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Journal number 3 ∘ Iza Bukia
The Estonian Model of Profit Tax – The Prospect of Economic Growth

Expanded Summary

The most part of Georgia’s budget (approximately 92%) is made up of tax revenues, that is why it is very important to implement such legislative amendments, which, on the one hand, business and entrepreneurs will be tailored and on the other hand, to mobilize budget founds. Therefore, it is very important to consider the change, which refers to the replacement of the existing profit tax model with the Estonian model (since January 1, 2017). The above mentioned change is a challenge for the Georgian economy, because budget revenues are reduced by 400 million GEL per year in terms of profit tax. However, it is a great stimulus for entrepreneurs, because they have the opportunity of not levying tax of reinvestment profit, which is a guarantee of business expansion.

Distributed profit tax in Estonia it has already been working for 18 years and it is regulated by The Income Tax Act, which entered into force in 2000. Distributed profit tax is subject to taxation:

  1. Distributed profit;
  2. Payroll benefits of employees;
  3. Gift, donation and representation expenses;
  4. Some expenses and/or deduction that are not related to the company’s entrepreneurial activities.

It should be noted, that the distributed profit tax and income tax rate is the same (20%), whereas, company tax profit and financial profit are equal to each other. (Which is different from the Georgian model operating until 2017).

As to the profit tax model acting on January 1, 2017, the taxable profit of a resident enterprise was taxable profit (15%). It was defined as the difference between the taxable income of the taxpayer and considering the deductions by this Code.

The profit tax model, which came into force from 2017, (Rate remained the same – 15%) the object of taxation for a resident enterprise is defined as follows:

  1. Distributed profit; (Distributed profit is profit, which is distributed by the enterprise as a dividend to its partner, in cash or non-monetary form)
  2. Costs incurred or other payments, which is not related to economic activity;
  3. Deliver the goods/services and/or provide cash for free;
  4. The cost of representative expenditure of the amount exceeding the limit set by this Code.

As regards, commercial bank, credit union, insurance organization, microfinance organization and pawnshop, whereas, the person who works in the systematic-electronic form of the totalizator in this part of the activity, for them the object of taxation remained the same until January 1, 2019 – so it is the difference between the taxable income of the taxpayer and the considering the deductions by this Code in the calendar year.

If we look at its results in Estonia, revenues from the profit tax after the adoption of this model (2000) are dramatically reduced, however, since 2003, it has reached the mark of the reform (1999 – 107 million). Here also should be considered the economic crisis in the post-reform period and as well as reduced profit tax rate from 26% to 20% (since the rate has already been 20% since 2015), which was held in Estonia in 2000-2017. However, in spite of this, the amount which has received from the profit tax in 2015 has reached its maximum (approximately 425 million). Distributed profit tax model may be considered a defective that it is not spread massively and short-term perspective has a negative result, because budgetary revenues are decreasing in profit tax margin. This may result in a budget deficit. In the case of Georgia, the profit tax rate in the budget revenues varied between 12-13% (about 800-900 million GEL), which has a big impact total tax revenues. After the launch of the Estonian model, according to the results of 2017, the profit tax rate in tax revenues is 7.7% (756 million GEL), whereas profit tax is reduced approximately by 300 million GEL.

However, it should be noted, when the initiative was announced by the Government about this expected change in 2015 (which was adopted by the Law on Parliament of Georgia on 13.05.2016 – N5092, so it come into force from 01 January 2017), in order to reduce the expected budget deficit, the government has adopted a number of decisions such as: increase excise tax (periodically different products), reduction of costs incurred by various structural units. For example: if we compare profit and excise taxes in 2011-2015, the profit tax rate is relatively high than excise, but announcement of the initiative of  legislative about the Estonian model of profit tax (2015), since the budget deficit was expected, in order to balance it, the excise rate has increased periodically on various products, which led to the equalization of revenues from profit and excise taxes in 2016 and in 2017, when this legislative amendment has already entered into force about a new model of taxation of profit tax, as expected, revenues from profit tax decreased, however, tax revenue from excise dramatically exceeded the share of profit tax. That's an expected (approximately 400 million) deficits, have filled up an excise tax in 2017, which made it possible to be relatively balanced budget deficit caused by the introduction of the Estonian model by taxing profit.

As we mentioned, this change is a part of the tax policy considered for a long term, its goal is to create a tax system that stimulates entrepreneurial activity, increase the volume of capital, improve the investment environment, because in turn, developed business and tax system are mechanisms for promoting economic development, which will be a major push for economic growth in the long term.