If you are familiar with the Georgian personal taxation system, it is very likely that you’ve heard of the famous 1% tax regime – the Small Business status for Individual Entrepreneurs. This regime allows individuals engaged in most types of independent business activity to register their business in Georgia and minimize their income tax liability. Naturally, Small Business status is not for everyone. After all, the Tax Code of Georgia categorizes it as one of the “special” tax regimes. In this article, we will be going over the most common reason why many Individual Entrepreneurs fail to actually take advantage of the regime and what the Georgian 1% tax risk is.
Restrictions for the Small Business Status
Georgian tax legislation lists a number of activities and income types that render taxpayers unable to use the 1% rate. The Ordinance N415 of the Government of Georgia provides lists of prohibited activities and excluded incomes.
To shed some clarity on the difference, if you perform a “prohibited” activity, you cannot acquire or retain the Small Business status. The “Excluded Incomes” list, on the other hand, is a list of incomes (mostly composed of general types of passive income) that you can legally earn as a Small business, but cannot tax at a 1% rate.
Arguably the most prominent example of “excluded” income, however, is directly referenced in the Tax Code of Georgia – salary income, i.e. income from employment. In other words, if you are employed at a company (regardless of where it is incorporated) and reside in Georgia while working, you will not be able to tax your salary at a 1% rate, even if you have a Small Business status.
Instead, the Government will expect you to pay the standard 20% flat tax on your annual salary and penalize you if you do not do so.
Attempts at Disguising Employment and Revenue Service’s Response
Given the tax advantages offered by the Small Business status, many applicants attempt to obtain the tax regime even if they do not actually qualify.
The most common example of this is when full-time employees switch to contractor status with their companies without actually changing anything in the way they carry out their work. The process typically involves intentionally misclassifying oneself as a freelancer/self-employed person in the “service agreement” concluded with the “client”. This is what is known in the tax world as “disguised employment” – a deliberate attempt to appear as if the person is an independent agent, when in reality they work full-time for a company.
It goes without saying that disguising one’s true form of activity does not sit well with the tax authorities. But it is not always deliberate. Some individuals fall into this category inadvertently, because they do not have the knowledge of the criteria that Georgian tax authorities use for determining the legal status of the applicant’s business activities.
In 2021, the Revenue Service published a quiz that established the above-referenced criteria. It contains 38 questions and can determine the status of your activity based on the answers you submit. The questions relate to common signs of employment, such as having a fixed payment schedule, working mostly for one entity, being entitled to paid leave, etc.
Notably, however, these criteria are nowhere to be found in the actual law. Therefore, despite the quiz being a pretty useful tool for gauging your eligibility for the Small Business status from Revenue Service’s perspective, its legally binding force remains questionable.
Since the Government is not actively examining every application for the Small Business status for disguised employment schemes, it is extremely important that the applicants themselves are aware of this issue in advance. Just because your Small Business application got through, it does not mean that you are legally entitled to put yourself in the 1% tax bracket.
If you get audited (which could happen completely randomly at any given time), the Government is entitled to thoroughly examine your activity. If they end up finding signs of your engagement in full-time work for some company, you could end up reclassified as an employee.
In simple terms, you could be in trouble.
Reviewing Your Contract
The most obvious way the Revenue Service can identify your real relationship with your client is by having a look at your work contract. For this reason, it is absolutely crucial that your contract is in proper order and it does not make references to anything that could bear a resemblance to employment.
Please note, however, that having a proper contract in place does not guarantee that the Revenue Service will not come after you. The tax authorities can, and in many cases, do look beyond what’s written in your agreement, and use other methods to uncover any signs of employment (online search, background checks on your clients, etc.). For this reason, it is extremely important that you do not use a false contract with the intention of deceiving the authorities while continuing to work full-time for your company.
If you have doubts about your status, it is always recommended to have a tax professional assess your case. A qualified tax attorney can analyze the terms of your contract and point out the areas that are particularly risky when it comes to possible reclassification as an employee.
How ExpatHub Can Help
ExpatHub helps its clients achieve legal clarity by assisting them with tax analysis and contract review.
You can schedule a call with our Senior Tax Attorney or request a written opinion to analyze the feasibility of your desired business setup and discuss your options further.