GETTING DOWN TO DETAILS
Businesses have continuously praised efforts to streamline the tax code, but idiosyncrasies still cause headaches. Investor.ge spoke with tax experts, accountants, business owners and policy makers to see what issues exist – and how the government plans on addressing them.
Maia Edilashvili
The Georgian government has spent an enormous amount of time and energy working on the tax code. However tax laws ending in ‘etc.,’ unexplained double taxation and mixed messages from officials indicate that the Georgian tax code is still a work in progress.
To break with the Shevardnadze past, the Saakashvili government passed a new code in 2005. Two years later, the new Customs Code followed. As a result of the reform, only six taxes remained instead of the initial 21, and just seven out of 15 customs procedures are still in force.
The result has been accolades from business surveys like the Doing Business report (Georgia has scored in the top twenty economies for the past few years) and record high investment. Businesses operating in Georgia, however, state that inconsistencies and other issues remain.
Luc Caltrider, an advisor to Finance Minister Kakha Baindurashvili, maintains that there have been numerous reforms to enhance tax administration and the audit process.
Prior to his appointment at the ministry, Caltrider worked in Georgia’s business sector for five years.
One example, he said, are the structural changes which improved the efficiency of tax administration. “A few years ago, if you had a tax problem, you would be dealing with multiple ministries with no clear procedure, and the process was overly cumbersome and bureaucratic,” he told Investor.ge in an email interview. “These problems have been eliminated and the MoF has established a clear system of controls and procedures.”
Other practical improvements he said include the establishment of the Tax-Free Zones – “a major benefit for international investors and business owners” – and the introduction of the new electronic filing system for tax declarations.
According to Mariana Guledani, there have been noteworthy improvements to the tax code and tax administration.
But problems remain. One issue, she said, is that the code is so vague at times that businesses and tax lawyers have a hard to anticipating how it is interpreted by the authorities.
“Definitions [in the law] are sometimes so broad that it creates serious problems,” Guledani, founding partner of CFS Legal, Guledani & Partners, a financial law firm, said.
She noted that in countless cases a rundown of 25 paragraphs end with “etc.” giving the tax inspector too much discretion while discussing disputed issues.
Some other complaints are very specific, and the impact is substantial – and costly - for those affected.
Ivo Bakhuijzen, general director of Dutch Design Garden, the Dutch garden designer Martin Veltkamp, has faced obstacles making oversea payments since the Tbilisi office opened in 2008.
“The biggest problem for us is to pay our bills…since we have to pay all of them overseas,” Bakhuijzen explained to Investor.ge.
The company pays a VAT of 18 % at the Sarpi customs office for every new supply which comes from its Dutch partner. Once the goods are sold, Bakhuijzen transfers part of the earnings to the Netherlands as a cost of the purchase. Doing this, he has to pay VAT again and 10 % more – 28 % in total.
The same system of taxation is levied against Bakuijzen when he pays for Dutch consultants to come to Tbilisi.
According to Irakli Siradze, the deputy chairman of the Finance Ministry’s Revenue Service, double taxation is necessary to level the burdens on resident and non-resident taxpayers
Siradze noted that the 10 % tax, which is withheld apart from 18 % of VAT, is levied on a non-resident taxpayer for income made in Georgia. However, he noted that the government is reducing this tax: by January 1, 2011 it will be zero percent.
Irakli Shavishvili, a tax expert with NESG, a Tbilisi-based think tank, agrees that double taxation is necessary. Regarding the 10 % tax, which is withheld apart from 18 % of VAT, he says it can be either income tax or profit tax, depending on circumstances.
“Withholding income tax for a service provided by a non-resident or levying a double taxation requires identifying where the service has been performed,” Shavishvili told Investor.ge. “If the service has not been performed in Georgia, then double taxation should not apply. But since the consultation was performed in Georgia, it had to be taxed.”
Adding to the problem for Bakhuijzen is an overseas repayment obligation. To open the Tbilisi office, its Dutch owner invested 500,000 euro, a loan from the Dutch bank. Now, in order to pay interests, he has to transfer 1,000 euro to the Netherlands monthly.
“Paying an overseas company for consultation or paying [loan] money back to the bank – every cent that seems to go abroad [from Georgia] is taxed,” Bakhuijzen noted.
Shavishvili agreed that paying loans – a financial service – should not be charged VAT. “Giving out loans is a financial service, which is exempt from VAT.”
Remaining loopholes
But businesses and experts agree that many of the previously insoluble tax-related problems have been tackled by the government.
One that continues to be an issue, however, according to Guledani, is the Tax Code’s inability to precisely qualify a taxpaying model for a foreign-registered investment fund.
“Often I have to include in discussions both auditors and the ministry representatives to determine a taxpaying model for the investment funds and results are not so straightforward,” she said. “There always are arguments for and against certain conclusions. Often we have to give up exemptions for the sake of security.”
Local banking regulations prohibiting the settlement for goods and services on the Georgian territory in foreign currency is a challenge too.
The issue is troubling because there are thousands of companies in Georgia that involve foreign currencies in their business.
This issue, Guledani says, creates foreign exchange risks “while the typical instruments for hedging this risk are virtually nonexistent in Georgia.”
The problem, according to business insiders, is that overnight fluctuation of the Georgian lari exchange rates can cost a company significant sums.
A senior official of a Tbilisi-based investment fund, who preferred to remain anonymous, noted that this typically wouldn’t be a major risk: literally small percentages, like less than 1% or even less than 1% of the transaction amount, assuming the currency is more or less stable.
“But, if - though chances are rare - there is a sudden and major currency depreciation - for example, due to an unexpected crisis or event - at the moment when a very large payment is being made, the loss could be large,” she told Investor.ge in an email comment.
According to Catrider, this is not an uncommon challenge around the world, but the problem in Georgia is that the Georgian securities market does not have a mature, developed derivatives market to offer USD/GEL or EUR/GEL options and futures.
“If these instruments were more available and traded often, then investors would have the opportunity to lock in specific currency exchange rates for a period of time,” he said. “These hedging operations are done all over the world every day, but, unfortunately, they are not currently available, on a large scale, for the Georgian lari.” So he thinks that if this market can develop, then foreign currency risk will be dramatically mitigated.
The dangers business face with currency exchanges was underscored last year, when the lari’s worth fell by over 13% in the span of a few days.
Kakha Rukhadze, the chair of the tax committee at the Georgian Federation of Professional Accountants and Auditors (GFPAA), singles out two more burning problems about the tax regulations.
The first is that the ministry’s printed response to anyone, which had asked a question, has no legal power. “That company may follow the ministry’s explanation but later it may somehow turn out to be the wrong decision. Then the document provided by the ministry will not be of any help and the company will face penalties,” he said, adding that this sticky question has long been put on the ministry’s agenda but no outcome is in sight.
The second problem is the lack of communication among the ministry’s departments as well as a piece-meal approach to similar cases.
“One of the members of our organization …requested an explanation from the ministry’s tax collection service and … from the 077 hotline service, which is also part of the ministry, and got two different answers.” Rukhadze said.
He added, however, that the 077 service is a success story, providing useful service free for those who can not afford to hire an auditor.
Progress, progress, progress
A further illustration of the gap between the local and the international laws is Georgian law’s incapacity to acknowledge the tax neutral nature of special purpose entities involved in the arrangement of structured finance products.
Laws recognizing such practices allow for the creation of special purpose entities in order to eliminate risks: these entities take responsibility over one company’s assets and pass the assets over to another without risk for the ultimate purpose of raising funds. The status of such intermediary companies is non-commercial and hence, they are normally exempt from taxes.
“We cannot even dream of such a benefit,” Guledani said.
CFS Investment Bank creates structured finance products using intermediary companies for the issuance of securities and raising debt capital.
Such money, Guledani explains, is cheap and less risky. Therefore, it helps keep the financial system healthy and diversifies ways of drawing financial resources. “[These type of operations] are very complicated here as our tax code does not recognize a non-commercial nature of such intermediaries.”
But Gudedani notes that there have been some “important” amendments to the tax code this year, specifically decreasing income tax from 25% to 20% and dividend tax from 10% to 5% starting from January, 2009.
According to her most of the problems are simply growing pains: the law has not caught up with the quickly developing business community. Guledani noted that she believes when the number of complaints reaches a critical mass, change will follow.
“In any country, when laws are written, they are not sophisticated from the very beginning. Especially, in our country, as we have just switched to a market economy,” she said. “Usually, faults are corrected after it becomes clear that there is a need for the change.”
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