VOLUME 18, NUMBER 1 >>> JANUARY 2016
Turkey Abdulkadir Kahraman KPMG, Turkey As a member of the G-20, Turkey is still an attractive market for MNEs. This article addresson Turkey s current tax climate, and covers recent tax developments that should be assessedwhen considering how to manage tax strategy for investments in Turkey. Abdulkadir Kahraman is Head of Tax at KPMG, Turkey I. Turkey s Approach to Transfer Pricing Audits The recent implementation of a special TP auditing group under the Turkish Tax Auditing Board has been a landmark development, leading to an increase in the number of transfer pricing audits for MNEs. In particular, royalty payments are receiving more scrutiny than in the past and are a hot topic for tax audits in Turkey. Royalty payments are generally criticized for the following reasons, which often lead to transfer pricing adjustments: s royalty payments are often not made on an arm s length basis; s there is no or limited value addition/creation or benefit resulting from them; s more exceptionally, there is the argument that the local company should have gained the relevant know-how inherently over long periods and no royalty payment should need to be made. Under this approach, the issues considered with regard to royalty payments are as follows: s rates applied in other business sectors; s periodic failure to properly meet comparability criteria or to properly make adjustments, resulting in final comparable sets sometimes not reflecting the actual correct range; s use of secret comparables, which prevent taxpayers from being fully able to defend themselves and develop opposing arguments against the administration s claims; s instead of arm s length range, the use of an arm s length single rate ; s instead of a multi-year approach, the use of oneyear results of comparable entities; s disregarding some crucial documents and benchmark studies (including internal comparables) as presented by taxpayers in some tax audits; s royalty rate range setting without taking indirect taxes into account as part of costs (e.g. special consumption taxes). Taking this approach in tax audits will lead to incomplete examinations and inaccurate assessment results, and thence harmful penalties for taxpayers. Under the circumstances, TP rules lay the burden of proof on taxpayers through documentation and taxpayers meet this requirement by preparing transfer pricing reports and other supporting analysis and documents. II. Extension of Loans and the Resource Utilization Support Fund Issue The Resource Utilization Support Fund ( RUSF ) is a transactional tax charged on loans. Turkish banks are liable to apply RUSF on loans received from foreign non-financial institutions by Turkish companies where they act as an intermediary to the transaction. Additionally, loans received from abroad are also subject to RUSF depending on maturity of loans and importation on installments. RUSF is collected from the clients but the reporting and payment obligations remain with the Bank. To make a long story short, loan extensions will not be subject to the RUSF. It should be noted that the RUSF rates that were changed through the Council of Ministers Decree 2012/4116 were to be effective for loans that would be borrowed as of February 1, 2013. The loans granted before February 1 would be subject to the rates that were effective at the time of granting. Therefore, any extension should be considered as a new loan, and the RUSF shall be paid on the basis of each extended loan according to the provisions of the legislation applicable on the date of such extension in accordance with the ruling provided by the Revenue Administration to the Turkish Banking Association. However, the authors have disagreed, 1 arguing that this should not be the case. Recently, in a new ruling, the Revenue Administration changed its policy regarding RUSF practice in cases where maturities are extended in respect of loans borrowed before the date of effect of the practice introduced by the Decision No 2012/4116. 2 01/16 Copyright 2016 by The Bureau of National Affairs, Inc. TPETS ISSN 1754-1646
At this time, the practice of considering the loan extension as a new loan where the maturity is extended based on the loan previously borrowed and the loan agreement is preserved, will continue. The rationale behind the ruling is as follows: s in case of loans borrowed from abroad, RUSF withholding should be made based on RUSF ratios that are effective on the date of borrowing of the loan; (with an average maturity of less than three years) by making RUSF withholding is time-extended by preserving the original the loan agreement, regardless of whether the average loan maturity is less or more than three years together with the extension period, no RUSF withholding should be made on the basis of the time-extended loan; the RUSF amount withheld according to the average maturity on the date of borrowing of the loan should not be returned; (with average maturity of three years or more), without being subject to RUSF, is time-extended by preserving the original the loan agreement; since the average maturity calculated from the date on which the loan was first borrowed shall be more than three years; regardless of whether or not the extended period is less than three years, no RUSF withholding should be made on the basis of the time-extended loan; is paid off before the maturity date (extended maturity date in the case of time-extended loans) and if the period that elapsed between the loan borrowing date and pay-off date is less than three years, RUSF will be collected with a penalty payment on the basis of the loan based on the average maturity to be calculated from the date of initial loan borrowing to the loan pay-off date. It is understood that, in line with the policy summarized above, the Revenue Administration acts in parallel with the Turkish Central Bank s strategy and it would not increase borrowing costs in Turkey. However, solving one problem creates another: The Administration s solution appears conditional: the policy of extension by preserving the original loan agreement has been formed on the assumption that only the maturity of the loan shall be extended (renewed), and the other conditions of the loan agreement shall remain as is in the original agreement. III. Notional Interest Deduction On April 7, 2015, a new Law was enacted by the Turkish Parliament (Law No 6637) to introduce the Notional Interest Deduction ( NID ) as a new tax incentive measure for cash capital increases, effective after July 1, 2015. In the context of the new NID Law, Turkish capital corporations (except for those operating in the finance, banking and insurance sectors) will be able to deduct 50% of the interest to be calculated on cash capital increase amounts which are registered with the Turkish Trade Registry or the interest calculated on the cash capital contributions of newlyestablished corporations, from their taxable income. It is a new measure to encourage equity financing for capital companies in Turkey. As a net basis rule, companies can be financed through loans, and interest expenses of those loans are deductible from the corporate tax base. Now, with this new incentive, capital increase (equity injection) becomes a strong financing alternative. Briefly, providing an interest deduction opportunity to companies in return for a cash capital increase will help corporate capital accumulation and will lead savings to increase due to the strength of capital structure of companies in financial markets. It can also be foreseen that there will be a reduced risk of borrowing from related parties and shareholders within the scope of thin capitalization. In line with Decree No 2015/7910, additional deduction rates have been determined for publicly-traded stock corporations. The Decree approves deduction rates of an additional 25 or 50 basis points, depending on the free float rate on the Borsa Istanbul ( BIST ). Considering the fact that the free float rate of companies traded on BIST is 48% on average, it would have been more useful for the capacity and financial strength of capital markets in terms of public traded companies if higher additional deduction rates were available. For instance, if the additional deductions rate had been set at 50 and 100 points, respectively, this might have provided further valuable opportunities to increase financial capacity. We believe that planned moves by the Council of Ministers will motivate companies in terms of higher free float rates and cash capital increase. IV. Medium Term Fiscal Plan (2016-2018) and BEPS A. Basic Economic Expectations under the Plan The Higher Planning Council announced the Medium Term Fiscal Plan ( MTFP ) covering the period 2016-2018 in the Official Gazette dated October 11, 2015. The MTFP pertaining to the next three years (2016-2018) is reviewed and the basic macroeconomic indicators have been determined as follows. GDP Growth (%, at fixed prices) GDP (billion TRY, at current prices) CPI Year-End (%) 2016 2017 2018 Average (%) 4 4,5 5 4,5 2.141 2.376 2.640 6,5 5,5 5 5,7 Having compared this MTFP with the previous one, Turkey s growth rate expectation for the next three years has been revised down from 4.7% to 4.5%, while inflation rate expectation has been revised up to 5.7%. Within this context, we should state that there are no major differences in expectations. B. Revenue Objectives in the MTFP The objectives within the scope of Central Administration Budget Revenues during the period of 2016-2018 are as follows: 01/16 Tax Planning International European Tax Service Bloomberg BNA ISSN 1754-1646 3
(billion TRY) Central Administration Budget Revenues (Net) Central Administration Budget Tax Revenues (Net) 2015[1] 2016 2017 2018 452 525 571 619 390 444 490 541 C. What is BEPS and why is it Necessary? The Base Erosion and Profit Shifting ( BEPS ) initiative came into the world in 2013 as a result of a joint G-20 and OECD initiative. The increasing budget deficits of, particularly, G-20 countries have increased the importance of tax collection, which is recognized as the most robust source of revenue. The main reasons underlying BEPS can be explained as follows: s the gap between governments revenues and expenditures following the global financial crisis developments in social responsibility activities and common understanding; s increasing interest from the media in tax and taxrelated issues; s the level of globalization of international trade; s The speed of the internet and the opportunities it offers in terms of the growth of the digital economy. BEPS actions are based on the following three main conditions or pillars: s conditions related to compliance and substance; s conditions related to coherence of the international tax system; and s transparency and certainty. The question What is the focal point of BEPS recommendations and BEPS-influenced policies? can be answered as follows: s strengthened minimum international standards regarding transfer pricing and tax treaties; s common approaches and best practices for local legal measures; s analytical reports along with recommendations (such as with regard to digital economy and multilateral instruments); and s detailed reports on BEPS measurement. BEPS policies have been set up by the OECD and political will has been given by G-20 countries. The support from these countries will need to be sustained to carry the policies into effect. D. Is There any Sign of BEPS in the MTFP? Amongst the MFTP priorities, there have not been any concrete elements related to BEPS other than Efforts under the programme for alignment with the acquis within the scope of participation to European Union will be continued. We now hope to see the arrangements related to BEPS in the MTFP of the forthcoming year. E. Where is Turkey as far as BEPS is Concerned and What Comes Next? Turkey has taken part in this initiative as a member of the G-20 and the OECD. Within this framework, Turkey has, in the first place, agreed on the minimum standards in BEPS. It is possible to say that, as a minimum, action is expected in the following areas: s harmful tax practices; s treaty abuse/treaty shopping; s transfer pricing documentation; and s activation of a mutual reconciliation mechanism in inter-country disputes. During this process, Turkey has asked to be included in discussions relating to changes that would need to be made as regards Country-by-Country Reporting ( CbCR ), particularly with respect to information regarding management expense charges and intangible rights payments at the time of automatic exchange of information between countries. In conclusion, BEPS will be an influence both on multinational companies that invest in Turkey and also multinational companies based in Turkey. Therefore, we recommend that these multinational companies make the following assessments. s In order to determine how their organizational and commercial structures will be influenced after the application of BEPS-influenced practices, they need to evaluate their legal entity structures, existing business models, transfer pricing policies and documentation and tax status of each of entity in the structure, advance rulings related to taxation, and the way financing is structured through related and non-related companies. s They need to evaluate how tax burdens are affected by BEPS, in respect of cash flow and effective tax rates. s They need to consider matters such as compliance with legislation, and public disclosure based on each country involved in the business activity, s They need to develop a communications strategy that will facilitate the sharing of company information with the public, particularly relating to business objectives, commercial reputation risk and financial effectiveness. V. Turkish Thin Cap Rules and Income Reclassification A. Consequences of Thin Capitalization In the case of thin capitalization in Turkey, interest and foreign exchange losses arising from the amounts paid or accrued on the thin capital should be treated as a nondeductible expense. Consequently, where the loan is characterized as thin capital, the related income is no longer treated as interest but is recharacterized as a deemed dividend for the related party lender and subjected to dividend withholding taxation. Without giving detailed information about how the correction will be made, the same law states that in order to make the correction, the taxes assessed for the corporate taxpayer who has borrowed the loan 4 01/16 Copyright 2016 by The Bureau of National Affairs, Inc. TPETS ISSN 1754-1646
that has been treated as thin capital shall be imposed, and paid by the borrower. The reason for the correction is to prevent double taxation, where the party that pays the interest and other similar expenses within the scope of the thin capitalization rules treats these expenses as a nondeductible expense and, by recharacterizing the interest income of the party granting the loan as participation profit exemption, the mentioned interest income will not be taken into account during the determination of the corporate tax, will hence be exempt from corporate tax and the double taxation will therefore be eliminated. However, the Turkish Revenue Administration states that if the borrower is in a loss-making position, the lender cannot benefit from the participation profit exemption. In other words, in cases where the party that is using the loan treated as thin capital is declaring a tax loss, there will be no taxes assessed for this party and recharacterization by the party granting the loan by treating the interest income as exempt from corporate tax will not be applicable. B. What the Courts are Saying about Recharacterization There have been disputes with regard to this issue. To the best of our knowledge, there have been a few tax court resolutions where the court found in favor of the tax administration. In summary, the resolutions are based on the literal meaning of the provisions and thus, as long as the party that is using the loan within the scope of thin capitalization rules does not declare any base and pay any taxes as a result of the reclassification of income, the party that is granting the loan cannot benefit from participation profit exemption. Recently, there have been two Turkish Supreme Court resolutions provided by different Divisions, but the resolutions are conflicting as they have been provided by different divisions of the Supreme Court. The first Resolution by the 4th Division, which is in favor of the taxpayer, states that the lender could benefit from the participation exemption as their actions were in accordance with the rationale of the provisions in Turkish tax legislation. In this case, the judges agreed unanimously. In summary, the Court s Resolution indicated that even if the borrower makes a loss, the lender can benefit from the participation exemption. The second Resolution, by the 3rd Division, which is in favor of the Tax Administration, states that the lender could not benefit from the participation exemption by relying on the literal meaning of the provisions in Turkish tax legislation. However, the resolution was not agreed unanimously; two of the five judges found in favor of taxpayer. The dissenting opinion provided by the judges of the 3rd Department were the same as the rationale of the Resolution made by the 4th Department. Basically, the dissenting opinion states that even if the borrower makes a loss, the lender can still benefit from the participation exemption. Therefore, if any taxpayer faces such a situation, the corporate tax return shall be declared with reservation and the case should be brought to the Tax Court in light of the recent Turkish Supreme Court Resolutions. Abdulkadir Kahraman is Head of Tax at KPMG, Turkey. He can be contacted at akahraman@kpmg.com. NOTES 1 Please see my blog post in Turkish: http://www.kpmgvergi.com/blog/ Pages/FullBlog.aspx?article=235 01/16 Tax Planning International European Tax Service Bloomberg BNA ISSN 1754-1646 5