In practice, the legal form of a transaction may not always reflect its true economic substance. While in civil law such inconsistencies may be addressed through the concept of fraudulent transactions, in taxation, the issue can be approached differently.
Under the Georgian Tax Code, the Revenue Service is authorized to reclassify a transaction for tax purposes if its legal form does not correspond to its actual economic content.
This approach, known as the substance over form principle, allows the tax authorities to determine tax liabilities based on the real economic effect of an operation rather than its declared structure. It ensures that taxpayers cannot reduce or avoid tax obligations by merely adopting artificial contractual arrangements that disguise the true nature of a transaction.
For a deeper look at how different forms of transactions can trigger specific tax consequences, you may also find our article on Tax Obligations Related to Business Sale in Georgia useful.
How the Reclassification Process Works
Changing the qualification of a transaction is not an arbitrary decision; it must follow a structured and evidence-based process.
The Revenue Service may reclassify a transaction only if the operation affects the taxpayer’s tax liability and there are clear indications that its declared form does not reflect the parties’ actual intention.
According to the Revenue Service guidelines, the tax authority follows several stages to reach such a conclusion during an audit. It begins with the identification of a potentially suspicious transaction, followed by its description and detailed analysis. The next step involves an assessment of the transaction’s substance, after which the taxpayer is given the opportunity to provide explanations and supporting evidence.
If necessary, the Revenue Service may also request information from third parties connected to the transaction.
Finally, based on the gathered evidence, the authority may proceed with the reclassification of the transaction and issue an official decision reflecting the resulting tax consequences.
This multi-step process ensures that any change in the legal qualification of an operation is backed by sufficient factual and economic justification.
Practical Example of Reclassification
A common example illustrating the substance over form principle involves transactions between a company and its founder.
Suppose that during a tax audit, it is revealed that a company’s shareholder has lent GEL 100,000 to the company. Later, the company repays GEL 120,000 to the shareholder, GEL 100,000 as principal, and GEL 20,000 as interest. The company withholds 5 percent tax at source on the interest payment, assuming it represents a standard loan transaction.
However, during the audit, it is also established that:
- The company had undistributed profits during the period under review, and
- There was no documented business need or purpose for taking the loan from the shareholder.
In this situation, the Revenue Service may conclude that the operation does not represent a genuine loan, but rather a distribution of profit disguised as interest.
Under Georgian law, distributed profit is subject to 15 percent Corporate Income Tax (CIT) at the company level, and dividends paid to individuals are further taxed at 5 percent withholding tax at the time of payment.
Accordingly, the GEL 20,000 paid as “interest” may be reclassified as a profit distribution, triggering both levels of taxation, 15 percent CIT and 5 percent dividend tax.
This example demonstrates how the substance over form principle prevents companies from avoiding distribution-related taxes by artificially structuring payments as loans, management fees, or other forms of compensation.
The substance over form principle is one of the most powerful tools available to the Georgian tax authorities in ensuring that taxation reflects economic reality rather than formal declarations.
For businesses, this principle highlights the need for proper tax planning, transparent structuring, and detailed record-keeping.
Understanding how and when the Revenue Service may reclassify transactions helps companies avoid disputes, unexpected assessments, and risks. In a broader sense, adherence to substance-based reporting strengthens Georgia’s reputation as a transparent and trustworthy tax jurisdiction.
About Andersen in Georgia
At Andersen Georgia, we assist businesses and investors in analyzing and documenting their transactions to ensure compliance with Georgia’s substance-over-form rules. Our tax and legal team advises on corporate structuring, related-party dealings, financing arrangements, and profit distribution planning to minimize risks of reclassification during tax audits.
We also provide valuation and transaction review services to ensure that all operations reflect genuine economic substance and meet both domestic and international compliance standards.
For professional advice on tax structuring and audit readiness in Georgia, contact us at tax@ge.andersen.com.
Disclaimer: This article is based on Georgian legislation and public information as of November 2025. It is intended for informational purposes only and does not constitute legal or tax advice. Readers are encouraged to seek professional guidance tailored to their specific situation before making any tax-related decisions.