The tax rate on the transfer of real estate is 2 percent of the taxable amount. The tax is due prior to the registration of the documents transferring the property. If the property is not registered, the tax is due at the time the property is transferred.

For property received as inheritance, the tax is due no later than 6 months from the receipt of documents transferring title. For property received as gifts, the tax is due within 1 month of the transfer.

Tax on the Use of Natural Resources. Physical and legal persons engaged in any activity that requires a license for the use of natural resources (with the exception of land) owned by the state must pay this tax. The tax is imposed on the volume of natural resources extracted.

The tax rates vary by natural resource. For minerals, the rate is between 1 and 15 percent (of the price of the mineral resources extracted), timber 2–34 percent, water 3–10 percent, animals 2–55 percent.

The tax for the use of natural resources is due before the 15th of the month following the reporting month. However, the tax for timber and flora resources should be paid at the time of their transportation from the forest; the tax for water resources should be paid before December 1st of the relevant year; and the tax on hunting birds in migration should be paid on receipt of the license.

The tax on natural resources must be paid within 3 months after receiving the license for using the natural resources.

Exempt from this tax are the mineral resources gained in the course of underground construction. In addition, the tax rate is reduced by 70 percent for use of natural resources in connection with scientific and cultural activities and for users of natural resources that have carried out restoration or replacement of natural resources from their own funds, within the limits of the volume of restored resources.

Environmental Taxes. This tax must be paid by physical and legal persons engaged in any activity listed in categories 1–4 of the Law of Georgia on Environmental Permits (October 15, 1996), who pollute the environment from fixed sources or who import or produce gasoline, diesel fuel, kerosene, natural gas (except as used as a raw material for production of goods), or liquid gas.

Tax rates are based on the pollutant emitted, whether it is emitted into the atmosphere or water (either directly or through sewers and storm drains), and geographic region. For other items the tax is based on the amount imported or produced. Imported goods that are later exported are exempt from this tax.

Tax rates apply to pollutants emitted within limits set by environmental laws. Pollutants emitted in excess of established limits are subject to a fine equal to five times the tax rate for pollution within the limit (see the section on fines and penalties below).

Taxpayers who pollute the environment from fixed sources must submit a tax return certified by the Ministry of Environment and Natural Resource Protection to the tax agency and pay the tax by the 15th of the month following the reporting quarter. Taxpayers who produce or supply gasoline, diesel, kerosene, natural gas, or liquid gas must submit a tax return by the 15th day of the month following the reporting month.

Taxpayers who import any products subject to the pollution tax must pay the tax before the customs agency clears the products. Customs may clear the products only after the tax agency issues a receipt indicating that the tax has been paid.

1.3.4 Existing Taxation Practices

Background. Georgia was one of the first CIS countries to codify its tax legislation in a comprehensive Code. However, since its adoption in 1997, there have been numerous amendments, which have considerably reduced the consistency of the Code. Some of the mayor changes in recent amendments include: i) changes in the tax rates for tobacco products and the tax rates of the motor vehicles ownership tax; ii) repealing provisions in the Code allowing the tax administration to seize and sell delinquent taxpayers property; iii) introduction of exemptions from property taxation for enterprises and physical persons in mountainous regions. The IMF carried out a review of tax policy in 2000 and a number of the recommendations from this review were actually included in a tax reform package prepared by the Ministry of Finance in September 2001. However, this package has not been presented to Parliament so far. Key issues remaining on the tax policy side are:

Unstable tax policy framework. The history of tax policy changes in Georgia since adoption of the tax code demonstrates a lack of long-term policy planning and a focus on short-term policy measures, disregarding the general consistency of the Code. Such approach has led to constant changes to Article 273 (on transitional provisions). Even fundamental policy changes are not introduced as permanent features of the tax system, but as temporary ones. A typical example is the cigarette taxation, which has been modified six times (!) since the Code entered into force. New taxation schemes are often introduced late in the year, for short periods of time and without clarification as to their duration. The current taxation scheme for tobacco products was introduced for the year 2001 only on December 2000 and was extended for another year through another amendment to the Code on December 2001. An even worse case is the excise tax on the importation of pyrolysis liquid products which was set at a rate of 400 GEL per ton on December 2000 and reduced to 50 GEL per ton less then four month later. There are numerous similar examples of short-term tax policy measures and frequent changes of tax legislation Such an approach neither allows the business community to calculate its tax burden over a longer period of time, nor does it permit the revenue authorities to design appropriate taxation strategies and develop a long-term planning of resource mobilization. The strong influence of lobbies in Parliament and the obvious tendency of parliamentarians to further narrow the tax base by granting sector and specific exemptions and rate reductions also contributes significantly to the low quality of tax policy making in Georgia.

VAT Threshold. Currently, VAT registration is mandatory for businesses with an annual taxable turnover of 24,000 GEL or more (and voluntary for a businesses below this threshold).[4] As a result of the low registration threshold, the tax administration has to deal with a large number of small businesses as VAT taxpayers who contribute little to total VAT revenues. For example, an increase of the threshold from 24,000 to 100,000 GEL would reduce the number of mandatory taxpayers from around 13,000 to 3,200. It would at the same time reduce the total VAT collection by around 23 percent. A reduction in the number of taxpayers could substantially facilitate the administration of the tax and help combat VAT evasion by permitting a more comprehensive cross-checking of VAT invoices and making it more difficult to establish shell companies for evasion purposes. [5]However, this result can only be achieved if the scope for voluntary registration is reduced. The Ministry of Finance therefore should consider to limit voluntary registration, e.g. by excluding businesses with a turnover below 50,000 GEL.

VAT Distortions. There is increasing frustration with the performance of VAT and the distortions its creates because the tax net is narrow and businesses are often unable to deduct VAT payments on their inputs. First, despite the low threshold, the number of 17, 000 businesses registered is quite low by international standards. Second, a true VAT, which is supposed to avoid tax cascading and economic distortions, requires a prompt and full refund of the part of the tax on inputs which exceeds the tax due on outputs. This is especially important for exporters. In Georgia the amount of unpaid VAT refunds is large (about 29 million GEL at the end of 2001). Tax inspectors should eliminate the practice of treating VAT as advanced payments against future tax liabilities in order to meet their monthly revenue targets (see section on tax administration below). Third, while many countries have introduced limited exemptions or reduced rates in their VAT laws to reduce regressive elements of the tax, the scope of tax privileges in the Georgian VAT continues to increase, and the country has embarked on the dangerous path to use tax privileges as a way to compensate for administrative or legal deficiencies.

Frustration with the distortion effects of the VAT has caused some policy makers to consider whether to replace the VAT with a sales tax. The objective would be to reduce compliance risks by applying the tax to one stage of the business cycle only. There are serious concerns regarding this idea. VAT despite its relatively low efficiency has become the main revenue source, contributing 45 percent to total gross tax revenues in 2001. Experience in other countries shows that sales taxes have a far lower revenue potential than the VAT, because it does not capture the total value added in the production and distribution phases and their rates normally are not higher than 5 percent--because of administrative difficulties. In addition, compliance risks and compliance management challenges would not be reduced because collection would have to rely on the retail sector which is more difficult to administer. Rather than replacing the VAT with a sales tax, the focus should be to improve VAT administration and actually implement the key principles of the tax, such as an effective refund system for exporters. A performance of the tax improves; consideration could then be given later to lowering the standard VAT rate.

Proposed simplified tax. To compensate for the revenue loss caused by increasing the VAT threshold, MoF plans to introduce a simplified tax for taxpayers who are not registered for VAT, and to modify the current presumptive tax for individual enterprises, which raises relatively little revenues (in 2000 actual presumptive tax collection was only 5 million GEL or 0.7 percent of total tax revenues), by changing it to a fixed tax with a broader tax base. The MoF proposal is to levy the simplified tax rate of 7 percent on gross income, which will require some basic accounting. The fixed tax will, similar to the current presumptive tax, be based on the nature of the business activity, the size of the business and the business location; it will include more types of small businesses than the presumptive tax. Although some (Foreign Investor Advisory Service (FIAS) December 2001 report[6]) consider a fixed tax to be extremely complicated, it need not be so. The fixed tax, if well designed, can be transparent and easy to administer tax. It offers no scope for negotiation to taxpayers, does not require detailed bookkeeping, and could reduce the opportunity for corruption and the compliance costs for taxpayers. There are some issues regarding this presumptive taxation scheme:

The combined fixed tax and simplified tax is supposed to compensate for the increase of the VAT threshold. However, estimated revenues from the fixed and the simplified tax are 27 million GEL, which is far less than the expected decrease in VAT revenues. While the increase of the VAT threshold and the introduction of the fixed tax are laudable reforms, the revenue impact of the reform will need to be studied further.

Parliament has rejected the proposed simplified tax because it considers the rate (7 percent) too high and the coverage too narrow. According to some parliamentarians, the scope of the tax should extend to some larger businesses, which clearly reflects the interest of certain business sectors to simplify and reduce taxation. Presumptive taxation based on gross figures should be limited to Small & Medium-Sized Enterprises (SMEs) with no sufficient bookkeeping, while all larger businesses are required to keep books and records and are taxed on a net basis. There is no good reason to extend the scope of the simplified tax to larger tax payers.

Excise Taxation. Due to its open borders and weak administrative capacity Georgia faces major problems collecting excise taxes. Reduction in excise tax rates has been the preferred method to improve compliance, but with no positive results so far. Despite this experience the trend to reduce excises continues, which is worrisome. Georgian excise taxes are actually very low by international standards already, and the focus should more be on efficiently enforcing the excise tax regime. Compared to the CIS country average, excise tax revenues in Georgia are low; in 2000 excises in Georgia contributed 1.5 percent to GDP, while the CIS average was 2.1 percent. Looking at neighbouring countries, excise revenue performance is much higher in Armenia with 2.5 percent of GDP and somewhat higher in Russia with 1.9 percent of GDP; it is much lower, however, in Azerbaijan with only 0.5 percent of GDP (which is together with Tajikistan the lowest figure in the CIS region). The fact that Georgia has managed to accumulate a surprisingly high level of tax arrears in an area where arrears normally should not build up – according to IMF data the amount of tax arrears on excises was equivalent to 2.7 percent of GDP by beginning of 2000 – shows, however, that excise revenue increases will also depend on the ability and support of the tax administration to collect revenues from major businesses in the oil and cigarette industry.

Income and social tax. The high tax burden of the personal income tax (PIT) and the social security tax provides a strong incentive to evade the payment of these taxes. Although the personal income tax has reasonably progressive rates (from 12 percent to a maximum of 20 percent), the marginal cost of taxes for both employees and employers creates strong incentives not to formalize the labor contract: employees prefer current to future consumption, while employers seek to reduce costs and increase competitiveness. Overall, the taxation rate of the PIT and the social security tax over the net wage is 68 percent. This implies that for each additional GEL paid to worker in net wage, there is 0.68 GEL to be paid in taxes if the contract is formalized. Financing of the pension system continues to suffer from low compliance in the area of social taxes. (for more details see Social Protection Chapter).

Corporate and income tax exemptions. The Tax Code currently includes a number of exemptions from corporate and personal income tax, which narrow the tax base, increase the discretion of tax inspectors and the potential for corruption. The IMF has recommended to review and abolish many of these exemptions. The Ministry of Finance has started preparing an amendment to the Code eliminating most of the current exemptions from personal and corporate income tax. This includes in particular the exemptions from CIT for enterprises in mountainous regions, the exemption of profit generated by energy renewable sources, consumer appliances and energy saving equipment. However, this proposal to amend the Code will still have to be finally presented to the Parliament, after it was withdrawn in September 2001.

Administrative provisions for tax enforcement. An essential feature of a good tax code is a clear definition of tax administration procedures and rights and obligations of taxpayers and tax officials. A reasonable balance needs to be defined between the interests of the taxpayer to simplify taxation procedures and reduce administrative burden and the interest of the tax administration to effectively enforce taxation. In Georgia, the possibility to enforce tax collection has been unduly restricted by reducing the powers given to the tax administration in chapter 42 of the tax code to seize and sell delinquent taxpayer property. As a consequence the only remaining enforcement measure, which does not require a court ruling, is the freezing of a taxpayer’s bank account. Considering the absence of specialized tax courts and the weakness of the court system in Georgia, this does not provide the tax administration with sufficient means to improve its compliance management. Enforcement powers of the tax administration should be harmonized with current practice in Organization for Economic Co-operation and Development (OECD) countries.

Abolishing nuisance taxes. Earlier the World Bank and IMF reports have recommended the elimination of nuisance taxes because they typically have extremely low revenue yield and are a burden for small businesses. The tax package prepared Ministry of Finance included the elimination of some of these nuisance taxes, (e.g., the tax on economic activities, the resort tax, the hotel tax, the advertisement tax, and the tax on the use of local symbols), but no progress has been made partly because these taxes are assigned to local governments. However, due to their very limited revenue potential, they contribute less than 10 percent of total local revenues. Considering the administrative and compliance costs of these taxes the actual revenue gains might even be negative, efforts to eliminate these taxes will need to continue.

1.3.5 Tax Reform Areas

General. The public perception of the quality and fairness of tax and customs administration in Georgia is generally very negative.[7] Substantial and visible improvements on the ground will be needed to begin dispelling this perception. This also requires a political commitment to abolish practices which protect and support special interests of taxpayer groups by introducing special exemptions in the tax legislation, thus eroding the tax base, or/and executing pressure on the revenue authorities to grant favourable treatment to specific taxpayers. It will also be necessary to reduce the incentives for revenue officials to participate in corrupt practices and to develop the necessary control mechanisms to detect and punish such behaviour.

Efforts to reduce capture and corruption are to be complemented by long-term strategies to improve the tax policy design and build revenue administration capacity. Tax policy reforms should focus on overall policy design issues instead of exclusively discussing the level of tax rates. Eventual tax rate reductions will only be feasible if accompanied by broadening of the tax base and administrative improvements. Key to improving administration is the effective implementation of self-assessment and the fair and equitable treatment of all taxpayers. Two areas that require special attention are (a) customs administration, and (b) enforcement of personal income tax and social security contributions.

Short-term Reform Priorities. While substantial capacity building in tax and customs requires long-term strategies, there are a number of essential short-term reform initiatives, which should be launched immediately, to improve revenue performance and reduce tax-related distortions.

Tax policy. The main challenge is to stabilize the tax policy framework, and avoid ad-hoc short-term policy measures. In general, the revenue impact of tax exemptions should be properly analyzed, and no further exemptions/tax reductions should be introduced without such analysis is explicitly presented in Parliament. Any tax policy changes should be taken in the context of the annual budget. It also recommended that the 2001 tax package prepared by MoF be re-submitted to Parliament, including key elements such as: reducing the scope of exemptions, raising the VAT threshold to GEL 100,000 (or US$50,000) and introducing complementary simplified tax.

Tax administration. A number of actions could be take to support long-term reform efforts:

Discontinue the practice of soliciting advanced payments to meet revenue targets and Design a new performance measurement system with appropriate indicators, supplemented by special incentives to improve revenue administration practices;

Centralize revenue accounts in the Treasury and make payments on “a first come first served basis”;

Begin implementation of special program to control imports through the railway system, especially of petroleum products;

Increase coverage of LTI and focus on improving LTI performance.

Prepare legislative changes to reintroduce sufficient powers for the tax administration to enforce tax collection.

A Longer-term Agenda. A more comprehensive reform program for the medium and long-term reform of the Georgian revenue system will then need to consider the following issues:

Broadening the base and lowering tax rates. While some taxes may be relatively high and may promote non-compliance especially the general VAT rate of 20 percent and the combined tax burden on labor taxes from excisable products are not fully exploited. A longer term tax policy reform objective for a poor economy like Georgia should be to reduce the tax burden on consumption and labor. However, this can only be achieved by (a) broadening the tax base of VAT and profit/income taxes; (b) increasing collection by improving the efficiency and effectiveness of tax and customs administration.

Past experience with tax policy reform in Georgia has shown that mere tax rate reductions without corresponding improvements in enforcement and compliance management will not contribute to increasing tax compliance. Rate reductions therefore do seem not feasible as long as revenue losses from the rate reduction cannot be compensated by a broader tax base and a better enforcement. Tax policy reform in Georgia therefore will need to mirror experience with tax reform in OECD countries in the last two decades, where rate reductions (mainly in the area of direct taxation) were achieved through base broadening and improving tax administration.

VAT Reform. The VAT should not be replaced by a sales tax. Rather, the VAT as the mainstay of the revenue system in Georgia should be strengthened. The VAT design appears buoyant, albeit if its base has been eroded by exemptions, privileges, and fraudulent practices involving both tax inspectors and tax payers. Increasing the threshold and reducing the number of taxpayers will help improve its administration and implement the true spirit of the VAT. Corresponding decreases in revenues can be compensated by introducing a simplified tax, as proposed by Government, and reducing exemptions to broaden the tax base. The implementation of a true VAT necessarily has to ensure refunds for exporters and zero rated goods. On the administrative side, it is important to advance existing initiatives to improve cross-checking, monitor registration, and regulate invoices.

Tax Simplification. The elimination of nuisance taxes will facilitate administration and reduce the administrative burden on small businesses. In Georgia, nuisance taxes are local taxes generating little revenue. The best would be to eliminate these taxes and find alternative (more solid) own revenue sources for local governments, such as the land and property tax, which are not currently collected centrally (see Chapter IV on Inter-governmental Fiscal Relations). In some cases, these are complemented by a small turnover tax, as is already the case in Georgia.

Addressing corruption. The creation of an Inspector General Office (IGO) within the MoR has been a step in the right direction. The work of the IGO should be provided with the appropriate legal and technical instruments to carry out its function. Technically, it is important to develop accurate assessments of where the opportunities for corruption arise, through an analysis of the business process and the use of indirect statistical methods. Legally, the IGO must have the powers to access relevant information from tax-offices and taxpayers. It should also be clear to the agencies and to the public how the recommendations of the IGO would be implemented. The role of the Chamber of Control in evaluating tax performance will no doubt be helped as the IGO builds up strength. The government needs to consider if the current profile of corruption requires development of legal instruments, other than those dealing with corrupt practices in the public sector, to address corruption in the revenue agencies.

Making effective a functional organization. The centrepiece of a modern approach to tax administration is self-assessment. To properly implement self-assessment requires changing the culture, both in government and society, of how taxes are calculated and collected. The direct contact between officials and taxpayers should be reduced, with emphasis shifted to taxpayer services, quick attention to arrears enforcement and selective but effective auditing. Internal control and anti-corruption services should help keep taxpayers and officials honest. Appeals mechanisms should serve to protect taxpayers rights. The extensive advise provided by donors has already acquainted the authorities with the principles of self-assessment. However, the reform agenda continues to be broad and will take time to implement. Te following issues would seem to require special attention:

Registration. It is necessary to review the current registry with emphasis on taxpayers that are not active and looking for quality taxpayers that may be hiding as small or not even registered.

Arrears enforcement. The current stock of arrears plus fines and penalties is large but a large portion of it might not be collectable. It is necessary to make a realistic assessment of what can be collected from the stock and develop timely methods to prevent new arrears from aging, setting clear priorities.

Auditing. There should be a sustained effort to build the quality of auditing. Special attention initially could be placed on critical aspects of the VAT such as VAT refunds, cross-checking of credits and fake invoices. Important to good auditing is the development of risks profiles to guide selection and improve effectiveness. Greater information management capacities available now have to be used to develop such profiles.

LTI. The LTI in not a centre of excellence. Efforts to update the roaster of large taxpayers and to reach coverage of at least 50 percent of the revenues collected by the tax agency are worthwhile, but they have to be sustained. The LTI has to take a more proactive attitude to performance and reform and it is good place to begin developing new incentive mechanisms away from simple revenue targeting.

IDA Support to the Private Sector in Georgia

IDA's Policy. To support private sector development and attract needed foreign investment, the World Bank (namely IDA) has developed the Country Assistance Strategy (CAS), which focuses on removing key policy and institutional (including governance) constraints, as well as financial, energy and infrastructure bottlenecks. On the basis of the FY03 Integrated Trade Development Strategy IDA will provide reform support and progress monitoring through the ongoing Enterprise Rehabilitation Project, an FY06 Private Sector Development Project, and the ongoing Business Environment Surveys and Studies. IDA will also provide support (in conjunction with USAID) for improving access to affordable finance through further financial sector reform, and will help reduce trade, transit and marketing costs through the FY05 Trade and Transport Facilitation Project, building on the FY03 South Caucasus Trade and Transport Facilitation Study. IFC will complement these activities through investments in small and medium-sized businesses and, in coordination with USAID, through technical assistance for business development. Support for alleviating energy bottlenecks will be provided by IDA’s ongoing energy portfolio and dialogue.

Support to SMEs. The Small and Medium Scale Enterprise (SME) sector is a crucial area for potential private sector growth, and IDA has been supporting the sector through its ongoing Enterprise Rehabilitation Project. IDA plans, through the FY06 Private Sector Development Project to provide expanded support for management training, creation of export-oriented clusters of SMEs, advice to business associations and government, and monitoring of the business environment. Additionally, IFC will conduct a targeted study of the SME sector in Georgia to identify key obstacles to its development, and then recommend specific improvements in the regulatory and administrative environment.

IFC Financial Support to the Private Sector in Georgia

IFC's Policy. IFC’s lending and investments in Georgia have been tailored to the country’s special circumstances: limited foreign investments, the non-existence of large local companies, limited access to financing for a nascent SME sector, and the lack of advice for private companies on business related issues such as corporate governance and leasing. IFC would also provide support directly to the private sector through the Georgia Business Development Project, a five-year technical assistance program implemented by the Private Enterprise Partnership with the support of the Canadian International Development Agency (CIDA). The main components of the project, as already stated in the above, include development of the leasing sector and improvement of corporate governance practices. The corporate governance initiative is helping Georgian businesses improve their practices to build investor confidence and increase their access to financing. This component of the program also includes advice to the Government on improving corporate governance policies and regulations.

Assistance to SME Sector. To reach small and medium enterprises, IFC provided equity and long-term credit lines to TBC Bank and helped establish Georgia Microfinance Bank – the ProCredit Bank - the country’s first bank specializing in lending to micro and small enterprises. In June 2000, IFC purchased a 10 percent stake in TBC Bank. IFC’s support helped TBC to grow from a “pocket” bank into the largest and one of the best performing commercial banking institutions in Georgia. In 1999, IFC helped establish the ProCredit Bank - the first bank dedicated to lending to micro and small enterprises in the country, and now the fastest growing banking institution in Georgia. IFC has also supported other Local Companies, for example, GG&MW, a mineral water production company, where IFC’s loans supported the company’s acquisition of key strategic assets and strengthened control over its key brand, Borjomi mineral water. IFC’s equity investment helped the company rehabilitate two mineral water bottling facilities, diversify its product mix and develop the distribution network. IFC sold its stake in the company in 2002.

Development of Mortgage Lending. In the financial sector, IFC has focused on supporting the development of the housing finance market. The introduction of mortgage financing has allowed individuals for the first time to leverage their residences to increase their standard of living. In 2000, IFC extended a $3 million credit line to the Bank of Georgia, and together with re-flows, this credit line financed over 500 projects totalling $4.5 million. In June 2003, IFC provided a second $5 million credit line to the Bank of Georgia for housing finance and for on-lending to small and medium enterprises. In August 2001, IFC provided a second $3 million loan to TBC Bank to support the development of its mortgage lending.

Facilitation of Foreign Investments: IFC invested in equity and provided loans to Ksani Glass Factory, a producer of high-quality glass bottles and packaging. IFC’s The $2.5 million equity investment and $6.3 million loan supported Ksani’s expansion and modernization. At project completion, the facility will be producing 40,000 tons of high quality glass bottles annually with a high level of product flexibility. In the power sector IFC provided a $30 million loan to AES Corporation to support the newly privatized Tbilisi area power distribution company. The loan was pre-paid in August 2003, when the AES Corporation sold Tbilisi electricity distribution system to UES.

1.6 Legislative Basis for the Operation of the Private Companies

General. The operation of the private companies in Georgia is mainly regulated by the following two laws: a) Law on Entrepreneurs (LoE) (Corporate Law), which sets the corporate governance principles for the private companies (i.e. Limited Liability Companies and Joint Stock Companies); and b) Securities Market Law (SML), which regulates the activities of the private companies permitted to issue and trade the shares on the securities market (i.e. Joint Stock Companies). Both laws are reviewed below.

1.5.1 Law of Georgia on Entrepreneurs (LoE) (Corporate Law)

Under the Law of Georgia on Entrepreneurs the following forms of commercial entities may be established in Georgia:

i. Sole proprietorship—An enterprise operated by a physical person with unlimited liability and no minimum capital requirement. A sole proprietorship is not considered a legal entity under the commercial code of Georgia.

ii. Joint Liability Company—A legal entity with unlimited liability established on the basis of a partnership of several individuals or companies.

iii. Limited Partnership—A legal entity consisting of general and limited partners. The limited partners have limited liability and general partners bear full and direct liability for the obligations of the company.

iv. Limited Liability Company—A legal entity that is separate and distinct from its shareholders (one or more legal or physical persons). The company’s liability is limited to its authorized capital. Founders and shareholders are not liable for the obligations of the company.

v. Joint Stock Company—A legal entity characterized by the limited liability of the partners. The company’s liability is limited to its authorized capital.

vi. Cooperative—A legal entity characterized by the limited liability of the shareholders. In Georgia, this is a common form of organization for agricultural enterprises.

Sole proprietorships, joint liability, limited partnerships and cooperatives are rarely established by foreign investors in Georgia. Therefore, the following focuses on the legal requirements for Limited Liability Companies (LLCs) and Joint Stock Companies (JSCs), which are the most popular forms of incorporation used by foreign investors in Georgia.

The Law on Entrepreneurs does not set limitations on the domicile of partners. A partner in a legal enterprise can be a citizen or resident of any country. Foreign companies can be established as fully foreign-owned enterprises or in partnership with Georgian companies or physical persons. In accordance with the Law on the Promotion and Guarantees of Investment Activities of November 12, 1996, companies with foreign investments enjoy national treatment and the same rights as Georgian companies.

Provisions of the Law on Entrepreneurs for Limited Liability Companies (LLC):

· An LLC can have a maximum of 50 shareholders. The minimum equity capital requirement is 2,000 GEL. The share of the equity capital to be covered by each of the partners may be determined freely, but it must be divisible by 10;

· At least 50 percent of the equity capital must be paid up at the time of incorporation, with the remaining 50 percent due within one year;

· The Law stipulates that a partners’ meeting be held at least annually. Special meetings may be called at the request of partners or directors of the firm;

· Partners’ meetings are required to consider issues such as amendments to regulations, reorganization or liquidation of the company, appointment of directors, and so on;

· Day-to-day management of the company is carried out by one or more directors who are appointed and dismissed by the general meeting or the supervisory board, when such a board is established at the discretion of the general partners meeting;

· A partner may sell his shares without seeking consent of other partners, unless otherwise stated in the charter of the company;

· Partners who posses 5 percent and more of the equity capital are authorized to call a general meeting.

Provisions of the Law on Entrepreneurs for Joint Stock Companies (JSC):

· An entity with more than 50 partners is required to have a legal form of a Joint Stock Company (JSC);

· Minimum equity capital for JSC is 15,000 GEL;

· A JSC with more than 100 shareholders is required to maintain its share registry through an independent registrar (In 2003 amendments were adopted into the law requiring that a JSC with more than 50 shareholders is required to maintain its share registry through an independent registrar);

· A general shareholders' meeting must be held in two months time form publishing annual financial accounts;

· A general shareholders' meeting is entitled to elect the supervisory board members, make amendments into the charter of the company, approve the annual report presented by the company directors, elect auditors and so on;

· Creation of a supervisory board is mandatory for a JSC. Supervisory boards must have between 3 and 21 members, but the number must be divisible by 3. The Law provides for representation of company staff on the supervisory board (up to 1/3 of the members);

· Supervisory board is elected for the period of 4 years. The company directors may not be the members of the supervisory board;

· Supervisory board meeting must be held al least once in a quarter;

· Day-to-day management of the company is carried out by one or more directors who are appointed and dismissed by the supervisory board;

· Supervisory board oversees the activities carried out by the company directors, checks the annual financial accounts, appoints and dismisses the company directors, etc.;

· The consent of the supervisory board is needed to conduct the following activities: purchasing or selling more than 50% share of entities, purchasing or selling the assets of the company, setting up or liquidating the branches of the company, etc.;

The law envisages a cumulative voting for electing the members of a supervisory board to protect minority shareholders, but this is not a mandatory requirement.

Representative Offices and Branches. A foreign company may operate a branch or a representative office in Georgia. A branch is not a separate legal entity and it is allowed to engage in commercial activities that would constitute all or part of the activities of foreign head office. For purposes of registration, representative offices are treated as branches and are obliged to fulfil the same requirements.

All actions on behalf of a company can be performed by the head of the company (executive body) or by any person authorized to perform such actions by a power of attorney of the relevant body of the company. Foreign legal entities bear full liability for the activities of branches or representative offices.

Analysis - Law on Entrepreneurs (LoE). As the main company law for Georgia, the Law on Entrepreneurs provides a good basis for corporate governance for all the private companies including those with traded securities. However, based on the experience of other central and eastern European countries, there are several provisions in the Law on Entrepreneurs that could be amended to further strengthen the corporate governance provisions. They are: (1) although the LoE envisages a cumulative voting for electing the members of a supervisory board to protect minority shareholders, it should be made a mandatory requirement. As a result, there will be a mandatory cumulative voting for members of supervisory boards as a means of allowing shareholders with small shareholdings to vote at least one member of the supervisory board; (2) requirement that the shareholders’ meeting approve the auditing company’s contract (covering the scope of work and annual auditing fees) so that shareholders interested in a highly quality audit, requiring more time from the auditing company, can obtain such an audit, and (3) There is a need to establish a minimum quorum below which no shareholders’ meeting may be considered valid; (4) although the LoE requires the financial statements of JSCs to be prepared on the basis of the International Accounting Standards (IAS), it does not specifically require that audits are conducted in accordance with the International Standards on Auditing (ISA), which needs to be amended; and (5) the LoE does not provide takeover rules to protect the interests of minority shareholders.

More specifically, the World Bank (WB) and the International Monetary Fund (IMF) conducted the Assessment of the Implementation of the Corporate Governance Principles of the Organisation of Economic Co-operation and Development (OECD) in Georgia. It is interesting to note that the assessment identified a number of the shortcomings in the corporate governance practice existing in Georgia. Namely, according to the study: (i) There are uncertainties in knowing if shareholders are sharing in company’s profits; (ii) It is not uncommon practice of failing to hold the required shareholders’ meetings; (iii) Markets for corporate control are limited; (iv) Court system has not yet made any decisions on the cases concerning corporate disputes; (v) Minor role is played by supervisory boards in the strategic guidance of companies; (vi) There is a less than complete disclosure by most reporting companies, particularly of financial and operating results; (vii) There are weak auditing practices;

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