pwc 1 st Communiqué of Corporate Tax Law 1 ST Communiqué of Corporate Tax Law

Transcription

1 1 st Communiqué of Corporate Tax Law This booklet is not intended for definite advice but merely as an explanatory guide. We would strongly recommend that readers seek professional advice before making any decision. For further information please contact the specialist names given below in PricewaterhouseCoopers office in Turkey.

2 MAJOR HEADLINES OF THE COMMUNIQUE 1. Capital Gains Exemption 2. Controlled Foreign Corporation 3. Deduction of the Foreign Taxes Paid 4. Foreign Branch Profit 5. Participation Exemption 6. Thin Capitalization 7. Transfer Pricing 8. Free trade Zones 9. Anti Tax Heaven Applications

3 1. CAPITAL GAINS EXEMPTION 1. Capital gains exemption for sales of participation shares and real estate, founders shares, bonus shares and pre-emptive rights Since the sales of real estate and participation shares before 21/06/2006 are arranged in the framework of 8/12 of the Law numbered 5422, the capital gains total will be exempted within the terms of the said clause. The provisions stated in 5/1-e of Corporate Tax Law numbered 5520 will be applied to the capital gains arising from the sales of real estate, participation shares, founders shares and bonus shares which eventuated after the publication date of the new Corporate Tax Law, namely 21/06/2006. In respect of this,75% of the capital gains derived within the provisions of this clause will be exempted and the remaining part will be taxed. All corporate taxpayers including non-resident taxable corporations will benefited from the said exemption clause The economic assets subject to the exemption application You may find below the economic assets those are subjected to the exemption when the profits accrues after the sales of such assets Immovable assets Immovable assets subject to exemption are assets defined as Immovable in the Turkish Civil Code which cannot be moved from one place to another because of their basic nature, thereby being fixed in their location. These are stated in clause 704 of the Turkish Civil Code as; - Land - Substantive and perpetual rights booked in separate pages in the Land Register. - Independent sections registered in the freehold flat register. For gains derived from the sales of immovable subject to exemption, the immovable should be registered to the Land Register according to clause 705 of the Turkish Civil Code. The definition of immovable should include the elements that are a supplementary part of the immovable. The definition of immovable should not include elements in the form of outlying parts. When the exemption application is evaluated within the framework of the machines related to the fixed production parts of the building, the devices will be accepted as supplementary part in case the building is destroyed and damaged when those devices are removed. The gains derived from the sales of assets that are supplementary to the immovable will also be exempted. Besides, if the machines are sold separately from the immovable, the sale would be accepted as a movable asset sale since the characteristic of component part will no longer exist.

4 The participation shares, founders shares and bonus shares The expression of participation shares in the clause states the stocks included in the security portfolio and partnership interests. These are: - Partnership interests and the stocks of joint stock companies (including investment partnership stocks established according to Capital Markets Law) - Participation shares of limited companies - Partnership interest of the dormant partner of the commandite partnership whose capital is divided into shares - Partnership interest of the business associations and ordinary partnerships - Partnership interest of the cooperatives. The participation certificates of the funds subject to the regulation and control of the Capital Markets Board will not be evaluated as participation shares Conditions related to the exemption application General Conditions: In the said section of the communiqué, the conditions related to the application of the exemption and the detailed explanations are stated. The detailed explanations are given under the below mentioned headings. - Fixed assets should be utilised for -at least- for two years - Acquisition date of the non-paid up stocks and preferred stocks - Acquisition date in the case of takeover and spin-off - Determination of the two-year period in the buildings under construction - Determination of the two-year period in the acquisition of the participation shares of the same company Keeping the profits derived from the above sales in a special reserve account - Since the exemption is applied to 75% of the sales profit, the total sales profit does not have to be booked in a special reserve account; it is sufficient to book the sales profit that benefited from the exemption in a special reserve account. - Besides, it is possible for the taxpayers to benefit from the exemption for their particular part of the profit. - In a cash sale and also in a time sale, the 75% of the sales profit would benefit from the exemption in the period that the sale takes place as long as the sales profit is booked in a special reserve account for at least five years. - The sales revenue should be collected within two years. If the sales revenue is not collected within two years, the taxes not accrued on time will be claimed back with penalty The sales profit kept in the fund account should not be withdrawn from the company The time interval to keep the revenues in special reserve account should be interpreted as the time period until the last day of the fifth year starting from the following year of the sales transaction.

5 It is clear that if the sales profit which is booked in a special reserve account is withdrawn from the company during the five-year period or after the said period, it should be regarded as a profit distribution. The addition of such reserve to the capital does not mean withdrawal from the company. 2. CONTROLLED FOREIGN CORPORATION Controlled Foreign Corporation Profit According to Corporate Income Tax Law article 7., tax resident companies and real persons whom invested in foreign subsidiaries those satisfy certain conditions are subject to Corporate Income Tax Law irrespective of whether foreign subsidiary s profit is distributed or not. Corporations that are established abroad and are controlled directly or indirectly by tax resident companies and real persons by means of separate or joint participation in the capital or dividends or voting rights by at the rate of minimum 50% are considered as Controlled Foreign Corporations. Directly or indirectly and Separately or jointly expressions in article used in order to avoid being out of scope of the article by distributing the subsidiary s participation shares between group firms and real persons. In case of existence of chain relation in indirect subsidiary relation determination process, all participation relations will be considered until the last indirect relation Controlled Foreign Corporation To define a foreign subsidiary as CFC, that institutions capital, dividends or voting rights had to held by resident companies or real people directly or indirectly at the rate of minimum 50% are controlled by means of separate or joint participation. Control rate is considered as the highest rate owned in the related fiscal period to determine foreign subsidiary is whether a CFC or not. In case of divestment of all participation shares of foreign subsidiary (capital, dividends or voting rights) without collusion before the end of fiscal period of foreign subsidiary, that article will not applied to related foreign subsidiary Conditions to be subject to CIT in Turkey for corporate income of foreign subsidiary For foreign subsidiaries those above mentioned control rate condition is satisfied, below conditions should be applied together in order to be deemed as controlled foreign corporation in corporate income tax law application and accordingly CFC s corporate income subject to CIT irrespective of profit is distributed or not % or more of the gross revenue of the foreign subsidiary must be composed of passive income 25% or more of the gross revenue of the foreign subsidiary must be composed of passive income in related year Effective tax rate on foreign subsidiary profits in its home country The CFC must be subject to an effective income tax rate lower than 10% for its commercial profit in its home country.

6 Effective tax rate will be determined according to definition at subparagraph (b) of article 5 of Corporate Income Tax Law. Accordingly, comments in section of that communiqué had to be taken into account about effective tax rate Minimum gross revenue condition of foreign subsidiary In order to be deemed as CFC according to Corporate Income Tax Law, gross revenue of the CFC must exceed the equivalent of YTL100,000 in a foreign currency in the related period. CFC CBRT FX buying rate will be taken in to consideration for calculation of foreign subsidiary s gross revenues equivalent of YTL by the last day of the related fiscal year CFC earnings included in tax base of resident companies CFC earnings that will be taxed in Turkey according to article will be before tax earnings in which all expenses including losses deducted but exemptions included. There will be no taxation in Turkey if CFC has no distributable profit due to previous years losses. On the other hand, to take into consideration of CFC losses while calculating resident companies earnings which participated in that subsidiary is not possible Offset of taxes that subsidiary paid abroad According to article 33 of CIT law, income tax, corporate income tax or similar taxes that the CFC pays over its profit in the related foreign country will be offset from the tax calculated for the same revenue in Turkey. However, taxes that the CFC pays out of its home country could not be offset from CFC revenues those taxed in Turkey Taxation in case of subsidiaries dividends distribution There will be no taxation on portion of CFC dividends taxed in Turkey if CFC profit distributed afterwards. However, if there will be dividend distribution if following years that exceeds the amount taken into consideration in taxation in Turkey, exceeding portion will be taxed separately CFC regulations against Avoiding Double taxation agreements Effective bilateral double taxation agreements do not prevent Turkey s taxation of its residents according to CFC regulations of CIT article 7. In other words, whether a profit is distributed or not from another state resident company to Turkish resident company, CFC regulations will be applied. However, if a non-resident company distributes dividends to a resident company over profits that has been taxed in Turkey according to CFC regulations, taxation of dividends and avoiding double taxation provisions in agreements will be applied normally Effective date of CFC revenues CFC article of CIT law is effective from 1/1/2006 to be applied for revenues earned after 1/1/2006. Accordingly, CFC revenues for those fiscal years end after 1/1/2006 will be included to resident companies revenues those participated directly or indirectly in mentioned subsidiaries according to their shares.

7 On the other hand, for dividend distributions of profits before 1/1/2006, those dividends will be taxed according to CFC regulations due to transfer date of dividend is after effective date of article. 3. DEDUCTION OF FOREIGN TAXES PAID 3.1. Deduction opportunity Taxes paid in foreign countries related to the revenues which are generated in foreign countries and are to be taxed in Turkey can be deducted from the corporate tax calculated due on the same revenues generated in Turkey. The foreign exchange rate of the transfer date of the revenues to the final accounts to which the foreign taxes relate is required to be used Deduction Period Without prejudice to the limitations provided below, in case that the foreign taxes paid relating to the foreign revenues included in Turkish corporate tax returns could not be partially or completely deducted as there is no taxable income due to the deduction of losses and exemptions, the deduction for the foreign taxes paid will be used until the 3 rd consequent fiscal period Limits of deductible foreign taxes The foreign corporate taxes and other foreign taxes of similar nature, which will be deducted from the taxes assessed in Turkey, cannot exceed the amount calculated by implementing 20% (corporate tax rate) on the revenues generated in foreign countries. If the foreign taxes paid are to be deducted from the corporate tax calculated in Turkey, the total amount of foreign revenues added to the Turkish tax base must be grossed up so as to include the mentioned taxes. i.e. Company (A) generates YTL 100,000.- corporate income through its establishment in country (B). The company pays 25% corporate tax or any other similar tax in a foreign country. In this case, Company (A) will add YTL to its corporate revenues in Turkey, however, can not deduct the amount exceeding the tax in Turkey calculated [ ( x 20%)=5000] from the taxes calculated in Turkey. This tax cannot be deducted in either the current year or the consecutive years. On the other hand, in the case when the revenues generated abroad are exempted from corporate tax, the foreign taxes paid over those revenues abroad can not be deducted from the corporate tax calculated in Turkey Taxes paid by the controlled foreign entity In the cases when article 7 of the corporate tax law would be applicable, all income, corporate and similar taxes paid by the controlled foreign entity can be deducted from the related entity's tax liability calculated over the taxable income in Turkey Deduction of taxes paid on the dividend income generated from foreign participations The foreign corporate, income or similar taxes paid over the revenues sourcing the profit distribution in the foreign country can be deducted from the Turkish corporate tax liability of a resident company's dividend income generated through its direct or indirect participations in

8 foreign entities with at least 25% of capital shares or votes. The dividend included in the revenues will be taken into account by including the foreign corporate or income taxes paid abroad Deduction of foreign taxes from advance tax It is possible to deduct foreign taxes from advance tax. In case there is foreign income within the advance tax period, all taxes withheld or paid due on the mentioned incomes can be deducted from the advance tax calculated for the respective period. However, the amount to be deducted cannot exceed the figure calculated by implementing 20% advance tax on the mentioned foreign revenues Documentation of Foreign Taxes Paid The foreign taxes paid cannot be deducted unless supported with appropriate receipts and similar documents certified and affirmed by the Turkish consulates or embassies or similar institutions and representative offices of Turkey in that respective country. In case the documents proving that the deducted taxes are paid in a foreign country cannot be submitted by the taxpayer during assessment, the foreign taxes paid or will be paid will be estimated using the tax rates of that foreign country, in any case no greater than 20%. Then the amount corresponding to the value to be deducted will be delayed, and the assessment will be corrected accordingly, if the necessary documents are submitted within one year following the date of assessment. In case the documents are not submitted on time for reasons other than force major, or if it is found out that the total value to be deducted is less than the amount subject to delay, then late payment interest will be charged onto the delayed taxes in accordance with article 6183 of the law. 4. FOREIGN BRANCH PROFIT 4.1 Foreign branch profit Explanations about the foreign branch profit are given in part 5.8 of the communiqué. In accordance with article 5/1/g of Corporate Tax Law, profit of companies which made through foreign permanent establishments or permanent representatives is exempt from corporate tax in Turkey in certain conditions. Please find below the conditions of the exemption of profit made through foreign permanent establishments or permanent representatives; Profit should be subject to tax like income or corporate tax at rate of at least 15% in the country where the profit was made. Profit should be transferred to Turkey until the deadline of submission of corporate tax return for the fiscal period that the profit is made. If the main activity of the affiliate is ensuring finance, included financial leasing, insurance services or investment of marketable securities, profit should be subject to tax like income or corporate tax at least at the rate of Turkish corporate tax rate (20%) according to the tax laws of the country where the profit was made. According to this clause, total tax liability would be determined according to the explanations of the part of the communiqué.

9 4.1.1 Non-Deductibility of the expenses which are related with the exempt profits from other income In accordance with the Article 5/3 of the Corporate Tax Law, excluding the financial expenses regarding the purchase of participation shares, expenses of a company related with the profit exempt from the Corporate Tax or losses arising from the exempt activities are non-deductible from the income of the company that is made by non-exempt activities. According to the amendment bill for the third paragraph of the Article that is accepted in the TGNA Planning and Budget Commission; if loss arises during the profit making process by the exempt activities, loss amount also cannot be deducted from the company profit like related expenses; as the loss is composed by the surplus of expenses. Therefore this regulation is suggested as in profit making process in exempt activities, expenses and activity loss should be evaluated in the same category because in fact loss is the surplus of expenses. In consequence, this regulation covers only the corporate tax-exempt profit that exists in the Corporate Tax Law and in some special laws. Expenses related with the profit that is exempt from the corporate tax should be regarded as non-deductible expenses, with the exception of financial expenditures due to the purchase of affiliate stocks. Similarly, in case of loss making during the realization of exempt activities, this loss amount also cannot be deducted from the profit that is made by the activities rather than exempt ones. This clause states that expenses related to the profit making process that is exempt from tax, should not play a role in minimizing the income of the company from other activities and if the loss occurs by the exempt activities, expenses should not play a role in maximizing the company loss. According to this, expenses, which are made during the profit making process, can only be valued as deduction in the determination of the profit that is exempt from the corporate tax Refund of Foreign Losses In case of occurring loss from the company s foreign activities, it is possible to refund the loss amount from the company s income, within the conditions that are mentioned in the law. However, refund of the loss amount relating to the foreign activities which are exempt from corporate tax in Turkey is unacceptable. Therefore, as the profit from the foreign construction and reparation activities are exempt from corporate tax in Turkey according to the article 5/1/h of Corporate Tax Law, if loss occurs from these activities it is not possible to deduct this loss amount from the income that is born by the other activities. If the loss from foreign activities, which are deducted from income in Turkey, is refunded or evaluated as expense in related foreign country; the foreign profit amount before the refund process should be added to tax return in Turkey Documentation of Foreign Loss It is obligatory to be audited by an authorized institution and to get a report every year, and it is also obligatory to submit the related report and its translated copy to the concerned tax office in Turkey. Besides, the tax return, balance sheet and income statement that would be in the attachment of the report needs to be approved by the authorized agencies of foreign country. If an authorized auditing institution does not exist in the host country; the tax returns, balance sheet and income statement with translated versions which are approved by the Turkish embassy or

10 consulate in the country, should be submitted to the concerned tax office in Turkey. If Turkish embassy or consulate does not exist in that country, institutions that support the Turkish interests with similar nature can approve the aforementioned documents Obligation of being auditing In order to refund the foreign losses, Turkish tax payers should present their reports concerning the last five years, which are prepared by the bases mentioned in the article. For example, if a full fledged tax payer, who made profit in 2002, 2003, 2004 and 2005, makes loss in 2006; it is possible for the company to deduct 2006 foreign loss in Turkey except the amount related with the activities exempt from corporate tax in Turkey, by submitting reports for last five years to the related tax offices. However, if tax payers fail to submit aforementioned reports in time, it is also accepted to submit them in period of the refund of foreign loss. 5. PARTICIPATION EXEMPTION Participation exemption is regulated in article 5/1/a. According to this Law; 1) Earnings derived by corporations through participating in the capital of another full taxpayer corporation (excluding participation certificates of investment funds and dividends obtained from stocks of investments partnerships) 2) Any dividend income acquired via founders shares and redeemed shares which enable the participation in the profits of any other full tax payer legal entity. are excluded from Corporate Tax Law. This exclusion is intended to prevent double taxation.. - In order to prevent double taxation in companies which acquire dividends through this means the profit income of the founders shares and redeemed shares are accepted as a participation exemption in Corporate Tax Law. - Any dividend income acquired by a company due to its participation shares via a representative on the board of directors will benefit from the said exemption. - From the perspective of participation exemption, the participation ratio to the subsidiary is not necessary. - Any dividend income acquired via participating funds or investment partnerships shall not be subject to participation exemption regardless of its nature. 5.1 Participation exemption of foreign subsidiaries Under the certain circumstances, according to article 5/1/b of the new Corporate Income Tax Law, the incomes of foreign subsidiaries will be considered as tax exempt.

11 In order to benefit from this amendment, foreign subsidiaries are required to fulfil the following conditions: - The subsidiary should be incorporated as a joint stock or limited company, - The legal and business center of the subsidiary should not be located in Turkey - At least 10% of the paid-in capital of foreign subsidiary should be held. - As of the acquisition date of participation income the participation share should have been kept for at least one fiscal year. - Participation income is expected to carry a minimum 15% tax burden in a residence country. In the event of the core business of the foreign subsidiary is insurance, finance procurement or marketable security investment, in order to benefit from the foreign participation exemption the foreign subsidiaries should be subject to taxation (taxes such as income or corporate tax) in the company of which the subsidiary is operating, at a rate that should not be less then the corporate income tax rate in Turkey. - Participation income has to be transferred to Turkey before the submission deadline of the corporate tax declaration In order to apply the participation exemption the conditions have all to be fulfilled. 5.2 Participation exemption for the disposal of full liability corporations foreign subsidiaries stocks According to article 5/1/c of Corporate Tax Law, in order to benefit from the exemption, a minimum of 75% of total assets, excluding cash and cash equivalent assets, must be composed of the shares of the foreign subsidiary for at least one continuous year, the company in Turkey must hold at least 10% of the shares of the foreign subsidiary and these shares must to be held by a resident joint stock company for at least two continuous years. In accordance with the above stated conditions; - The foreign subsidiary must have the status of a limited liability company or a joint stock company and this foreign subsidiary has to be a full taxpayer. - A minimum of 75% of total assets, excluding cash and cash equivalent assets, must be composed of the shares of the foreign subsidiary for at least one continuous year and the company in Turkey must hold at least 10% of the shares of the foreign subsidiary; - These shares must be held by the resident joint stock company for at least two continuous years. 6. THIN CAPITAL The 12 th article of Corporate Tax Law rearranges the thin capital issue, and explicitly specifies the debt-to-equity ratio, equity and the definition of related party..

12 6.1 Thin capital concept and debt-to-equity ratio For every kind of loan directly or indirectly received from shareholders or persons related to shareholders for use in the business, if the debt-to-equity ratio exceeds 3:1, the exceeding amount will be considered as thin capital for the related fiscal year. Debts used for business purposes will be considered within the scope of thin capitalisation on condition that: The loans are directly or indirectly received from shareholders or persons related to shareholders, The loans are used for business purposes, The debt-to-equity ratio exceeds three times the equity at any time within the fiscal year. 6.2 Shareholders The shareholder relationship covers both the relations of a corporation with its shareholding corporations, and the real persons or corporations that are shareholders of the aforementioned corporations. In this relationship, the distributive share has no limitation. If loans are received from corporations listed on the Istanbul Stock Exchange, the shareholding rate should be at least 10% for the loans to be in the scope of thin capital. 6.3 Related parties to shareholders The thin capitalisation rule defines related parties to shareholders as follows: Corporations owned by the shareholder directly or indirectly at a rate of 10% or corporations owned by the shareholder with at least a rate of 10% in terms of voting rights or rights to receive dividends. Corporations or real persons directly or indirectly owning a minimum of 10% of the equity, voting rights or rights to receive dividends of the shareholder or the corporations related to the shareholder. 7. TRANSFER PRICING 7.1 Profits distributed in a disguised manner through transfer pricing In accordance with article 13 Corporate Tax Law; if a taxpayer enters into transactions regarding the sale or purchase of goods and services with related parties, where the prices are not set in accordance with the arm s length principle, then related profits are considered to be distributed in a disguised manner through transfer pricing. The expression of purchase or sale of goods and services is used in a broad scope that involves transactions such as buying, selling, manufacturing, construction, borrowing or lending money and other transactions such as payment of bonuses and wages etc. 7.2 Related party concept and arm s length principle Related party is defined as a company s own shareholders and corporations and individuals that are related to those shareholders; and corporations and individuals who directly or indirectly control or are controlled by the company via management, supervision or capital. Moreover, spouses of

13 shareholders, siblings and ancestors of shareholders up to the third decree (inclusive) natural and in-law relatives of the shareholders are also considered as related parties. All transactions with the countries and regions declared by the Council of Ministers are considered as if they have been carried out with related parties. The Council of Ministers takes into account the taxation capacity of the countries compared to the taxation capacity of the Turkish tax system and the exchange of information within the countries when determining these countries. 7.3 The arm s length principle is defined as applying the same prices for the purchase or sale of goods or services between related parties as the prices that would be determined had the same transactions been carried out between unrelated parties. It is an obligation to keep the bookings, scales and documents regarding the calculations of prices and costs determined through the arm s length principle as supporting documents. 7.4 Methods to be applied when determining transfer prices Corporations are free to determine their transfer prices by applying one of the methods below, deemed as most suitable for their transactions carried out with related parties Comparable (uncontrolled) price method: The arm s length price should be determined by comparing the price charged for goods or services transferred among related parties to the price charged for comparable goods or services transferred in a comparable transaction among unrelated parties. The application of this method is possible provided that transactions among related parties and transactions between unrelated parties are comparable. The expression comparative is used in the sense that the features of goods and services transferred and the conditions of the performed transactions should be alike between the related parties and unrelated parties Cost plus method: The arm s length price shall be calculated by increasing the relevant costs of goods and services with a reasonable rate of gross margin. The expression of appropriate gross profit rate is, hereby, defined as the profit ratio reflecting the price as if the goods and services are to be sold to unrelated parties. If conditions are suitable, the gross profit ratio used by the taxpayer in transactions of goods and services towards the third parties shall be the ideal rate. If the number of transactions is insufficient, the margin for appropriate gross profit will be determined by considering the profit, reflecting the price as if the transactions had been carried out among unrelated parties. It is predicted that this method will be particularly useful in transactions regarding raw materials, semi-finished goods and manufactured goods Resale price method: The arm s length price shall be calculated by deducting an appropriate rate of gross margin from the price that is to be applied in the event of the resale of goods or services in the market to third parties. In this method, the basis to reach the arm s length sales price or cost is the price or cost that shall be referred to in a probable selling transaction with unrelated third parties. In order to reach the arm s length price, an appropriate rate of gross margin should be deducted from the cost or the price fixed presumptively. The gross margin stated above refers to the profit which is applicable immediately at the time of the transaction of the goods or services, determined according to objective market conditions. The arm s length price used for the selling transactions of goods and services to the related parties is the price after deducting that profit.

14 7.4.4 Other methods: Companies can also use methods determined by themselves regarding the nature of the transactions, other than those cited above, if it is not possible to apply the methods stated therein. During the process of choosing the best method among the mentioned ones, to determine the most appropriate price or cost, first of all the prices or costs used by the taxpayer in the transactions carried out with unrelated parties should be the internal precedent for comparison. If there is no internal precedent or no reliable internal precedent for comparison purposes; the transactions of similar taxpayers or corporations would form the external precedent for comparison. Furthermore, the crucial point is to assess the right and reliable cost and price; to achieve this it is possible to use both the internal and external precedent simultaneously. 7.5 Consequences of transfer pricing Profit distributed completely or partially in a disguised manner through transfer pricing will be reclassified as a dividend distribution in the applications of Income Tax Law and Corporate Tax Law for resident tax payers; for non-resident taxpayers it will be reclassified as profit transferred to headquarters. However, to make the necessary adjustments in the corporations for which profits have been transferred in a disguised manner through transfer pricing, the taxes should be assessed and paid in the name of the company transferring the profit. In the case of the transfer of the aforementioned dividend to another corporation, this gain would be evaluated as participation gain. In the case of the transfer of the aforementioned dividend to a nonresident taxpayer; or to a corporation or real person that is exempt from tax, this dividend would be assumed as a net dividend and the withholding should be calculated on the grossed up value of this net dividend. 8 CORPORATE TAX EXEMPTION IN THE FREE TRADE ZONES 8.1 Legitimate application Law number 3218 regarding Free Trade Zone Law, article 6 amended by article 8 of Law number 5084 and the following provisional article 3 added by article 9 of Law number 5084 is as follows: Article-6 Free Trade Zones are deemed to be outside the customs borders. The legislation in regard to the customs and exchange obligation has no field of application in Free Trade Zones. The Ministry of Finance is authorised to make the necessary arrangements concerning what account books and documents users have to hold or prepare, regardless of the provisions of the Tax Procedural Law dated 4 January 1961 number 213. During the investment and production phases, operators and users can benefit from the incentives determined by the Council of Ministers

15 Interim Article-3 (Amended by Law No.5084, dated 29 January 2004) With the entry into force of this article, taxpayers with an Operating Licence in a free zone established according to this Law will be subject to the following principles: a. The profits of users providing activities conducted in free zones will be exempt from income and corporate taxes starting from the date of entry into force of this article until the end of the duration of their Operating Licence. This exception has no influence on the reductions that would be realised according to sub-paragraph No.(6) of the first paragraph of article No.94 of Income Tax Law b. Salaries paid for workers will be exempt from income tax until However if the duration of the Operating License ends before , this exception will only be applied until the end of the duration of the Operating License. c. Operations concerning the activities of users in free zones will be exempt from all the provisions concerning other taxes, fees and reductions until Profits from production activities of taxpayers will be exempt from income and corporate tax until the end of the fiscal period of the year in which Turkey will become a full-member of the European Union. This exception has no influence on the reductions that would be realised according to subparagraph No.(6) of the first paragraph of article No.94 of Income Tax Law. These amendments regarding the Free Trade Zone Law published in the Official Gazette number on are effective as of the date of its publication. Law number 3218 regarding the Free Trade Zone Law has been rearranged by Law number As a result, the income or corporate tax exemption of taxpayers with full or limited tax liability in Turkey has ended. In interim article 3 of Law number 3218 amended with the Law No.5084, the exemption procedure for the transition period is arranged. 8.2 The scope of corporate tax exemption in transition period Interim article 3/1-a of Free Trade Zone Law states that: The profits of users providing activities conducted in free zones are exempt from income and corporate taxes starting from the date of entry into force of this article ( ) until the end of the duration of their Operating Licence. Taxpayers that applied to the related authorities to receive operating licenses but which have not yet received the licenses by the date of are excluded from this exemption. Taxpayers that have branches and the legal or commercial head offices of taxpayers in Free Trade Zones are not exempt from the revenue generated outside the boundaries of Free Trade Zones. 8.3 The determination of the amount of income exemption The exemption stated in provisional article of 3/1-a of Free Trade Zone law is an income exemption. Therefore, the profits from the operations of taxpayers in Free Trade Zones will be exempt from income and corporate tax after deducting the expenses related to their operations.

16 Foreign exchange gains and overdue charges related to the receivables from the operations performed in Free Trade Zone are assessed in the scope of tax exemption. Similarly, the revenues that are temporarily kept in bank deposit or repo accounts only within Free Trade Zones until their withdrawal for making payments related to operations undertaken in Free Trade Zones can be subject to exemption. Example: A branch of a company which has a head office in Ankara deals with ready-made manufacturing and trade. The revenue generated from these operations on was invested in repos until the payment of a debt on The earnings generated from the repo investment will be subject to exemption. However the money transferred to the branch in the Free Trade Zone by the head office in Turkey and invested in the repo, will not be in the scope of exemption. It is necessary to keep the books separately in the sense that the books should display the revenues and expenses within the scope of exemption and revenues and expenses excluded from the scope of exemption. In case there is loss at the end of the fiscal period of the exempted operations in the Free Trade Zone, the losses which do not fall in the scope of an exemption cannot be deducted from the profit and cannot be carried forward to the following years. On the other hand, the donations granted by TÜBİTAK or similar institutions for R&D projects within their legislation will be added to the revenue and will be exempt from tax. 8.4 The allocation of mutual general expenses and depreciation For a taxpayer firm, the headquarters or branch of which is located in a Free Trade Zone, the allocations will be made in accordance with the ratio of costs in these head quarters or branches to the total costs of both. In the calculation of cost, the cost of goods sold and operating expenses of the head quarters or branches will be summed. The machinery that is subject to depreciation will be allocated regarding the number of days that they have been used. If the determination of the use of machinery is doubtful, the depreciation will be allocated with the mutual general expenses. 8.5 The responsibility of the companies withholding the tax Taxpayers that operate in Free Trade Zones will be responsible for the deduction and declaration of withholding tax according to Income Tax Law and Corporate Tax Law after the date

17 8.6 Tax withholding in the case of a dividend distribution The exemption in provisional article 3/1 a in Free Trade Zone Law has no effect on tax withholding regarding dividend distribution. For this reason, in the case of a dividend distribution, taxpayers operating in Free Trade Zones will be responsible for withholding tax on dividends in the scope of article 94/1-6-b of Income Tax Law and articles 15/2, 30/3 and 30/6 of Corporate Tax Law. 8.7 Tax withholding in case of deposit interest and overnight repo Income gained on interest from deposit accounts from banks or other financial institutions in Free Trade Zones are subject to withholding tax in accordance with interim article 67 of Income Tax Law as long as the article is in effect. In order to be able to declare the withholding tax, the companies should apply for tax liability registration to the local tax office. 8.8 Withholding tax declaration Taxpayers who are obliged to declare withholding tax according to the provisions of article 94 of Income Tax Law and articles 15 and 30 of Corporate Tax Law should declare the payments, profits and accruals as well as the withholding taxes realised within a month using a withholding tax declaration. 8.9 The duration of the application of the exemption period According to article 3/1-a of Free Trade Zone Law, exemptions are limited to the operation period indicated in the license. Therefore the exemption period shall terminate on the last day of the license date (last day is included) The exemption to be applied to the manufacturing activities In general Profits from production activities of taxpayers will be exempt from income and corporate tax until the end of the fiscal period of the year in which Turkey will become a full-member of the European Union. This exemption shall apply to taxpayers that have just initiated their operations within the zone and taxpayers who will be subject to regular taxation following the termination of the time indicated on their operating license.

18 However, The following activities will not be subject to exemption; The operations out of the scope of manufacturing. The sale of goods manufactured outside of the Free Trade Zones. The sale of goods manufactured in areas other than the locations indicated on the operating license. The sales of products received from toll manufacturing inside or outside Free Trade Zones. The sale of products manufactured subject to the exemption can be sold both inside and outside of Free Trade Zones. According to interim article 3 of Free Trade Zone Law, in order to benefit from the exemption, the following documents should be submitted to the related tax department; A copy of the operating license for dealing with manufacturing in Free Trade Zones A copy of the capacity and industry certificates The list of machinery to be used in the manufacturing activity - for companies applying for tax liability registration to the local tax office - in the case of initiating a new field of manufacturing after registering the amendment to their operation license, with the first advance tax return following the amendment to their operation license Toll manufacturing within the scope of the exemption Although manufacturing operations have to be undertaken in the free trade zone in practice, performing some of the operations by outsourcing toll manufacturing does not constitute a barrier for the corporate tax exemption. However; the company is obliged to - undertake toll manufacturing within the scope of manufacturing operations as defined in the firm s industry register certificate or operating license, - undertake manufacturing operations by the firm s own manufacturing channels more than toll manufacturing since this exemption is permitted for manufacturing operations undertaken in free trade zones, - limit the income that will be exempted as a manufacturing operation with the actual capacity utilisation - assume the work risk and the organisation - assure raw materials and subsidiary materials. If a taxpayer who performs a manufacturing activity also deals with trade activity by the purchasing or selling of a commodity, the earnings from the manufacturing operations will be evaluated in the scope of the exemption whereas the commercial earnings will not be evaluated in the scope of the exemption without prejudice on the condition that the operating license is dated before

19 Example 1: A corporation has held an operating license since after the date of and produces shoes through its branch in a free trade zone. At the same time, when this corporation exports the shoes, which are produced outside of the free trade zone, over its free trade zone branch, the earnings obtained from the sale of commodity produced in the free trade zone will be exempted from corporate tax. On the other hand, earnings that are obtained from the sale of commodity which was produced outside the free trade zone will not be subjected to exemption. Example 2: A corporation which has held an operating license since after the date of produces toys through its branch in the free trade zone. At the same time, if this corporation imports the raw materials and sells them both inside and outside the country, the earnings obtained from producing toys in the free trade zone will be subject to the exemption whereas the earnings obtained from the sale of raw materials will not be in the scope of exemption. Example 3: If a corporation which makes ready-made clothes in a free trade zone agrees with a contract manufacturer to undertake the detailed work such as like sewing buttons, ironing and etc for producing a shirt, the earnings obtained from producing the shirt will be within the scope of exemption since the share of labour costs of all kinds of detailed work undertaken by toll manufacturing will be less than the share of labour costs from its own manufacturing Other subjects 8.12 Order of books and vouchers Taxpayers in free trade zones have to fulfil the regulations of Tax Procedural Law regarding bookkeeping and the order of vouchers. In addition, according to the Free Trade Zones Law article 6, the Ministry of Finance is authorised to state the necessary arrangements concerning the account books and the documents that users have to hold or prepare, regardless of the provisions of the Taxation Procedural Law Exemption application for mergers and transfers in free trade zones If an operating license prepared for a firm operating in a free trade zone which has been dissolved in the case of a merger or transfer as defined in Turkish Commercial Code articles and Corporate Tax Law, article 18 and the first and second paragraph of article 19 is renewed for the company that took over the former by the Undersecretariat of the Prime Ministry for Foreign Trade and the new company continues operating in the zone, the company which acquired the former company will be subject to Law number 3218 regarding the Free Trade Zones Law interim article 3 In the case of the transfer or purchase of only the operating license, the stated article will not be in effect Extending the Period for Operating license In Free Trade Zones Law interim article 3 it is determined that, If taxpayers get an operating license in free trade zones which are established according to this law as of the effective date of this article, a) The earnings in the free trade zones are exempted from income and corporate tax within the period limited with the operating license as of the effective date of this article. Therefore, taxpayers that have operating licenses for free trade zones can make use of the exemption from corporate tax as of the effective date of this article until the date determined on their operating license. After the date , if the operating license period is extended for various reasons (excluding construction time extension) by the taxpayer, the period of exemption will not be extended. 9. Anti tax-heaven applications

20 9.1 Countries in scope of applications In accordance with article 30/7 of Corporate Tax Law; any payment which has been made in cash or via a bank account to a resident or operative company (including offices of Turkish companies) in the countries determined by Council of Ministers taking into consideration the information exchange mechanism and where the taxation system of the country where the earnings are obtained from provides taxation opportunities at the same level as the Turkish tax system, will be subject to withholding tax at a rate of 30% over the total payment irrespective of whether these payments are subject to taxation or the recipient company is taxpayer or not. Concerning withholding tax, payments made to purchase goods or participation stocks, and rent sea and air transportation, and payments which must be made for the completion of the work done, the Council of Ministers is granted the authority to determine the rate of taxation and specify the scope of work to be done. However, while the authority is given to the Council of Ministers, there are two fundamental criteria regarding the determination of the countries which will be under the scope of such application. These are; - Weather or not the taxation system of the other country to where the payments are transferred provides taxation opportunities as at the same level as the Turkish tax system, - The information exchange mechanism. 9.2 Payments subjected to withholding tax Every kind of payment, made to a company resident or operating in one of the countries determined by the Council of Ministers or to a business place or permanent establishment of a full taxpayer company is subject to taxation regardless of whether the payment is in the scope of taxation or the recipient company is taxpayer or not. Dividend distribution payments are not in the scope of this article therefore dividend payments should be taxed in accordance with the articles related to the dividend distributions. The payments which are made via another country that is not determined by the Council of Minister will be considered in the scope of this article and will be subject to taxation. Issuing the document of payment in one of those determined countries is sufficient evidence of taxation within the scope of this article. If the payment is in the scope of this article and simultaneously an operational expense ıt can be considered as deductible expense while determining the corporate income. 9.3 Payments not in the scope of withholding tax The regulations only include the countries determined by the Council of Ministers. Therefore, any payments made to the countries other than the determined ones are not in the scope of article 30/7 of Corporate Tax Law. The principal capital, interest and dividend payments, regarding the loans obtained from financial institutions that are operating in the determined countries and insurance and reinsurance payments. On the other hand, the same payments made to the non-financial institutions are subject to withholding tax.