Position of the Association of Georgian Virtual Zone Persons in relation to the methodological reference issued on December 29, 2022 by the Revenue Service

In December 2010, the Parliament of Georgia adopted the Law of Georgia “On Information Technology Zones” (74, 24.12.2010), which means granting the status of a virtual zone to a legal entity operating in the field of information technology. According to this law, Virtual Zone companies are exempt from profit tax on the profits they receive from the creation of information technology products and their delivery outside of Georgia.

Over the past ten years, the Revenue Service has never questioned the origin of the information technology product created by the VZP companies, there were also no preconditions for the use of the tax benefits granted by law. It should be noted that during this period, there has been no adaptation of the tax regime to any other similar type of company, nor a change in the legislation or normative acts. However, in 2021, the Revenue Service unexpectedly changed the tax approach in taxation of the “Virtual Zone Persons”, which entailed massive inspections and fines for companies. The process of auditing and penalizing companies is still ongoing, some companies have been audited for almost a year, which hinders the stable operation of the companies. The Revenue Service and the Dispute Review Board chaired the Ministry of Finance during the argumentation of their decisions mainly relied on Orders (methodological references) issued at different times by the head of the Revenue Service. Namely N42644 of December 31, 2021; N7547 of March 25, 2022; N33544 of December 29, 2022;

Each new methodological reference canceled the previous one and established different approaches to taxation issues, which clearly indicates that the regulatory body has changed its position more than once in this short period of time regarding the legal basis for taxing companies with the status of a virtual zone. This caused additional financial and moral damage to the companies. 

In the first version of the methodological reference, it was said that the product should essentially be created and produced in Georgia, which was later corrected and removed, and it was also said that the wages of these companies should correspond to 40% of the revenue, which was also removed later, but before the changes in the latter approaches, several companies were fined precisely on the latter grounds (including using the 40% threshold). In addition, according to the second methodological instruction of the Revenue Service, one of the reasons for imposing penalties on companies with the status of a virtual zone person was the inconsistency of their paid salaries with market prices, which made the calculation of taxes by these companies completely unpredictable for many reasons. It is common knowledge, that the Tax Code does not define the concept of market wages at all (only the market price of goods and services), so it was completely unclear how the specified market price should be determined in conditions when the wages of such personnel in the labor market differ from places hiring workers, taking into account the specialization and their qualifications.

The Association constantly submitted reasonable remarks and comments to the Ministry of Finance and Revenue Service regarding the issued first and subsequent guidelines, shared business experience, and made relevant proposals that clarified the regulation of certain issues. The approach to cases where the activities of a person should be considered as activities in the field of information technology carried out on the territory of Georgia has changed, and, accordingly, information technologies created within the framework of such activities should be considered as created in Georgia.

In particular, technology products are considered to be created in Georgia if their creation is carried out directly by the employee(s) and/or the resident founder(s), including the possibility of purchasing services for creating such a product. In addition, even in the case when a company creates information technologies only through a resident founder and does not have employees of the relevant profile, it will be considered that his/her activity complies with the requirements of the Law of Georgia on Information Technology Zones “, as well as the Tax Code, and the conditions established for the use of the profit tax relief established by subparagraph “p” of the first part of Article 99 of the Tax Code are met. Accordingly, dividends given to a resident founder will no longer be subject to reclassification into wages by the tax authority. 

We also read in the order that if the software product is created directly and to a large extent by the employee(s) programmer, then it will be considered that the information technology that was provided outside the country was created on the territory of Georgia. Accordingly, the distribution of the net profit received to the founders for the purpose of tax relief in the profit tax, based on subsection “p” of the first part of Article 99 of the Code, will be exempted from the profit tax.

However, this record of the Revenue Service does not state that it is mandatory to hire programmer employee(s) directly on the territory of Georgia, there is no reference to the residence of the hired person(s), as it was determined in the case of the founder. Accordingly, during the entire past period, the position of the regulatory body that the goals of this law (development of the IT industry in Georgia, employment of local IT specialists, etc.) were flagrantly violated by companies turned out to be wrong. In addition, what will be the agency’s approach regarding the ratio of local and foreign employees and how the presented document will be implemented in practice is not yet known. We think it is important to get further clarification on these issues.

As it is known, the tax legislation of Georgia consists of the Constitution of Georgia, international treaties and agreements, the Tax Code, and by-laws adopted only in accordance with the Law. A hierarchy in tax legislation is also defined, and the law or regulation that is at the top of said hierarchy has superior legal force in tax legislation. In this case, according to the first article of the Law “On Information Technology Zones”, the Tax Code of Georgia establishes the rules for taxation and exemption from taxes. During the tax administration, priority is given to the hierarchically higher legislative act, and in this case, it is the Tax Code of Georgia and not the methodological references.

Accordingly, the Association’s position regarding the legislative clarification remains unchanged. We believe that only a clear and accurate record in the law ensures the stable and smooth operation of companies in the future.