Taxation of virtual zone enterprises in Georgia

grand solver. virtual zone status

News related to the taxation of virtual zone enterprises

A few months ago, the Revenue Service announced the taxation of “Virtual Zone Persons” (hereinafter VZP) and began implementing a new approach. According to this approach, VSPs do not have the right to benefit from the tax benefits imposed on them, if their information technologies are not created on the territory of Georgia and supplied abroad.

As a result, the “virtual zone persons” who did not have a sufficient number / qualification of employed persons in Georgia, retrospectively abolished the profit tax exemption and they were forced to pay the profit tax from the previous period.

Virtual Zone Person Status

“Virtual Zone Person” is the status given to Georgian companies operating in the field of information technology (IT) in order to be exempt from profit tax. A certificate is issued to the company to confirm such status.

A new rule of profit taxation for virtual zone enterprises

“Virtual zone entities” are exempt from income tax on profits they make by creating / delivering software products (e.g., website, mobile app, software) to foreign clients / delivering to foreign clients.

Pursuant to Article 6 of the Law of Georgia on Information Technology Zones, the Revenue Service considers that if the software product was not created directly on the territory of Georgia, the profit on the supply of such product is not exempt from profit tax.

For example, if a Georgian company with a VSP status hired a foreign programmer, for example, living in Cyprus, to fully develop the mobile app X, which the Georgian company would later provide to an American client, with the new approach of the Revenue Service, such app X would not be created in Georgia.

Because the developer of App X was in the process of creating it in Cyprus and not in Georgia, therefore, the profit earned by providing such an app is not exempt from profit tax.

Such is the new approach, which the Revenue Service has been implementing for about 10 years since the law came into force (in 2011), from the end of 2020 to the beginning of 2021.

The mentioned approach led to the imposition of profit tax and relevant sanctions on dozens (maybe hundreds) of virtual zone companies registered in Georgia. For information, the founders of most of these operating companies are foreigners.

Legislative Basics of Virtual Zone Enterprise Taxation

In Georgia, the issue of taxation and tax exemption of a “virtual zone person” is regulated by three main legislative norms:

1. Tax Code of Georgia;

2. Resolution of the Government of Georgia “On the Rules and Conditions for Granting the Status of a Virtual Zone Person and the Determination of the Person Granting the Status of a Virtual Zone Person”;

3. Law of Georgia on Information Technology Zones.

Article 2 of the Tax Code of Georgia defines the legislative hierarchy, according to which the Tax Code of Georgia has the force prevailing over the above-mentioned laws.

Tax Code

In total, 3 sub-paragraphs written in the Tax Code regulate the issues of taxation / exemption of a person in a virtual zone:

Article 8 (Definition) of the Criminal Code

„5. Virtual Zone Person – a legal entity that carries out information technology activities and has been granted the relevant status. “

„36. Information technology – the study, support, development, design, production and implementation of computer information systems, resulting in the adoption of software products. “

Article 99 of the Criminal Code (exemption from profit tax)

“P) Profit received from the supply of information technologies created by a legal entity of a virtual zone outside Georgia (distribution of profit)” In the presence of a precondition, also, the focus is unequivocally on the legal entity and not on the individual programmer).

As you can see, nowhere in the tax code is the precondition for exemption from profit tax that information technology must be created on the territory of Georgia, moreover, the law does not stipulate that the creation or not depends on the location of the main developer.

The current law sets 3 preconditions for exemption from profit tax for a virtual zone person:

1. Information technologies (the term is defined in the Code) must be created;

2. It must be created by a legal entity with the status of a “virtual zone person”;

3. Information technologies must be supplied outside Georgia.

It should be noted that the Code does not say “created by a legal entity on the territory of Georgia” and only “created by a legal entity”, ie the Code does not provide as a precondition for tax exemption that information technology should be created on the territory of Georgia.

In my opinion, the important question that needs to be answered for the correct interpretation of the above norm is the following:

Does not including this precondition for tax exemption in the Code mean that there is no such precondition if the Code does not specify the territory and does not state, for example, “Created on the territory of Georgia or outside Georgia …” Does this mean that we should look for an explanation in another law?

If for the correct interpretation of the above, Article 99 (j) of the Criminal Code, we need to look for an explanation in another law, then why does this article not refer to the Law on Information Technology Zone (on which the Revenue Service appeals) so that the reader is allowed a common law Make the correct interpretation through analysis?

Note: In fact, the Information Technology Zones Act redirects to the Tax Code, which I will discuss below. It should be noted that the Code entered into force later than the Information Technology Zones Act. The second norm is usually of a later date than the second norm).

The fact is that reading the main legislative norm (Tax Code) does not indicate any preconditions for the creation of information technologies on the territory of Georgia, nor does it refer to any other norm (which the legislator could have done very easily by adding 1-2 words). Which in any case leads to uncertainty or a definite conclusion that “creation on the territory of Georgia” as a precondition does not exist.

Therefore, it is reasonable to assume that the law was written correctly and that “creation on the territory of Georgia” is not required as a precondition, because if it did, the precondition would be directly spelled out in the law, or at least the law is flawed, misinterpreted and caused by a legislator (state). Now taxpayers must be held accountable, including in the past, when they had no information about it at all.

Law on Information Technology Zones

Even if we conclude that we must be guided by Article 6 of the Law on Information Technology Zones, which is appealed by the Revenue Service, it is important to actually analyze what is written in this article.

Article 6. Activities in the virtual zone

“Activities in the virtual zone include economic activities carried out by a legal entity, which will be aimed at the creation of information technologies on the territory of Georgia.”

Given the wording and meaning of the words, the record does not imperatively set any preconditions for tax exemption, but rather defines the purpose for which the “virtual zone person” tax exemption was imposed.

We read from the explanatory dictionary of the Georgian language that the word “directed” in some contexts is synonymous with the word “targeted”. That is, the said norm, on which the Audit Department relied, defines the purpose and not the precondition. It is also noteworthy that the record focuses on the future tense, which further reinforces the reasoning that it is about purpose and non-precondition.

To rearrange the sentence and replace the synonym with a word, we get the following wording:

Activities in the virtual zone include economic activities carried out by a legal entity, which will be aimed at creating information technologies on the territory of Georgia.

Also, as with regard to the Code, a similar question arises in relation to Article 6 of this law: if the creation of information technology on the territory of Georgia is a necessary precondition for tax exemption, then why was it not written directly, literally in this law? For example, as follows: “Only a person in the virtual zone who creates information technologies on the territory of Georgia and delivers them abroad” is subject to tax relief, or in other words, but clearly.

The purpose of the status of a “virtual zone person” would have been known to us if it had not been written in the above-mentioned norm (Article 6 above), because all states impose tax benefits in exchange for specific benefits (eg attracting investments, developing a specific business, raising awareness, etc.). Sh). In this case, the main goal is the development of the field of information technology (IT), we already know this logically and we would have known without the law, although the purpose of the law and the precondition for tax exemption are different things.

The main difference between a purpose and a precondition, in my view, is that failure to fulfill the purpose is not a ground for waiving the tax benefit unless that purpose is explicitly “converted” / formulated into law as a precondition for such an exemption.

Also, the purpose of the tax break can be achieved, in a reasonable time, in stages, but still be achieved. The precondition for exemption from tax is an instantly satisfactory factor in order for a person to enjoy a tax exemption, and it is explicitly written in the legislation.

To give an exaggerated example distinguishing between purpose and precondition:

Until 2021, the sale of 4 flats by individuals was exempt from VAT for 48 months. The purpose of this norm was to prevent flats sold by individuals under living conditions from being taxed with VAT, which would place a heavy burden on these individuals. However, this benefit actually exempted persons who sold apartments (ie, whose activities did not meet the purpose of the law) as part of their business activities.

Exemption also applied to such persons, as the purpose of the law was not to be “converted” in the law itself, in the precondition of the exemption, ie it was not explicitly written in the law that the sale of 4 apartments for non-economic purposes was exempt from VAT.

As a result, apartments sold by such individuals were completely legally exempt from VAT, even though the purpose of the law did not provide for their exemption. He was released before the law was changed. (There are relevant solutions to this issue, it’s not just my opinion).

It should also be noted that Article 3 of the same law is devoted to tax benefits for “virtual zone person”. This is a special norm in the law, which imposes tax benefits for individuals in the virtual zone.

In this article we read the following:

Article 3. Privileges of a person in a virtual zone

1. Issues related to the taxation of a person in a virtual zone are regulated in accordance with the Tax Code of Georgia (my note: that is, redirection from this law to the Code takes place and not vice versa).

2. Not taxed on information technologies created by a person in a virtual zone:

A) profit received from deliveries outside Georgia;

B) supply outside Georgia with value added tax;

C) removal from the customs territory of Georgia for export … “

As you can see, the special norm of the law used as a basis for accrual by the Revenue Service does not mention “creation of information technologies on the territory of Georgia” and, moreover, it does not provide any preconditions for tax relief.

Virtual Zone Enterprise Certificate

It should also be emphasized that companies are awarded a “virtual zone person” certificate by the state. The purpose of such a certificate is to put a certain “filter” so that not everyone enjoys this benefit and such a benefit applies only to those who meet the relevant prerequisites. To some extent, to give tax certainty to the business. If this were not the case then perhaps the existence of a certificate would be completely meaningless.

The companies to which the additional tax was accrued all held state-owned VSP status / certification.

In other words, the state grants the status without any problems, gives you a certificate, which is one of the important preconditions for tax exemption, and after a few years, contacts you and asks you for a tax from the previous period, even though it gave you a certificate for “filtering”.

Virtual zone enterprises are Georgian legal entities, which in accordance with the Code are considered as Georgian enterprises or are permanently located in Georgia.

Assuming that the tax exemption is a prerequisite for the use of tax benefits, that information technologies should be created on the territory of Georgia, why such technologies should be considered created on the territory of Georgia only if the main developer is a natural person in Georgia, when the information technology is created by a legal entity. He concludes a contract with the clients, an invoice is written in his name, the income is transferred to his bank account. A legal entity is a Georgian enterprise and is an independent entity from a natural person.

In other words, the law treats a legal entity as an independent entity and separates it from its founder and any other natural person. Also, a company whose place of registration (or management) is in Georgia is considered to be a Georgian enterprise.

Therefore, it would be logical for the information technologies created by the Georgian enterprise to be considered as created on the territory of Georgia, regardless of where the individual developer is located. The creator is actually the company and not the individual hired by that company. This company is considered to be an enterprise of Georgia in accordance with the Tax Code. (Registration criterion, Article 22.1 of the Tax Code).

Significant factual circumstances related to virtual zone enterprises

In addition to legislative issues, there are a number of factors / factual circumstances that need to be considered for a thorough analysis of a given issue.


A significant number of companies with the status of “virtual zone person” were registered in 2019-2020 (in my observation), when shortly after registration a pandemic was declared and the borders were closed. A person may have planned to move to Georgia soon and / or expand their business (in my personal experience, there are many such facts), but moving / expanding a business requires moving to Georgia, which was not possible at the time / was associated with threats.

Therefore, the activity was carried out remotely, through a Georgian company. As soon as the borders were opened, they were soon contacted by the Revenue Service to pay their taxes, which created a sense of instability and changed Georgia-related business plans in some cases.

That is, in many cases, the circumstances were such that objective factors did not allow individuals to achieve their goals and create sufficient economic content in Georgia.

Shortage of qualified staff:

As it turned out, foreign founders of VSP status companies found it difficult to find qualified staff in Georgia soon, which became even more difficult remotely and became more time-consuming.

Therefore, it is logical if the legislator would allow the purpose of the law to be fulfilled in stages, not necessarily immediately, because it is difficult for a person to register a company to get a tax benefit, immediately move to Georgia, immediately hire a local staff. Everything needs time, resources, overcoming the limitations of the current jurisdiction to move to Georgia, and also enough trust in our country.

In my personal opinion, if the purpose of the law (IT field development) is to be completed gradually, in a reasonable sequence (by pandemic resolution) and not instantly, it should still be considered as fulfilling the purpose of the law, as otherwise it would be practically more difficult.

One man company:

It turned out that the tax exemption for the “virtual zone person” was mostly interested in foreigners who are the founders, directors and programmers in the company and create the software themselves.

Here we are talking about programmers who generate a significant amount of annual revenue and seek jurisdiction to run their business where doing business is easy and taxes are relatively low. However, since these individuals already work remotely, they want to travel in parallel while doing business (a very common practice).

Some of these people founded a company in Georgia, they had an important economic connection with Georgia, they spend a few months here, but they travel at other times. They pay 5% tax on dividends received in Georgia, as well as 20% tax on a certain amount of salary. They do not need to hire another person.

They would bring exactly the same level of knowledge to Georgia and pay the same amount of tax if they spent 12 months here, which they brought in / paid for in a few weeks / months.

If we are talking about achieving the goal and the benefits received by the country, then the goal is achieved in the same way regardless of how much time such a person spends in Georgia (same amount of tax revenue, inflow of the same amount of knowledge). While the Revenue Service is the main criterion for evaluation (accrual or dismissal) – how much time did such a natural person spend in Georgia during the inspection period.

This begs the question: why should the issue of a company tax exemption / non-exemption be determined by the fact that a natural person (developer) has spent time in Georgia, given that the amount of time he / she spends in the country does not change anything for the country?

If one person’s virtual zone company is unacceptable to the law, then it should somehow be directly spelled out in the law itself. If he is a beneficiary (this is the case under the current legislation) and the person brings the same benefits to the country in terms of tax revenue and investment, regardless of how much time he spends in Georgia, that is, the purpose of the law is the same, then his days in the country should not be tax deductible. / No granting issue.

(In my opinion) What are the dangers of the new approach to the “virtual zone pyrene” for the investment environment?

You have read above the citation of all important legislative norms regarding VSPs, their consistency and analysis. Now put yourself, for example, in the position of a German IT developer (programmer) who earns around 100000-200 000 euros a year and thinks of starting a company in a country where doing business is easy, pays less and the salaries of hired people are not too high. Conditionally, this developer should be called Edward.

Edward found information about Georgia on the Internet, inquired about the law, and read everything (himself and / or through a local consultant). According to the existing legislation, in order to enjoy the tax benefit, he is required to do only two things: to obtain the status of a “virtual zone person” and to carry out relevant activities (creation of information technologies and delivery abroad) through this company. He also heard that for 10 years due to insufficient economic content, the Revenue Service has not fined any person in the virtual zone, at least, no one has heard of such a case.

He made the decision and in February 2020 established a company in Georgia, received the relevant status and temporarily left for Germany to soon return to find the appropriate staff (which is a constantly protracted process). Soon a pandemic was declared, the borders were closed, he could not arrive in Georgia. He continues to operate through a Georgian company, but so far without local staff, remotely (knowing that the law allows this).

He plans to return to his goals for Georgia as soon as the borders are opened and travel becomes secure, but when the borders are opened and travel becomes safe, he is immediately contacted by the Revenue Service and asked to pay the tax from February 2020 (plus interest). Then he thought he was fired.

How would you feel about Edward’s position towards Georgia? Perhaps the mistrust and desire to move the business immediately to another jurisdiction. Edward will probably pay the tax to avoid problems or start a tax dispute but it is highly doubtful that he will link Georgia to his future business plan again. Also, he is likely to tell too much about his negative experiences.

This reaction was caused by a sense of surprise / uncertainty / instability rather than a new tax expense. If Edward could, he would have read clearly in the law that he would be required to take advantage of the “this and that” tax credit, he would have had a choice and he would have decided for himself whether to start an economic activity in Georgia. If he started in a way that did not meet the (clearly stated in the law) preconditions, he would only be responsible for the negative consequences.

There are probably many people (foreign developers) who have not even thought about hiring or coming to Georgia or creating any economic content, however, on the one hand, their wording in the law has allowed this and, on the other hand, they should not oppress those who are real. They had / have plans to do business in Georgia, as well as those who already bring some benefits to the country. So to speak, not all should be boiled in one pot.

The country with such tax accruals will probably mobilize several million GEL in the budget. This is a positive development in the short term, but in my opinion, in the long term, the potential revenue will be lost, maybe 100 times, because the trust and interest of IT representatives in our country will be lost / significantly reduced, which we have been building for years.

We must also keep in mind that, at this point, we are the most attractive country for business “small” investors like Edward (especially in the service sector), because they are looking for simplicity and relatively low taxes. Therefore, it is especially important to take care of such a category.

We are not talking about the loss of potential investors who have established a company in Georgia and have not brought any benefits to the country yet and are not going to. The country may not really lose anything by losing them, but such negative information spreads very quickly, especially among individuals working in one field.

Going into this environment means that many more people who hear negative feedback from Edwardians will reconsider doing business in Georgia because of a sense of instability.

There are numerous forums, facebook groups, Youtube blogs, blogs, chats where individuals share positive and negative experiences with each other about countries. Therefore, in my opinion, negative attitudes will spread very quickly.

History of law / approaches

It is important to note that the legal norm on the “Virtual Zone Person” in the Tax Code came into force in 2011. No accruals have been made on this topic for 10 years. This reinforced the position of taxpayers / consultants that having economic content (living in Georgia, hiring local staff, etc.) in Georgia was not a mandatory precondition for VSPs to enjoy tax benefits.

I will draw a parallel with a similar tax exemption for “international companies” operating in the IT field. One of the preconditions for obtaining the status of an “international company” explicitly stated in the law is that it must be demonstrated that the company has sufficient economic content in Georgia. If it was written in the same way in the attachment to the “Virtual Zone Persons”, we would not face the problem.

It is clear that Georgia should receive some benefits from the benefits provided, as well as international organizations are monitoring the countries to see if any legislation allows for deliberate tax evasion, and therefore (and indeed) it is logical that the tax benefits are not intended for individuals who have no benefits. Nor are they going to bring it to our country.

However, this must be done with the correction of the law, with unambiguous explanations, and must be enacted when the relevant amendment enters into force. Otherwise the approach would not be fair to the taxpayers either, nor to the beneficiary-country.

It should also be noted that the Revenue Service did not order direct inspections and did not impose direct taxes and sanctions on “virtual zone persons”. At first there was verbal communication with VSPs when they explained the (new) position of the Revenue Service and were given a deadline for the companies to declare themselves and pay taxes on past periods in order to avoid being fined.

This approach is really a step forward and is much more liberal than, directly, entering into a careless inspection and imposing a fine along with taxes, however, thus eliminating the problem and avoiding a negative mood, unfortunately, still fails.

Summary: Tax changes for virtual zone enterprises

Virtual zone individuals have been heavily taxed in the past. The imposition of the tax is caused by a new approach / a new interpretation of the law, according to which, in order for a VSP to benefit from a tax exemption, it is necessary for the company to have a qualified hired person or persons in Georgia who create the software products.

It is clear that the purpose of the law is for the country to benefit from this initiative, although it is not explicitly written in any legislation, and what is not explicitly written in the legislation has now become the basis for imposing taxes and sanctions on tens or hundreds of “virtual zone persons”. , Including past periods.

The fact is that there is a dilemma: on the one hand, the law is interpretable and does not directly stipulate that the company must have employees in Georgia as a precondition for tax exemption. On the other hand, the country should benefit (investment attraction, industry development, tax revenues) from any tax breaks it imposes.

We think the most optimal way to solve such a dilemma is to correct the law, to formulate a precondition in the law itself, which will be valid only from the present / future period. This means that the author of the law (state) and not the taxpayer (investor / potential investor) will be responsible for drafting the law (in such a case), and everything will be sorted out from the present / future period.

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