TPsolution’t note:
We present to you the latest methodical guidance of the Revenue Service on the taxation of Virtual Zone Persons (VZPs).
Note that the purpose of the guidance on the taxation of VZPs is to present the interpretation of the current tax legislation (effective since 2011) by the Revenue Service. In other words, the methodological guidance does not change the tax legislation on the taxation/exemption of VZPs, but rather clarifies how the existing law is read and understdood by the Revenue Service.
Methodological guidance is presented below without changes (we only added the short titles of the examples to make it more understanding for you), and we will present our analysis and comments on the document below in the near future.
Information Source: https://infohub.rs.ge/ka
Order of the Head of the Revenue Service №33544
Dated 29/12/2022
Methodical guidance on taxation of virtual zone person’s profit tax
Article 1. Scope of regulation
1. The methodical guideline “On Taxation of Profits of a Virtual Zone Person” explains the rules related to granting and canceling the status of a virtual zone person to a person, as well as defines the tax obligations and rights within this status.
2. The activity of the virtual zone person is regulated by the following legal acts:
a) Tax Code of Georgia (hereinafter – the Code);
b) Law of Georgia “On Information Technology Zones”;
c) Resolution N49 of the Government of Georgia dated January 26, 2011 “On the rules and conditions for granting the status of a person of the virtual zone and the determination of the person granting the status of a person of the virtual zone” (hereinafter – the Resolution of the Government);
d) “On Administration of Taxes” Instruction “On Administration of Payments” approved by the order of the Minister of Finance of Georgia dated December 31, 2010 №996 (hereinafter – Instruction).
Article 2. Concept of Virtual Zone Person and assignment of status
1. According to the parts 35 – 36 of Article 8 of the Code, the person of the virtual zone is a legal entity that carries out information technology activities and has been granted the appropriate status.
2. In order to obtain the status of a person of the virtual zone, a candidate for the status of a person of the virtual zone must apply to the legal entity of public law – the Financial and Analytical Service. The candidate electronically fills out the application form posted on the official website of the Financial and Analytical Service (www.fas.ge) and sends it to the Financial and Analytical Service.
3. The application must be accompanied by a list of information technology projects (if any) during the last three years.
4. A person is granted the status of a virtual zone person no later than 10 working days after applying for the status.
5. An electronic certificate confirming the status of a person of the virtual zone is issued no later than 2 working days after the status is granted.
6. The status of the person of the virtual zone is issued for life.
Article 3. Use of tax relief in profit tax by the person of the virtual zone
1. In accordance with the first part of Article 97 of the Code, the object of taxation with the profit tax of the person of virtual zone is:
a) Distributed profit;
b) Expenses incurred or other payment not related to economic activity;;
c) Free delivery of goods/services and/or transfer of funds;
d) Representation expenses incurred in an amount greater than the threshold amount established by the Code.
2. According to Article 99, Part One, Sub-Clause “ჟ” of the Code, the profit received from the delivery of information technologies created by a legal person of the virtual zone outside of Georgia (profit distribution) is exempted from profit tax.
3. According to Article 6 of the Law of Georgia “On Information Technology Zones”, the activity in the virtual zone includes the economic activity carried out by a legal entity, which will be directed to the creation of information technologies in the territory of Georgia.
4. According to Article 8, Section 36 of the Code and Article 2, Subsection “C” of the Law of Georgia “On Information Technology Zones”, information technology is the study, support, development, design, production and implementation of computer information systems, resulting in software security products.
5. In accordance with Article 2, subparagraph “b” of the Government Decree, information technology is the study, design, development, implementation, support and management of computer information systems, in particular, software products and computer equipment.
Example 1-When Virtual Zone Person provides information technologies outsides of Georgia which were developed by VZP’s employees or/and subcontractors.
The creation of information technologies by a virtual zone person is carried out by one hired person (programmer) and a person hired on the basis of a service contract (programmer). A person (VZP) 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.
Assessment: When Virtual Zone Person provides information technologies outsides of Georgia which were developed by VZP’s employees or/and subcontractors.
According to the 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 person purchases services to create the software products. Taking into account that in the considered example, the person of virtual zone 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 VZP to the founders for the purpose of tax relief in the profit tax, based on subsection “j” of the first part of Article 99 of the Code, will be exempted from the profit tax.
Example 2-One Man Virtual Zone Company, when the shareholder of VZO is also a software developer in the company
A virtual zone person 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 enterprise does not have a person working for hire with the relevant work profile (software develoiper). The founding natural person receives income only in the form of dividends.
Assessment:
Considering that the founder of the enterprise is a resident of Georgia, the place of business of the enterprise is Georgia, the enterprise creates information technologies, it will be considered that its activities comply with the Law of Georgia “On Information Technology Zones”, also, the requirements of the Code and, in the case under consideration, the requirements established for the use of the tax benefit determined by subsection “P” of the first part of Article 99 of the Code have been fulfilled.
Example 3-Providing information technologies by Virtual Zone Person outside of Georgia
The company’s activity is design/development of products, software tools in the field of information technologies. Namely, architecture and layout design, creating applications for different devices and operating systems, 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.
Assessment: Providing information technologies by Virtual Zone Person outside of Georgia
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 later stages of development. Therefore, for the purposes of Article 99 of the first part of the Code, 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.
As 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 person of the virtual zone, is carried out outside the borders of Georgia, which is the basis for the use of the tax relief provided by subsection “P” of the first part of Article 99 of the Code, insofar as:
– The company’s activities are carried out through the hired person/persons;
– Creation of information technology by the company is clear;
– The company’s clients (recipients of services) are located outside of Georgia.
Example 4-Providing Electronic Service by Virtual Zone Company using hardware Software:
The company’s activity is the provision of a certain types of electronic services using various hardware and software.
Assessment- Providing Electronic Service by Virtual Zone Company using hardware Software
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 related rights” recognizes the concept of computer program. Specifically, according to Article 4(k) of this law, a “Computer Program” is a set of instructions in words, codes, diagrams, or other machine-readable form that allows a computer to be operated 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 person of the virtual zone, 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 received from such activity will not be considered as the profit received from the provision of information technologies, and therefore, its distribution cannot be exempted from corporate income tax based on the sub-paragraph “P” of the first part of the Article 99 of the Code.
Example 5-Corporate Income Tax exemprion of the Virtual Zone Person on profit received from licensing the software
In 2020, a legal entity created a software product, which in the same year it 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 person 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 contractors 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.
Assessment: Corporate Income Tax exemprion of the Virtual Zone Person on profit received from licensing the software
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, the income generated by the legal entity for the license of software after receiving the status (of Virtual Zone Person) will be considered as received in exchange for the provision of information technologies provided after receiving the status.
Accordingly, in this case, the corporate income tax exemption provided by by Article 99, Part 1, Sub-paragraph “P” of the Goergian Tax Code will be applied to the profit received in exchange for the information technology developed before receiving status of VZP and delivered outside Georgia after the VZP status was obtained.
Example 6 -When Virtual Zone Person provides information technologies outise of Georgia and in the territory of Georgia
The person of virtual zone, which is established by individuals in the territory of Georgia, creates information technologies, for which it uses the labor of individuals hired in Georgia with the appropriate profile.
In addition, the person of virtual zone provides the information technologies created 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 is not separated. The annual net profit of the virtual zone person 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 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.
Assessment: When Virtual Zone Person provides information technologies outise of Georgia and in the territory of Georgia
Taking into account that in relation to the person of virtual zone, 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 him in the territory of Georgia, in order to take advantage of the tax relief in the profit tax, profits exempted from profit tax must be identified. It is important to calculate the specific share of the exempted profit in the total profit. For this purpose, if the expenses incurred by a 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 person is entitled to calculate the amount of profit exempted from profit tax using such method. Based on the provisions of Article 99, Part 3 of the Code, in order to identify the amount of profit exempted from profit tax, it is considered that this amount is given first when distributing the dividend by the enterprise. In a specific case, if there is no possibility of using another more accurate and reasonable method:
Profit exempted from profit tax amounts to 800,000 GEL (1 000 000 *2 000 000/2 500 000).
In addition, since the distribution of profit received by the person of virtual zone 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, a person is liable for profit tax on the distributed profit in the amount of 200,000 GEL.
6. In accordance with Article 981, Part 2, Sub-paragraph “c” of the Code, the distribution of dividends to persons provided for by Article 2, Paragraph 3 of the Law of Georgia “On Entrepreneurs” (except for individual enterprises and persons exempted from profit tax in accordance with this Code) is not considered as distributed profit.
7. According to the “note” of subsection “A.D” of Article 401, paragraph 5 of the Instruction, as person exempted from income/profit tax in the relevant part of the activity shall be considered a person:
a) who is established for, or who has been granted the relevant status for the purpose of exemption from income/profit tax (for example: FIZ enterprise, special trading company, tourist zone business entity, highland settlement enterprise, agricultural cooperative, virtual zone person);
b) who carries out a permit activity exempted from income/profit tax (for example: a person who arranges a gambling club, a gaming machine salon, a totalizer (except for a person who arranges games in system electronic form)).
Example 7- When Virtual Zone Company receives Dividends from it’s daughter Georgian company
The virtual zone person is the sole founder of the resident legal entity (LLC “A”). On the other hand, the person of virtual zone is established by 2 physical persons. LLC “A” fully distributed the net profit of 100,000 GEL to the founder.
Assessment- When Virtual Zone Company receives Dividends from it’s daughter Georgian company
The legal person of 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 person of virtual zone is established for the profit (profit distribution) received by him/her from the delivery of the software product outside Georgia, the benefit will not be applied to the further distribution of the dividend received by it and accordingly, VZP will be taxed with the profit tax in the manner established by the tax legislation.
Thus, when distributing the net profit received from company “A” in the form of dividend VZP will not be considered exempted from Corporate Income Tax.
Accordingly, the distribution of the net profit received by “A” in the form of a dividend to a virtual zone person will not be subject to income tax on the basis of subsection “c” of part 2 of Article 981 of the Code.
However, the subsequent distribution of the dividend received by the virtual zone person to the founding natural persons is considered an object of taxation by Corporate Income Tax, which is not exempted.
Article 4. Taxation of income received from a virtual zone person at the source of payment
The person of virtual zone, in the cases provided for by Article 154 of the Code, is obliged to withhold the tax from the source of payment when making the relevant tax.
Example 8-Withholding tax obligation of Virtual Zone Person on dividends and salaries paid
The person of virtual zone creates information technologies on the territory of Georgia and provides them only outside Georgia. The founders of the enterprise are natural persons. In addition, the enterprise has employees who create information technologies on the territory of Georgia. The enterprise distributed the net profit in the amount of 100,000 GEL, and also paid a salary in the amount of 20,000 GEL.
Assessment: Withholding tax obligation of Virtual Zone Person on dividends and salaries paid
For the purposes of profit tax, the distribution of profit based on subsection “P” of the first part of Article 99 of the Code shall be exempted from profit tax. Regarding the issued dividend, the person of virtual zone is obliged to tax the dividend (100,000 GEL) paid to the natural person in accordance with Article 130 of the 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 person of virtual zone is also obliged to fulfill the obligation of the tax agent in relation to the paid salary (20,000 GEL).
Article 5. Cancellation of the virtual zone person status
1. The virtual zone person’s status is canceled, if:
a) If the status obtained by the person of virtual zone in accordance with the applicable legislation will be used to evade payment of taxes. In this case, the status of a person can be revoked by the Financial-Analytical Service based on the information provided to him by the relevant body.
b) On the basis of the electronic application of the person of the virtual zone, which is sent through the official website of the Financial and Analytical Service (www.fas.ge).
c) If the person of the virtual zone has been granted the status of an international company defined by the Code, in such a case, the status of the person of the virtual zone is considered canceled from the beginning of the month of granting the status of the international company to the person.
2. Information regarding the cancellation of the status of a person of the virtual zone for a person shall be notified in writing to the LSI – Revenue Service within 2 (two) working days after the cancellation of the status.
3. If the status obtained by the person of the virtual zone in accordance with the applicable legislation is used to avoid paying taxes, the profit received by him will not be subject to the preferential regime of taxation with the profit tax.
4. In case of cancellation of the virtual zone person’s status, the corresponding electronic certificate is cancelled, on the basis of which, within 2 (two) working days after the cancellation of the status, the Financial-Analytical Service ensures the deletion of the said electronic certificate from the official website of the Financial-Analytical Service (www.fas.ge).