Georgia Revenue Service (GRS-Georgian tax and customs administration), e.g., at Kostava Avenue, Tbilisi, take your queue number, and get served by a nice and polite girl (Assumption: at that moment, you are already registered as a taxpayer). You can visit the service center alone or with a tax adviser.
She asks the reason for your visit. You say that you need to obtain a “small business” status. The main question from here is: what is your business activity? If you say, for example, “a consultation service”, or only “employment” they tell you that you do not qualify for the 1% taxation mode. If you say that, for example, you carry out the IT service, you will receive the “small business” certificate.
The girl at the service center does not request service contracts and does not verify if you provide IT services; she relies on your words and issues the certificate.
However, if, for example, after two years, a tax inspection is initiated in your business, tax inspectors from the audit department of Georgia Revenue Service (where I worked for almost 8 years) will check your contract and the actual conduct of your business (the substance of the business transactions).
Imagine that they find out that your activity implies providing consultations regarding IT, and other forbidden activities instead of IT services. In this case, they will revoke your status and make tax assessments retrospectively, applying a 20% personal income tax instead of 1%, regardless of having the “small business” certificate. Plus, you will face a penalty of up to 50% of the additional tax and 0.05% interest on the principal amount of tax for each overdue day.
Notably, the statute of limitation in Georgia lasts for 3 years. In reality, this period is 3 years and 11 months for the taxes reporting period of which is a month. After that time, a tax period closes and a tax authority is not entitled to conduct tax inspections. For example, currently, it is December 2020, and tax authorities cannot check 2016 because it is a closed tax period. However, authorities can check for almost 4 years from January 2017. They can go nearly 4 years back and recalculate your taxes if they decide to revoke your “small business” status.
The same approach applies for “Virtual Zone Persons”
As you might know, besides 1% for individuals and many other tax benefits, Georgia also offers 0% of corporate income tax for IT companies providing IT services from Georgia abroad and holding a certificate of “Virtual Zone Person” (VZP). The same tax risk should be considered by companies having the status of VZP as for “small business.”
In particular, a certificate of VZP does not mean guaranteed exemption from corporate income tax because such certificate is not binding by the law for tax authorities, and such an exemption does not apply to any IT activities provided from Georgia to abroad; there are critical preconditions to meet for qualification under such tax exemption. So, if the government issued the VZP certificate for your company, that does not mean that the government has verified all information provided by you and no one will challenge your tax exemption in the future. Unfortunately, many misunderstand this issue.
In brief, there are many entrepreneurs in Georgia who benefit from 1% tax lawfully and they have zero problems with tax authorities. So, I encourage you to enjoy tax benefits in Georgia, but please, do it right.
In Georgia, 1% taxation of individuals (natural persons) is a great possibility for many entrepreneurs and freelancers to save tax expenses in a legal way. However, as I already noted, you should be careful before enjoying this tax benefit.
Before obtaining the status, you should receive proper pieces of advice and make sure that your business activity is subject to the 1% taxation, and your contract is well written and consistent with your business’ conduct.
Finally, for 8 years of working as a tax inspector, I have seen various cases proving that it is very “expensive” for businessman/entrepreneur to “solve” tax-related issues without consulting with a qualified professional. It frequently happens because of the hope that the tax inspection will never be initiated in their business. As a result, quite frequently they end up with a high tax assessment and penalties.
Thus, enjoy a 1% tax in Georgia as many entrepreneurs do, but do it carefully and correctly.
About the author: Gela Barshovi is an international and Georgian tax adviser and a managing partner of Tbilisi-based accounting/consulting firm TPsolution. Regarding business incorporation, tax consultation, and/or accounting services, you can directly reach out to him at firstname.lastname@example.org