Eurasia Insight:
GEORGIA'S LIGHTER TAX BURDEN COMES WITH POTENTIAL PITFALLS FOR TAXPAYERS
Giorgi Lomsadze 5/07/08

President Mikheil Saakashvili says his dream is “to turn Georgia into the Dubai and Singapore” of the Caucasus. And simplified taxes will help pave the way. But some members of Georgia’s business community caution that greater planning and attention to detail are needed to make the plan viable.

Not too long ago, much more than that recommendation would have been needed to haul the Georgian tax system out of what business owners recall as “a total mess.” Since 2004, however, Georgian companies have gone from seeing taxes routinely left to the discretion of the tax inspector to a simplified tax roster that includes a mere seven taxes (down from 22).

Further tax cuts have also been in store. In 2007, corporate income tax was reduced from 27 percent to 20 percent; a further reduction to 15 percent has been promised. The Value Added Tax (VAT) also has fallen, down two points to 18 percent. A revised tax code – although, to many critics, still undecipherable – completes the make-over.

Tax revenues, meanwhile, have steadily grown: up to 23.4 percent of Georgia’s Gross Domestic Product in 2005 from just over 16 percent in 2003, according to the European Bank for Reconstruction and Development.

The headline grabber, however, has been a decision to roll a social welfare tax (20 percent) and income tax (12 percent) into a single 25-percent rate. Many business owners and executives have welcomed the decision.

“The idea to simplify the complicated system of social and income tax into a lump income tax is great. Simple, clean, easy,” commented Amy Denman, executive director of the American Chamber of Commerce in Georgia. “This gave companies not only the chance to file with one form instead of two, but also gave them the option to increase staff wages slightly without any increase in the company costs.”

But there is a catch. Employers paid the tax for social welfare expenses, while employees are responsible for the income tax. That means that while employers are happy to get rid of a 20-percent tax, employees have seen their tax rate more than double to 25 percent.

Tax officials claim that all government offices and “most large companies” have raised their employees’ salaries so that they receive the same income as before the tax hike. The American Chamber of Commerce’s Denman says that “not one” of the group’s members, which include many of Georgia’s largest businesses, “passed the 25 percent income tax burden onto their employees.”

The law, however, does not require employers to raise salaries. And not all chose to do so. David Bughadze, a senior official at the Tax Revenue Service, says that the decision was made on the premise that employers would act in good faith and adjust pay rates for their employees.

Nino Mchedlishvili, who runs an Internet cafe in downtown Tbilisi, doesn’t welcome the change. “Think of all the consultants or temporary workers, for one,” she said. “Rates for services such as translation have not gone up, not a bit. Yet now they have to pay a stiff rate of 25 percent, instead of the previous 12 percent.” Mchedlishvili, who relies on temporary workers, has not increased salaries.

Bughadze says that the social welfare tax was cancelled largely because it did not serve its purpose. “When you pay a social tax, you should expect it to return to you in the form of social security,” he said. “This value of this tax as a social security tool was constantly disputed.”

Fiscal lawyer Nato Goderdzishvili contends that throwing out the social welfare tax is not the best way to tackle that problem. “What should’ve been done instead is to achieve a better tax administration and appropriation to make sure that the social tax is used only for social security purposes, not for other kinds of state spending,” she said.

Meanwhile, procedures for resolving tax disputes remain tangled. Courts have lost most of their responsibility for hearing tax disputes; instead, the ministry of finance’s tax revenue service considers claims. Lawyer Goderdzishvili says that in the wake of the change, the Revenue Service has been awash with complaints that threaten to hijack the ministry’s primary function. In 2007, fewer than 500 requests for tax-dispute resolution were filed with the finance ministry, while more than 300 complaints were already filed during the first three months of 2008 alone, she said. Tax officials confirmed the figures. “An administrative agency shouldn’t turn into a body for dispute resolution, which is the turf of the judiciary branch,” Goderdzishvili commented.

Taxpayers can now only take their cases to court after the relevant government office rules on the complaint. A complaint against assessed tax liability must be filed within 15 days of receiving notification. “We have a serious constitutional problem here,” said lawyer Ia Legashivili, a Tbilisi attorney who specializes in tax disputes, adding that the rule “denies” Georgian citizens their basic constitutional right of appeal.

Bughadze counters that the idea behind the change is to settle tax disagreements without having to go court. “We have a committee of appeals, which is more qualified then judges in the matters of taxes,” Bughadze said. “We can easily identify an irrelevant tax decision and provide citizens with better service and resolve a problem without having to go to a formal trial, which involves many costs, and wastes time.”

“If a citizen is still unhappy with our decision, he can always proceed to court,” Bughadze added.

The revised tax code doesn’t rank violations in tax returns in terms of type, but rather classifies everything as fraud. “The concept of culpability is conspicuously absent in the tax code,” Goderdzishvili said. “The code doesn’t discriminate between an inadvertent mistake and a deliberate act of tax evasion. … This does little to contribute to building a liberal, business-friendly environment.”

Bughadze argues that by excluding subjective judgments about the nature of a tax violation, authorities diminish the opportunity for corruption.

Some small business owners, however, complain that start-ups are likely to trip up amid Georgia’s ever-changing tax procedures and consequently face penalties disproportionate to their shoestring budgets. “Those who really get their fingers burnt are the one-man-band operations that just waded into the waters of entrepreneurship and cannot afford to retain an accountant,” cautioned Internet café owner Mchedlishvili. Fines that start at 500 lari (about $343) are “often more than what small businesses make monthly,” she added.

Some efforts are being made to correct the tangle. The European Union has paid for a Ministry of Finance call center to field taxpayer enquiries about tax and customs regulations. Meanwhile, an ongoing International Finance Corporation project is working to identify various other regulations that could prove additional stumbling blocks for small and medium-sized businesses.

Ultimately, though, stresses tax official Bughadze, responsibility for meeting tax requirements lies with Georgia’s businesses alone. “Business owners have to make it part of their job to be aware of regulations and to comply with them,” he said. “Otherwise, we’ll never get a functioning economy.”

Editor’s Note: Giorgi Lomsadze is a freelance reporter based in Tbilisi.