Issue 5, 2013. October-November



Paying for potential clients and customers to visit facilities or countries in which they are considering investing, dining with them, and putting on other promotional activities are a natural and important part of many businesses in many different sectors of the economy.

Alexander Melin

Article 8 of the Georgian Tax Code provides a definition of representational expenses using an enumerated list. Article 106 exempts certain expenditures from deduction; two that are worth mentioning are entertainment costs and costs not related to economic activity.

The problem with these provisions is threefold: legitimate representational expenses can occasionally include items beyond the enumerated list (e.g. dining), "entertainment" is not defined, and costs not related to economic activity are disallowed from deductibility.

Why are these of concern? First, using a rigid black-letter definition for representational expenses may exclude legitimate representational expenses not covered by the enumerated list. Second, entertainment is also expressly allowed to be deducted under the laws of many countries, but even more troublesome isthat because entertainment remains undefined, it is difficult for companies to gauge compliance with the law. This is especially important since entertainment expenditures (like representational expenses) are generally subject to VAT under Article 173 of the Georgian Tax Code. The third concern is of particular import to NGOs and non-profits. According to Tamar Gvaramadze at The Georgian Young Lawyers' Association, NGOs cannot deduct representational costs like a business because they are not "costs related to economic activity." Allowing them to deduct their representational costs would allow them to better fulfill their missions and be socially equitable.

Not all representational expenses that qualify for deduction can necessarily be deducted, and this is another area of possible improvement. Georgia employs a bright-line rule: Article 116 of the Georgian Tax Code caps tax-deductibility of representational expenses at 1 percent of turnover in a tax year.

Such a rule provides a somewhat arbitrary figure and appears to be an imitation of similar "hard-cap" laws elsewhere in the countries of the former Soviet Union like Russia, Kazakhstan and Armenia. Belarus and Ukraine, on the other hand, have amended their rules in recent years to allow absolute deductibility of representational expenses subject to strict substantiation requirements. However, in practice such requirements are exclusionary and the latter two rank poorly in Ease of Paying Taxes category of the World Bank (WB) Ease of Doing Business Rankings, suggesting that this is a dubious model.

One interesting variant is in the Philippines, where manufacturers of goods are accorded a one percent deduction as a function of turnover, producers of services are accorded two percent, and those companies that are engaged in both sectors use a proportional sliding scale. Yet, although countries employ a multitude of nuanced schemes, probably most common internationally is permitting a deduction of a set percentage of all representational expenses, e.g. at 50 percent or 75 percent. This assures equity across business sectors and discourages unnecessary representational expense spending - especially at the end of tax year - because there will be at least some tax burden associated with such expenditures.

Substantiating representational expenses also is difficult in Georgia; Article 105 of the Georgian Tax Code states that all expenses must be documented, but it is Article 72 that tells taxpayers what constitutes a sufficient document: a hard copy is required, and must identify the parties, i.e. be directly invoiced. Better would be to expressly allow electronic documentation - the way of the future - and to allow deduction of invoices to employees where there is corroborating evidence that the invoice is actually a company, not employee, expense.

In conclusion, Georgia's framework could be improved byproviding for a more principle-based rather than black-letter determination about whether certain expenses are representational (or entertainment) and substantiated by usingwell defined criteria; by extending the deduction to non-profit entities; by expressly allowing electronic documentation; and, finally, by critically reevaluating the fairness of the current one-percent-cap-as-a-function-of turnover-scheme. Georgia improved this year in its Ease of Paying Taxes category of the WB's Ease of Doing Business Survey - but there is always room for improvement.