e c o n o m y

e c o n o m y

From profit tax

to distributed profit tax system
Prepared by PMCG research team.

eorgia has a
consistent track
record with regard to improving its business
environment.

However, having a favourable business environment has yet to make a

significant impact on the countrys
competitiveness. Therefore, Georgia
is initiating a new corporate income
tax system, entailing a switch from
the classical profit tax system to a
distributed profit tax regime.
Georgia is classified as a lowmiddle income country. The GDP

per capita in Georgia in 2015 was

3 720 USD. Compared with other
nations, this is 20 times less than
in Norway (76 266 USD), 15 times
less than in the USA (55 904 USD),
10 times less than in France (37

728 USD) and 5 times less than in

Estonia (17 425 USD). Therefore,
GDP growth represents an important and substantial challenge for
Georgia. What can be done? The
options are plentiful. Thus, it is
necessary to prioritise and spend
resources on the most effective reforms that will address the primary
problem in the country, namely
low income. To stimulate more
investment and ease the business
environment in Georgia should be
a priority number one.
Recently proposed corporate tax
reform is a step forward in this regard. The current corporate income

taxation system in Georgia is a classical system, according to which eligible costs are subtracted from revenues and a 15% tax rate is imposed
on total profit. The core of the new

corporate income tax system (known

as the Estonian model), which will
come into force from January 2017
involves a shift of focus from the
moment of earning profit to the
moment of profit distribution. This
means that as long as profit is not
distributed, then corporate income
tax is not applicable to the company
(although some other costs, not related to business operations, will be
taxed). Regardless of how successful
your company is, it is possible to run
your company without any corporate
taxation.
Primarily, companies are subject
to income tax only in respect of
all distributed profits (both actual

and deemed), including:

Corporate profits distributed in
the tax period;

Gifts, donations and representation expenses and other expenses

and payments not related to business.
The uniqueness of the new corporate income tax model is the fact
that the object of income tax is
only the revenue that a company
pays to natural persons. Therefore,
the tax authority does not have to
detect whether a company received
revenues and when the revenues
were created. The task of the tax
authority is to check if the required
taxes have been paid on the basis
of the transactions of revenues
declared and paid by companies to
natural persons. In addition, the
tax authority also adjudicates the
relevance of business costs.
As distributed profit tax calculation
does not require separate detailed
analysis of the revenues and expenses and instead focuses on cash
disbursements, this model markedly simplifies tax administration.
Unlike the classical model of profit
tax, there is no need to control
costs not related to the outflow of
money from the company, i.e. there
is no need for rules concerning tax
depreciation, loss carry-forwards or
carry-backs, thin capitalization etc.
In the Regulatory Impact Assessment (RIA) conducted by a PMCG
consultant, the additional macro-

The analysis of stability of the

model and convergence speed to
the new equilibrium reveals that
these results will be realised within
approximately 1.5 years.
Currently, access to finance is
one of the main constraints for
companies in Georgia, especially
for SMEs. While globally the SME

Aggregate private consumption

will increase by 0.85% within 1.5
years.
The reform will increase the
government annual budget deficit

The reform is accompanied by

short run fiscal sustainability

The reform has the effect of

attracting investment. The stock
of capital will increase by 3.23%
within 1.5 years.
Real GDP will increase by 1.44%
roughly within 1.5 years.

georgiafinance | spring 2016

Current account deficit as defined

in the model will slightly decrease,
meaning some dividends that were
leaving the country will stay in
Georgia due to the investment attraction effect.

sector is a major source of private

sector growth, innovation, and jobs,
in Georgia it remains underdeveloped. SMEs account for nearly
94 percent of registered firms in
Georgia and 38 percent of formal
employment, but they account
for only 20 percent of gross value
added and for less than 19 percent
of turnover. Different research
analyses show that the distributed
profit tax mechanism leads to an
increase in holding of liquid assets.
As a result, the share of debt in
total assets decreases. The effect
will be stronger for small firms
who tend to find it more difficult
to access external funding.

economic effects of introducing

the Estonian corporate income
tax model for Georgia were assessed. The analysis shows that:

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by 3% at most. For smooth transition to the new system, the government might consider not increasing
government spending for the next
2-3 years.

risks. According to the data for

2015, corporate income tax makes
up 13% (1,025 mln GEL) of overall
tax revenue in the budget. If we expect that the profit tax revenue will
halve (as was the case in Estonia),
short run fiscal sustainability risks
may arise. The gap in the first year
of implementation of the reform
can be around 400-600 million GEL,
which is about 1.5% of GDP. The
revenue gap in the budget can be
adjusted by other supplementary
policies planned by the government.

In summary, we can say that in addition to the increased competitive

ability that companies in Georgia
will enjoy thanks to greater liquidity arising from lower corporate
income tax, they will also benefit
from the simplicity and comprehensibility of the act and smaller
administrative costs.
We can also state that this act,
along with the general business climate, other business deregulations,
anticorruption, as well as various
reforms on law, tax and trade that
Georgia put in place in the past
decade, will make the country a
more attractive destination for
investors.
Thus, in addition to its geographically advantageous location, Georgia has to strengthen and prove
its other competitive abilities in
every way and compete with other
emerging countries in creating a
more deregulated and welcoming
environment for doing business.
georgiafinance | spring 2016

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