Companies providing certain types of IT services from Georgia (study, support, development, design, production, and implementation of computer information systems that result in software production) to foreign customers can obtain a certificate of "Virtual Zone Person" (VZP) and enjoy exemption from corporate income tax (15 percent) Georgia under Law No. 4064- "On Information Technology Zones" adopted on December 15, 2010. This implies that at the time of distribution of net profits, companies with this status have an obligation only to pay dividend tax (5%).
The purpose of this Law is to attract investments and provide an enticing environment for persons who will carry out economic activities related to information technology.
From the beginning of 2011 to date, more than 1,000 companies have been granted the status of a virtual zone person by the Ministry of Finance, most of which were established by non-residents of Georgia. Majority of the companies work by outsourcing product development outside of Georgia, its implementation and sale by a Georgian company to foreign customers. The Government, represented by the Ministry of Finance, easily grants the status of VZP and issues certificates based on an electronic application (correspondence), to any entity, including companies that indicate that they plan to employ foreigners or order services outside the country.
Not only the tax inspectors did not verify these companies for compliance with their activities or the status of a person of the virtual zone from 2011 to 2020, but they did not make decisions on the additional calculation of income tax. That means, the tax department has not questioned the origin of information technology products created by the face of the virtual zone and did not present any prerequisites for the application of tax benefits throughout an entire past decade.
The aggressive approach of the tax service from 2021:
In 2021, mass audits of these IT companies were launched for verification of their activities with the preferential status received. The first stage - in the spring of 2021, employees of the tax authorities of Georgia began to contact (via mobile communication/e-mail) the representatives of the persons of the virtual zone with a request to provide evidence that the information technologies they provide to foreign clients were developed on the territory of Georgia. Partial verifications were carried out on the company's documentation (not as part of the audit, but through electronic correspondence) for the volume of cash flows on the territory of Georgia and abroad. The companies that could not confirm the development on the territory of Georgia (the criteria, due to their absence, were not applied, the tax inspectors were using their own personal logic during the inspections) were notified to GRS about the need to correct the declarations (retrospectively, including the previous period since 2018) and pay 15% corporate income tax.
The next step (summer 2021) was to conduct the official tax audits of these companies. As a result, the companies were charged income tax and fines in the amount of 50% of the tax. Amounts range from tens to hundreds of thousands of dollars. The actions of the tax department are aimed specifically at foreign holders of Georgian companies, who, due to geographical distance, language barrier, and other factors, cannot fully and quickly respond to offensive actions. At the moment, some companies are appealing the decisions of the tax inspections as the first step (Tax Department). Some complaints have not been satisfied, leading to step two, the Ministry of Finance of Georgia, and then - the Court.
In its approach in 2021, The Tax Department was guided by Art. 6 of the Law, which states: Article 6 - Activities in the virtual zone include economic activities carried out by a legal entity aimed at creating information technologies on the territory of Georgia.
The above-mentioned wording became the basis for the tax authorities to change their approach and demand payment of taxes if the software products supplied by them were not developed on the territory of Georgia. The law does not specify what costs the company should incur in Georgia. There is not a single criterion that determines the availability of product development in the country.
It is important to note, that according to the current informal opinion of GRS, software is considered to be developed on the territory of Georgia if the developer of such software was physically present in Georgia at the time of development.