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According to the order of the head of the Revenue Service N33544 of December 29, 2022, the methodical instruction was approved on the taxation of virtual zone IT company in Georgia.
The methodological reference explains the rules related to granting and canceling the status of virtual zone IT companies, as well as defines the tax obligations and rights within this status. We will discuss here the main examples given in the approved order.
Example 1:
The creation of information technologies by a virtual zone IT company is carried out by one hired person (programmer) and a person hired on the basis of a service contract (programmer). A person fulfills the obligation of a tax agent in relation to the taxes carried out in accordance with the rules established by the tax legislation of Georgia, in particular, he withholds the tax at the source of payment and pays it to the budget. The person supplies information technologies only outside of Georgia.
Evaluation:
According to the Tax Code and the Law of Georgia on “Information Technology Zones”, as a result of information technology activities, a software product should be created, which will have a form and, accordingly, will be available on the market in the form of goods or services. Based on the objectives of the legislation on information technology zones, software products should be considered as ready-made software developed for a wide range of users, as well as software intended for specific categories of users.
Software products are considered to be created if their creation is substantially performed directly by the employee(s) and/or resident founder(s), including the possibility that the virtual zone IT company purchases services to create the software products.
Taking into account that in the considered example, the virtual zone IT company has both a hired person employed in the relevant profile section (programmer), as well as one person hired on the basis of a service contract (programmer), it will be considered that the information technologies, which were provided outside the country, were essentially created in the territory of Georgia. Accordingly, the distribution of the net profit received by it to the founders for the purpose of tax relief in the profit tax will be exempted from the profit tax.
Example 2:
A virtual zone IT company is established by a physical person. Information technologies are created on the territory of Georgia directly by the resident founder and their delivery is carried out outside Georgia. The company does not have a person working for hire with the relevant profile section. The shareholder natural person receives income only in the form of dividends.
Evaluation:
Considering that the founder of the company is a resident of Georgia, the place of business of the company is Georgia, and the company creates information technologies, it will be considered that its activity complies with the requirements of the Law of Georgia “On Information Technology Zones”, as well as the requirements of the Tax Code, and in the case under consideration, the requirements established for the use of the tax relief are fulfilled.
Example 3:
The company’s activity is development/development of products and software tools in the field of information technology. Namely, architecture and layout design, creating applications for different devices and operating systems and designing and projecting databases and peripheral integration tools. The company carries out its activities through hired person/persons. And the created product is delivered only to persons registered outside of Georgia.
Evaluation:
Acceptance of the software as a result of the described activity implies a complex and multi-step process of software development. Due to this circumstance, it is possible that specific work performed in this process (for example, written code) may be removed or not included in the final product due to changes in the concept or other characteristics of the final software product in the later stages of development. Therefore, for getting tax relief, the purpose of the activity should be considered as the main circumstances, in particular, the provision of information technologies should mean the study, support, development, design, production, and/or implementation of computer information systems if the purpose of this activity is to create a software product.
In the part of the provision of the service in question, it will be considered that the supply of information technologies created by the company, as a virtual zone IT company, is carried out outside the borders of Georgia, which is the basis for the use of tax relief established by Tax Code, because:
– The company’s activities are carried out through the hired person/persons;
– Creation of information technologies by the company;
– The company’s clients (recipients of services) are outside Georgia.
Example 4:
The company’s activity is the electronic provision of services defined by it using various hardware and software.
Evaluation:
The legislation of Georgia does not define the concept of a software product and the regulations related to its creation. At the same time, the Law of Georgia “On Copyright and Neighboring Rights” recognizes the concept of a computer program, according to which a “computer program” is a set of instructions in words, codes, schemes or other machine-readable forms, which allows to operate a computer to achieve specified results. The term includes computer program design preparatory material.
As in “computer program,” software generally refers to a program or set of programs that contains instructions necessary for the computer itself to operate or instructions to perform other tasks. Software is independent from hardware (computer devices) and it is through it that computers can be programmed.
In order to comply with the activity within the status of a virtual zone IT company, it is important that the company’s activity implies the implementation of such activity in the field of computer information systems, which is used in the development of software. Accordingly, if the company’s activity is limited to the electronic provision of services defined by the company using various hardware and software, the purpose of which is not to create a software product, the profit from such activity will not be considered as a profit from the supply of information technologies, and therefore, its distribution cannot be subject to the tax relief prescribed by the Tax Code.
Example 4:
The company’s activity is the electronic provision of services defined by it using various hardware and software.
Evaluation:
The legislation of Georgia does not define the concept of a software product and the regulations related to its creation. At the same time, the Law of Georgia “On Copyright and Neighboring Rights” recognizes the concept of a computer program, according to which a “computer program” is a set of instructions in words, codes, schemes or other machine-readable forms, which allows to operate a computer to achieve specified results. The term includes computer program design preparatory material.
As in “computer program,” software generally refers to a program or set of programs that contains instructions necessary for the computer itself to operate or instructions to perform other tasks. Software is independent from hardware (computer devices) and it is through it that computers can be programmed.
In order to comply with the activity within the status of a virtual zone IT company, it is important that the company’s activity implies the implementation of such activity in the field of computer information systems, which is used in the development of software. Accordingly, if the company’s activity is limited to the electronic provision of services defined by the company using various hardware and software, the purpose of which is not to create a software product, the profit from such activity will not be considered as a profit from the supply of information technologies, and therefore, its distribution cannot be subject to the tax relief prescribed by the Tax Code.
Example 5:
In 2020, a legal entity created a software product, which in the same year was provided to clients operating outside of Georgia under a license. In exchange for said license, customers pay a monthly license fee. This legal entity received the status of a virtual zone IT company in 2021.
The transfer of the mentioned software for temporary use is not a one-time process that limits the contractual obligation of the legal entity to its clients, but further support services are an integral part of the software transfer agreement. In turn, this service implies (1) constant availability of the software transferred under the license and timely response to emerging defects and (2) conducting work for software improvements and updates. The counterparties are not contractually granted any right to independently modify or transform the temporarily transferred product.
The service of further support of the software product is the most important component of the use of this product, as the economic activity of the legal entity’s clients and, accordingly, the income of this entity itself essentially depends on its faultless operation.
As a result of the changes made to the software by the legal entity, the support costs have a significant share in the total operating costs of the company.
Evaluation:
One of the stages of software development is the post-release support, development, and servicing of a software product, which is typically performed by software developers. This phase may include the detection and elimination of various errors, process updates, software updates, and other similar activities that ensure the error-free operation of the product and its further development.
Since the further support and service of the software product is an important component of the use of this product, it will be considered that the income received by the legal entity in exchange for the license to use the such product after receiving the status is received in exchange for the information technologies provided after receiving the status.
Accordingly, in this case, the tax relief established by the Tax Code will be applied to the profit received in exchange for information technologies delivered outside of Georgia by the legal entity after receiving the status of the software product created before the status of the virtual zone IT company.
Example 6:
The entity of the virtual zone, which is established by individuals in the territory of Georgia, creates information technologies, for which it uses the individuals hired in Georgia with the appropriate profile.
In addition, the virtual zone IT company provides the information technologies created by him in the territory of Georgia, both in the territory of Georgia and outside its borders. The work of the employees who serve to provide information technology both in the territory of Georgia and outside it is not separated.
The annual net profit of the virtual zone IT company was 1,000,000 GEL, and the annual financial income was 2,500,000 GEL. The received income consists of the income received from the delivery of information technologies created on the territory of Georgia outside of Georgia (2,000,000 GEL) and on the territory of Georgia (500,000 GEL).
The person fully distributed the received net profit to the founding natural persons.
Evaluation:
Taking into account that in relation to the virtual zone IT company, the tax relief in the profit tax is established only in the part of the profit (profit distribution) received from the supply of information technologies outside the territory of Georgia, and at the same time, the person may receive income from the supply of the information technology created by the company in the territory of Georgia, in order to take advantage of the tax relief in the profit tax, the company must to identify profits exempted from profit tax. It is important to calculate the specific share of the exempted profit in the total profit. For this purpose, if the expenses incurred by the person cannot be attributed to a specific income, the calculation of the exempted profit can be carried out in accordance with the specific share of the income received from the delivery of information technology outside of Georgia in the total profit. However, if in a particular case it is possible to use another more accurate and reasonable method, the company is entitled to calculate the amount of profit exempted from profit tax using such method. Based on the provisions of the Tax Code, in order to identify the amount of profit exempt from profit tax, it is considered that this amount is given first when distributing the dividend by the company. In this case, if there is no possibility of using another more accurate and reasonable method:
Profit exempted from profit tax is 800,000 GEL (1,000,000 *2,000,000/2,500,000).
Taxable profit – 200,000 GEL (1,000,000 *500,000/2,500,000).
In addition, since the distribution of profit received by the virtual zone IT company from the delivery of information technologies created on the territory of Georgia outside of Georgia is exempted from profit tax, the said profit will be considered as distributed in the first place. Accordingly, the company is liable for profit tax on the distributed profit in the amount of 200,000 GEL.
Example 7:
The virtual zone IT company is the sole founder of the resident legal entity (LLC “A”). On the other hand, the virtual zone IT company is established by 2 physical persons. LLC “A” fully distributed the net profit of 100,000 GEL to the founder.
Evaluation:
The legal entity of the virtual zone, which has been granted the relevant status for the purpose of exemption from profit tax, will be considered as a person exempted from profit tax as part of the relevant activity.
Taking into account that the tax benefit in the profit tax for the virtual zone IT company is established for the profit (profit distribution) received by it from the delivery of the software product outside Georgia, the benefit will not be applied to the further distribution of the dividend received and accordingly, it will be taxed with the profit tax in the manner established by the tax legislation.
Thus, when distributing the net profit received by LLC “A” as a dividend to a virtual zone IT company, will not be considered exempt from profit tax.
Accordingly, the distribution of the net profit received by LLC “A” in the form of dividends to the virtual zone IT company will not be subject to income tax.
However, the subsequent distribution of the dividend received by the virtual zone IT company to the shareholder natural persons is considered an object of taxation with the profit tax, which is not exempted from the profit tax.
Taxation of income received from a virtual zone IT company at the source
The virtual zone IT company, in the cases provided by the Tax Code, is obliged to withhold the tax from the source of payment when making the relevant payment.
Example 8:
The virtual zone IT company creates information technologies on the territory of Georgia and provides them only outside Georgia. The founders of the company are natural persons. In addition, the company has employees who create information technologies in the territory of Georgia. The company distributed the net profit in the amount of 100,000 GEL, and also paid a salary in the amount of 20,000 GEL.
Evaluation:
For income tax purposes, distributions of profits based on the Tax Code are exempt from profit tax.
Regarding the dividend issued, the virtual zone IT company is obliged to tax the dividend (100,000 GEL) paid to the individual in accordance with the tax code at the rate of 5% of the amount paid at the source of payment and to carry out the relevant tax reporting. In addition, the virtual zone IT company is also obliged to fulfill the obligation of the tax agent in relation to the paid salary (20,000 GEL).
Conclusion
According to the order of the head of the Revenue Service N33544 of December 29, 2022, the methodical instruction on “Virtual Zone IT company Taxation” the previous methodological guidelines have been revoked and we should be guided with the new one.
For more information or/and questions regarding the Virtual Zone It Company Taxation please contact us, we are always ready to help you.