Criteria for qualifying transactions considered as loans as capital contributions in international controlled transactions

18.02.2025

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Article 14¹ of the "Instructions on the Evaluation of International Controlled Transactions", approved by Order No. 423 of the Minister of Finance of Georgia of December 18, 2013, regulates the issue of qualifying a loan as a capital contribution in relation to international controlled transactions.

The above-mentioned article refers to internationally controlled operations or transfer pricing, in particular, to Georgian companies that carry out business operations with foreign interdependent persons and/or offshore registered companies regardless of interdependence.
 

The Order specifies the criteria that must be taken into account in order to exclude the qualification of an operation considered as a loan by the agreement concluded by the parties to an international controlled transaction and/or by the factual circumstances as a contribution to capital in full or in part.

These criteria are:

• A fixed schedule for repayment of loan principal/interest based on contractual relationships and/or actual circumstances, and ensuring that this schedule is consistent with market conditions and the purpose of the loan;
   
• Determining the obligation to accrue/pay interest based on the contractual relationship and/or factual circumstances, as well as determining whether interest is actually accrued/paid;
   
• In case of breach of obligation, the use of compulsory enforcement measures provided for by law to satisfy the claim (loan principal and interest) and the establishment of the fact of the lender exercising the aforementioned right upon the occurrence of relevant conditions, based on contractual relations and/or factual circumstances;
   
• Determining the subordination of the lender's claim to the borrower's other creditors by contractual relationship and/or factual circumstances;
   
• In case of violation of the terms of the agreement, various contractual restrictions on the borrower (including in connection with the sale of assets), the use of a fine and/or other means of securing the demand, and when the relevant conditions are met, the determination of the fact of the lender's use of the said means by the contractual relationship and/or factual circumstances;
   
• Determining the borrower's ability to meet loan obligations;
   
• When implementing a transaction considered a loan, the borrower's financial indicators (including the loan-to-equity ratio) are considered to be within the market range;
   
• Determining the need for taking the money and the purpose of spending it;
   
• Failure to pay the loan principal/interest within the agreed period and/or extending the loan principal/interest repayment period more than once;
   
• Granting the lender the right to participate in the strategic/operational management of the borrower and establishing the fact of the lender exercising this right upon the occurrence of relevant conditions, based on contractual relations and/or factual circumstances;
   
• Issuance of loans in proportion to share ownership and/or subject to ownership conditions;
   
• Possibility of converting a loan into equity.

It should be noted that in order to change the qualification of the operation, it is necessary to meet at least 3 (three) of the above-mentioned criteria, and at least one of these three must be "the ability to fulfill loan obligations" and/or "the borrower's capital structure" (When implementing a transaction considered a loan, the borrower's financial indicators (including the loan-to-equity ratio) are considered to be within the market range).

As a result of the aforementioned evaluation, the tax authority will be obliged to draw up a relevant conclusion on the qualification of the loan as a capital contribution, the motivation part of which must indicate the content of the operation, the reasoning and circumstances regarding the expediency of changing the qualification of the operation. The operation or part of it is subject to the change of qualification at the moment of implementation of this operation.

This regulation will allow the parties to avoid in advance an increase in income tax and financial penalties for incorrectly filed declarations and tax reductions.

Author: Iashagyan Oksana

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