Turkish Perspective on OECD Action Plan on Base Erosion and Profit Shifting

Turkey Ramazan Biçer and Mehmet Erginay* Turkish Perspective on OECD Action Plan on Base Erosion and Profit Shifting The OECD Action Plan on Base Erosion and Profit Shifting (BEPS) is a focal point of international tax debate. Although there are now a limited number of countries taking action against BEPS arising from activities of multinational groups, the authors believe that many other developed and developing countries will do the same. This article examines the Action Plan from a Turkish perspective, focusing on the most relevant actions of the BEPS Action Plan to Turkey. 1. Introduction Many scholars and practitioners would agree that the realm of international tax is being reshaped as never before. This indeed marks a new era where multinational enterprises (multinationals) will be faced with the new challenges. Following the lead of some of the most developed countries such as the United States, Germany and the United Kingdom, many countries have already declared that they will take action to combat international tax schemes resulting in base erosion and profit shifting (BEPS) by multinationals. International organizations such as the G20 and the EU Commission have also expressed their full support for any actions to counter BEPS. The most well known and comprehensive action has been put forth by the OECD. Supported by G20 countries, the OECD has released many studies and documents in the area of international taxation since the OECD Action Plan on BEPS (BEPS Action Plan) 1 was first endorsed by G20 countries at the G20 Summit in Saint Petersburg, Russia in September 2013. The OECD has already released the 2014 deliverables, and is expected to deliver more within the BEPS Action Plan in 2015. The project will likely conclude in 2015, as indicated by OECD officials. Therefore, the new era for taxpayers and governments will, in practice, commence in the period following 2015, as countries will move to reflect the results of the OECD project in their local laws after finalization of the BEPS Action Plan. OECD decisions fall under the concept of soft law and are not binding on OECD member countries. However, the BEPS Action Plan contains an action to develop a multi- lateral instrument which would enable interested parties to amend either bilateral tax treaties and/or domestic law. Thus, an international multilateral instrument will require the contracting states thereto to implement the actions in their legislation. Every country will reflect a different impact of the BEPS Action Plan in its laws, and some actions will not be relevant for all countries, especially developing countries. This is because the BEPS risks faced by developing countries differ from those faced by developed countries. Also, economic conditions in developing countries are unequal to those in developed countries. Therefore, it is anticipated that the certain OECD member countries classified as developing countries will focus on only some actions in the Action Plan, and that their actions will result in changes associated with the relevant actions in the BEPS Action Plan. This has been observed in recent actions by certain developing countries, such as China, India and Mexico. As a developing country, Turkey will not be different in its BEPS approach than other similar developing countries. As discussed below, recent tax developments in Turkey also prove that Turkey will regard some actions in the BEPS Action Plan as more relevant than others. These actions will likely be related to the digital economy; interest deductions and other financial payments; controlled foreign company (CFC) rules; artificial avoidance of PE status; transfer pricing (including documentation, intangibles and value creation); and exchange of information. However, this does not mean that Turkey will not take action with regard to other elements of the BEPS Action Plan. Accordingly, this article will mainly focus on actions under the BEPS Action Plan that are most relevant to Turkey. 2. BEPS Action Plan from a Turkish Perspective As mentioned, not all actions in the BEPS Action Plan are relevant to Turkey, and certain elements of the Action Plan will be less emphasized by the Turkish tax authorities. Table 1 summarizes the actions of the BEPS Action Plan and their relevance to Turkey. * Ramazan Biçer is a Transfer Pricing Senior Manager with PwC in Istanbul; he can be contacted at ramazan.bicer@tr.pwc.com. Mehmet Erginay is a Transfer Pricing Senior Consultant with PwC in Istanbul; he can be contacted at mehmet.erginay@tr.pwc.com. The authors are part of PwC s Value Chain Transformation and Transfer Pricing Practice. The views expressed in this article are those of the authors and not necessarily those of the firm. 1. OECD, Action Plan of Base Erosion and Profit Shifting (OECD 2013), International Organizations Documentation IBFD. 52 INTERNATIONAL TRANSFER PRICING JOURNAL JANUARY/FEBRUARY 2015 IBFD

Turkish Perspective on OECD Action Plan on Base Erosion and Profit Shifting Table 1 OECD Action Action 1: Address tax challenges of the digital economy Action 2: Neutralize effects of hybrid mismatch arrangements Action 3: Strengthen CFC rules Action 4: Limit base erosion via interest deductions and other financial payments Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance Action 6: Prevent treaty abuse Action 7: Prevent artificial avoidance of PE status Action 8: Assure that transfer pricing outcomes are in line with value creation: intangibles Action 9: Assure that transfer pricing outcomes are in line with value creation: risks and capital Action 10: Assure that transfer pricing outcomes are in line with value creation: other high-risk transactions Action 11: Establish methodologies to collect and analyse data on BEPS and the actions to address it Action 12: Require taxpayers to disclose aggressive tax planning arrangements Action 13: Re-examine transfer pricing documentation Action 14: Make dispute resolution mechanisms more effective Action 15: Develop a multilateral instrument Relevance Thus, nine actions are expected to be more relevant in a Turkish context. The other six actions (e.g. hybrid mismatch arrangements and dispute resolution mechanisms) would be less relevant, as either they are handled at the international level and not regulated under Turkish law, or their impact on Turkish tax revenue is relatively limited. 2.1. Action 1: Address tax challenges of the digital economy The digital economy has shown tremendous growth around the world in the last decade. The digitalization of trade also has a great impact on business and on tax revenues. At first view, some may think that the digital economy has been advantageous for developed (and to some extent for developing) countries. However, all is not as it seems. In fact, most BEPS has been seen in the digital economy, as such trade is borderless and least regulated. Some developed countries, such as the United States, attempted to unilaterally combat BEPS arising from the digital economy, but it has been proven that current international tax arrangements are not sufficient to totally eliminate such BEPS. As the BEPS Action Plan clearly indicates, there are limited tools for countries to tax the digital economy. Also, many countries lack knowledge and rules on taxation of the digital economy. In Turkey, the experience has been similar and the Turkish tax authorities have taken certain actions to prevent the loss of tax revenue because of practices within the digital economy. New software was developed to track sales in the digital economy and was introduced by the Turkish Finance Minister, Mehmet Şimşek, in 2013. However, it was capable of tracking only companies registered in Turkey. As a significant amount of trade in the digital economy is conducted by foreign companies outside of Turkey s jurisdiction, the impact of the implementation of this software is therefore limited. This fact, as in many countries, is well known by the Turkish tax authorities. Therefore, Turkey should be expected to increasingly keep an eye on international developments in this area. New rules in accordance with the BEPS Action Plan could be introduced in the near future, as this is also a part of the action plan on the unregistered economy, which was developed by the Turkish Ministry of Finance. In addition, there are more tax audits of companies carrying out business in the digital economy. Recent tax audits involving the digital economy are also associated with transfer pricing, exchange duties and VAT, and it is expected that the Turkish tax authorities will increase their scrutiny of the digital economy in the coming years, in addition to implementing new rules related to BEPS. 2.2. Action 2: Neutralize the effects of hybrid mismatch arrangements According to the OECD 2014 deliverable of neutralizing the effects of hybrid mismatch arrangements, 2 a hybrid mismatch arrangement is one that exploits a difference in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions so as to produce a mismatch in tax outcomes, where such mismatch has the effect of lowering the aggregate tax burden of the parties to the arrangement. Such hybrid mismatch arrangements are generally not used by Turkish taxpayers. Nevertheless, neither Turkish tax law nor Turkish tax treaties contain any provisions to prevent the implementation of hybrid mismatch arrangements. In addition, Turkey is a civil law country and, depending on the type of hybrid mismatch, generally either legally recognizes or disregards such mismatches. For example a trust or a partnership is not recognized under Turkish corporate law. Therefore, it is difficult to predict whether Turkey will introduce rules in its tax law or amend its treaty network in this regard. Nevertheless, the authors believe that certain provisions will be added to the law to prevent BEPS arising from hybrid arrangements (e.g. double deductions), as the effects of such arrangements on tax revenue are significant. Thus, the Turkish tax authorities might consider the BEPS Action Plan when amending tax law and other domestic law provisions would prevent the results of hybrid mismatches. A new law would most likely contain a provision to deny a deduction for a payment that is also deductible in another 2. OECD, Neutralising the Effects of Hybrid Mismatch Arrangements (OECD 2014). IBFD INTERNATIONAL TRANSFER PRICING JOURNAL JANUARY/FEBRUARY 2015 53

Ramazan Biçer and Mehmet Erginay jurisdiction or a payment made to a tax-exempt entity in another jurisdiction. 2.3. Action 3: Strengthen CFC rules CFC rules apply if a Turkish resident company (i) controls, directly or indirectly, at least 50% of the share capital, dividends or voting power of a foreign company, (ii) 25% or more of the gross income of the CFC consists of passive income, (iii) the CFC is subject to an effective tax rate lower than 10% in its country of residence and (iv) annual total gross profit of the CFC exceeds the foreign currency equivalent of TRY 100,000. Turkish CFC rules do not include any outbound investment scenarios where, for instance, interest payments are deducted against the taxable profit of a Turkish company while the corresponding interest income is taxed favourably or not at all at the level of the CFC. This is because Turkish CFC rules focus on the tax rate applicable to the CFC, rather than the taxation of income items. It is clear that the current Turkish CFC rules do not have the capacity to prevent certain BEPS arising from CFC activities. Accordingly, in the near future the deductibility of interest expense might also be taken into account in the tax law in situations where related interest income is not fully taxed or the underlying debt is used to inappropriately reduce the earnings base of the issuer in another jurisdiction. Also, Turkish transfer pricing rules need to be amended in accordance with the CFC rules if Turkey takes action in this regard. 2.4. Action 4: Limit base erosion via interest deductions and other financial payments Considering the volume of intra-group financing transactions, the most significant effect of this Action is likely to be on intra-group financing provided from financing centres in Europe. On the other hand, companies with foreign shareholders conduct high-volume financing transactions in Turkey with their group companies which are located in European financing centres, especially Belgium, Luxembourg and the Netherlands. In this context, intra-group financing transactions are a significant issue from the perspective of the Turkish tax authorities. In terms of intra-group borrowings, lenders may choose to apply higher interest rates to borrowers in order to obtain a higher profit level and increase the deductible amount for the borrower. The result, from the borrower s perspective, is decreased taxable income. In Turkey, thin capitalization rules and transfer pricing regulations currently limit the extent to which a tax deduction may be claimed for interest paid between a borrower and related parties. Under thin capitalization rules, if the debt (calculated at any time during the year) owed by a Turkish entity to its related parties exceeds three times the equity, the excess debt (i.e. above a 3:1 debt-to-equity ratio) is deemed to be disguised equity. As a result: any financial expense incurred on related-party debt exceeding three times the shareholders equity may not be deducted for corporate tax purposes; and interest actually paid on the disguised equity is deemed to be a disguised dividend and subject to dividend withholding tax at 15% (unless reduced under an applicable treaty). In the context of transfer pricing rules, when a Turkish entity receives funding from related parties, the interest and other expense charged on the loan must be consistent with the arm s length principle. Any excess amount paid by a Turkish entity which is not consistent with the arm s length rate may not be deducted for corporate tax purposes. Furthermore, such excess is deemed to be disguised dividends and subject to dividend withholding tax at 15% (reduced rates are applicable in tax treaties). Although not a direct part of transfer pricing rules, there is a provision (entered into force on 1 January 2013 as part of article 11), in the Corporate Income Tax Law (Law 5520) which is related to the restriction on deductibility of interest expense on loan financing. Specifically, under article 11 of the CITA, if a Turkish company s loan financing exceeds the company s shareholder equity (excluding financing obtained from loan financing institutions, financial leasing, factoring and financing companies), a portion of the interest and related expense incurred on foreign resources attributable to the excess loan finance are regarded as a non-deductible expense for corporate tax purposes. This portion of the interest and related expenses are to be determined by the Council of Ministers depending on the particular industry, but may not exceed 10%. However, even though authority to determine the relevant rates has been granted to the Council of Ministers by law, no rate has yet been specified. Therefore, the regulation currently has no area of application. However, in accordance with BEPS Action Plan developments and specifically for Action 4, it is expected that a rate will be determined in accordance with the above-mentioned legal provision. In addition, in Turkish transfer pricing practice there are no specific explanations of how to determine the arm s length interest rate. Additionally, loan benchmarking studies are not common among Turkish taxpayers, as the acceptability of such studies has not been clearly articulated by the tax authorities. However, with the BEPS Action Plan it is expected that, as long as the interest rate and terms applied to a loan increase, more thorough and well-grounded loan benchmarking studies will be needed. On the other hand, there might be different solutions or guidance regarding the application of the arm s length principle in the context of Action 4. Financial transactions other than intra-group borrowing are also within the scope of the Action. Such transactions include financial and performance guarantees; derivatives (including internal derivatives used in intra-bank dealings); and captive and other insurance arrangements as noted in the BEPS Action Plan. Although Turkish transfer pricing regulations indicate that these transactions should also be consistent with the arm s length principle, there is no additional explanation of how to determine the arm s length consideration 54 INTERNATIONAL TRANSFER PRICING JOURNAL JANUARY/FEBRUARY 2015 IBFD

Turkish Perspective on OECD Action Plan on Base Erosion and Profit Shifting in these transactions. This is also the case in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Transfer Pricing Guidelines) (2000). In this context, it is highly anticipated that there will be substantial changes in the OECD Transfer Pricing Guidelines regarding financial transactions, and that a new chapter will be added to the Guidelines. It is also anticipated that the Turkish tax authorities will make relevant changes to the determination of the arm s length nature of financial transactions in accordance with developments in the BEPS Action Plan. 2.5. Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance The BEPS Action Plan requires a review of harmful regimes in OECD member countries by September 2014. In this regard, a preferential tax regime is applicable for technology development zones in Turkey. The profits gained by individual and corporate taxpayers operating in such zones from software and R&D operations exclusively in these areas, are exempt from income and corporate tax until 31 December 2023. The salaries of R&D personnel working in these areas and support personnel corresponding to no more than 10% of the number of R&D personnel with regard to their related tasks, are also exempt from any kind of tax until 31 December 2023. The Turkish tax authorities recently made a presentation on technology development zones at the OECD level. They claimed that technology development zones do not give rise to a harmful tax regime. In fact, through technology development zones, the Turkish government aims to attract more direct investment and support R&D activities in Turkey. In addition to technology development zones, the Turkish shipping regime has also been scrutinized by the OECD within Action 5. This shipping regime provides a corporate income tax exemption for earnings from the international shipping activities, as well as an individual income tax exemption for employees of international shipping companies. Consequently, the OECD 2014 deliverable on countering harmful tax practices 3 has clearly stated that technology development zones and the Turkish shipping regime do not constitute harmful tax practices. The authors believe that the OECD has not found such regimes in Turkey to be harmful, as many countries including developed countries provide similar incentives. Apart from the above, Turkey will likely support transparency and substance rules developed by the OECD deliverable on Harmful Tax Practices. 2.6. Action 6: Prevent treaty abuse Like many others, Turkish tax treaties have the potential to be used for abusive purposes. Turkish domestic tax law contains a general anti-abuse rule that is applicable where a person attempts to circumvent provisions of domestic tax law. However, there is no rule under Turkish tax law that would prevent a person from attempting to use treaty benefits. In other words, Turkish tax law does not regulate the interaction between tax treaties and these domestic rules. This naturally gives rise to BEPS for Turkey. For example, neither Turkish tax treaties nor Turkish tax law contains rules regarding beneficial ownership. In addition, Turkey has never introduced any rules to combat treaty shopping, although certain areas (such as transfer pricing and CFCs) are regulated under income tax law. Therefore, Turkey would likely conclude that a specific anti-abuse rule based on a limitation-on-benefits provision needs to be included in Turkish treaties. Furthermore, Turkish tax treaties do not include any provisions on entitlement to benefits and do not address such issues. Accordingly, Turkey may conclude that there is a need to develop rules denying benefits otherwise available under an applicable treaty where one of the main purposes of an arrangement or transaction is to obtain a more favourable tax treatment. This would also require changes in domestic law as stated in the OECD 2014 Public Discussion Draft on BEPS Action 6 (preventing the granting of treaty benefits in inappropriate circumstances). 4 In this context, it would be anticipated that rules regarding financing transactions (including thin capitalization), CFCs and transfer pricing would be recharacterized by the Turkish tax authorities, in addition to implementing specific rules on preventing treaty abuse. 2.7. Action 7: Prevent the artificial avoidance of permanent establishment status In Turkey, many tax audits have been conducted on permanent establishment (PE) issues in recent years. Tax auditors claim that some companies operating in Turkey attempted to artificially avoid PE status such that BEPS results. The most well known cases are related to sales support activities of subsidiaries of multinationals. In this regard, tax auditors generally make the following claims related to artificial avoidance of PE status: the Turkish entity sells products mainly in the Turkish market in the course of its entrepreneurial distributor activity; the Turkish entity is the only direct contact in the entire Turkish market; the Turkish entity is not presented as the legal representative of the non-resident entity; the sales team at the Turkish entity supports the direct sales by the non-resident entity to Turkish customers; regarding direct sales, the Turkish entity performs negotiations with the Turkish customers; the Turkish entity is accepted as authorized to have entered into contracts with customers; the sales/pricing confirmations are mainly provided by the Turkish entity; and 3. OECD, Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance (OECD 2014). 4. OECD, BEPS Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances (OECD 2014). IBFD INTERNATIONAL TRANSFER PRICING JOURNAL JANUARY/FEBRUARY 2015 55

Ramazan Biçer and Mehmet Erginay the Turkish entity is not remunerated for these sales activities which are performed on behalf of the nonresident entity. As is in many countries, Turkish tax law does not include special rules to prevent the artificial avoidance of PE status. However, this topic is quite hot in Turkey, and it has been observed that more audits on PE status are pending. Thus, Turkey could potentially change its PE rules in the near future. The authors assume also that the BEPS Action Plan will accelerate such a change in the tax law. Also, specific rules defining exemption from PE status would be inserted in the law. The focus could be on multinationals that artificially fragment their operations among multiple group entities so as to qualify for exceptions to PE status for preparatory and ancillary activities as well. 2.8. Action 8: Assure that transfer pricing outcomes are in line with value creation: Intangibles As transactions involving intangibles are common among related parties, the OECD project on intangibles is a significant part of the BEPS Action Plan. This is also noted in the executive summary of the OECD/G20 Guidance on Transfer Pricing Aspects of Intangibles Action 8: 2014 Deliverable, which was released on 16 September 2014. It states that: This document contains guidance on the Transfer Pricing Aspects of Intangibles. It contains final revisions to Chapters I, II and VI of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2010) which have been developed in connection with Action 8 of the Action Plan on Base Erosion and Profit Shifting (OECD, 2013). These changes to the Guidelines clarify the definition of intangibles under the Guidelines, provide guidance on identifying transactions involving intangibles, and provide supplemental guidance for determining arm s length conditions for transactions involving intangibles. These final modifications to the Guidelines also contain guidance on the transfer pricing treatment of local market features and corporate synergies. 5 However, it also states: Because the interactions between work on ownership of intangibles, hard to value intangibles, risk and re-characterisation are particularly pronounced, a decision has been made not to finalise the work on some sections of this document at this time. Accordingly, bracketed and shaded portions of this document should be viewed as interim drafts of guidance, not yet fully agreed by delegates, which will be finalised in 2015 in connection with other related BEPS work. 6 It is crucial to identify the key factors in the guidance in order to understand the possible effects on Turkish transfer pricing regulations. In this regard, the authors opinion is provided on points that might have a more decisive effect on Turkish transfer pricing regulations. 2.8.1. Identification of intangibles The OECD/G20 Guidance on Transfer Pricing Aspects of Intangibles (OECD/G20 Guidance) provides a defini- tion of intangibles which is not mentioned in the current chapter VI of the OECD Transfer Pricing Guidelines. The OECD/G20 Guidance notes the requirements to classify an asset as an intangible: the word intangible is intended to refer to something which is not a physical asset or a financial asset; an intangible asset is capable of being owned or controlled for use in commercial activities; intangibles must be distinguished from market conditions or other circumstances that are not capable of being owned or controlled by a single enterprise. Therefore, an intangible asset must be capable of being owned or controlled by a single enterprise; the identification of an intangible is distinct from the determination of the price for the use or transfer thereof based on the facts and circumstances in the cases between independent enterprises; intangibles that are important to consider for transfer pricing purposes are not always recognized as intangible assets for accounting purposes. Article 9 of the OECD Model Tax Convention can be applied by its characterization for accounting purposes, but will not be bound by such characterization only; and legal, contractual or other forms of protection may affect the value of an item, but are not a necessary condition for an item to be characterized as an intangible for transfer pricing purposes. Additionally, an intangible asset does not need to be separately transferable. 7 The OECD/G20 Guidance also categorizes intangibles into different groups, namely patents; know-how and trade secrets; trademarks, trade names and brands; rights under contracts, government licences, licences and similar limited rights in intangibles; goodwill; and going-concern value. However, group synergies and market-specific characteristics were not deemed to be intangibles, as group synergies and market-specific characteristics are not owned or controlled by a single enterprise. The OECD/G20 Guidance specifies that this should be taken into account in a transfer pricing analysis through the required comparability analysis. This might be a significant point from the Turkish transfer pricing practice, as in some cases group synergies are deemed to be intangibles and are scrutinized by the tax authorities. Additionally, paragraph 6.68 of the OECD Transfer Pricing Guidelines specifies conditions for when the legal owner of an intangible is entitled to all returns attributable to the intangible. 8 Therefore, the importance of a detailed functional, risk and asset analysis is emphasized in the OECD/G20 Guidance. This is also significant for the Turkish transfer pricing practice from the perspective of both taxpayers and the tax authorities. As there is no detailed rule on intangibles under Turkish tax law from a transfer pricing perspective, it can be anticipated that the 5. OECD, OECD/G20 Base Erosion and Profit Shifting Project, Guidance on Transfer Pricing Aspects of Intangibles, Action 8: 2014 Deliverable (16 Sept. 2014), at 11. 6. OECD, supra n. 5, at 10. 7. OECD, supra n. 5, at 28-29. 8. As specified in the executive summary section of the Guidance, this part is a bracketed and shaded portion of this document which is subject to further revision considering other actions of the BEPS Action Plan. 56 INTERNATIONAL TRANSFER PRICING JOURNAL JANUARY/FEBRUARY 2015 IBFD

Turkish Perspective on OECD Action Plan on Base Erosion and Profit Shifting Turkish tax authorities will promulgate regulations that are consistent with these ongoing developments. The OECD/G20 Guidance also deals with the identification and determination of prices for controlled transactions. The Guidance states that arm s length prices and other conditions for transactions are to be determined according to the guidance in chapters I through III of the OECD Transfer Pricing Guidelines, taking into account the contributions to the anticipated intangible, based on the functions performed, assets used and risks assumed at the time such functions are performed, assets are used or risks are assumed. It is well known that, due to the relationship among related parties, transactions involving intangibles can include structures that independent enterprises would not contemplate. Therefore, in a comparability analysis of transactions involving intangibles, the OECD/G20 Guidance specifies the following list of factors to be considered: exclusivity; extent and duration of legal protection; geographic scope; useful life; stage of development; rights to enhancements, revisions and updates; and expectation of future benefit. 9 The OECD Guidance specifically states that this list is not exhaustive and that the consideration of additional or different factors may be an essential part of a particular comparability analysis. 10 On the other hand, the OECD Guidance states that if reliable comparability adjustments are not possible, it may be necessary to select a transfer pricing method that is less dependent on the identification of comparable intangibles or comparable transactions. 11 These definitions and lists of intangibles are also very significant from a Turkish transfer pricing perspective, for both taxpayers and tax authorities, as clearer definitions will pave the way for more thorough documentation by taxpayers and provide a clearer perspective to tax authorities in their potential tax audits. 2.8.2. Using databases As in every related-party transaction, the comparability analysis and possible adjustments are also essential for transactions involving intangibles. The garden variety practice is the use of databases which include licence or other similar agreements containing intangible property elements. However, special care should be given when using these databases. In this context, the OECD Guidelines also support this approach by stating that it is important to assess whether publicly available data drawn from commercial data bases and proprietary compilations is sufficiently detailed to permit an evaluation of the specific features of intangibles that may be important in conducting a comparability analysis. 12 The provisions of 9. OECD, supra n. 5, at 67-69. 10. OECD, supra n. 5, at 67. 11. OECD, supra n. 5, at 71. 12. OECD, supra n. 5, at 71. paragraph 3.38 of the OECD Transfer Pricing Guidelines should be considered in evaluating comparable licence arrangements identified from databases. Currently, the use of these databases is still a question mark in the eyes of the Turkish tax authorities, and there is ongoing debate and even litigation arising from tax audits by tax inspectors. In this context, the position of the tax authorities will be much more clear after these court cases are resolved. It is also anticipated that the tax authorities will promulgate some new regulations in accordance with the BEPS Action Plan to be more consistent with international transfer pricing practices. From a transfer pricing methodology perspective, for transactions involving intangibles, the most reliable transfer pricing method is the CUP method. However, in many cases there are difficulties in obtaining reliable comparable agreements involving intangibles. It can be suggested that a profit split analysis be applied in such cases. It is also sometimes the case that certain intangibles are partially developed. The OECD Guidance states that in such an analysis, the relative value of contributions to the development of intangibles before and after a transfer of the intangibles in question is sometimes examined. 13 As main point in the application of the profit split method, estimations should be made to determine the contributions of the related parties to the arm s length income which will be generated in future years of the transfer. Valuation techniques can also be used in these transactions to identify an arm s length price. The applied method is an important point for Turkish transfer pricing practice, as the Turkish tax authorities tend to apply the profit split method rather than the CUP method, especially in the last few years. In recent audits, the tax authorities have criticized the use of foreign commercial databases in some benchmarking studies for transactions involving intangibles. The main point in this approach is that a reliable CUP analysis cannot be made regarding transactions involving intangibles, as it is not always possible to find reliable comparable agreements in these searches. The approach of the Turkish tax authorities is similar to the OECD Guidance on intangibles. However, there is not an explicit approach of the Turkish tax authorities to how valuation techniques should be applied when identifying an arm s length price. The authors believe that there should be a more explanatory approach by the Turkish tax authorities in order to be in line with OECD developments. 2.9. Action 9 and Action 10: Assure that transfer pricing outcomes are in line with value creation: Risks and capital/other high-risk transactions Under these Actions, discussion drafts were to be issued after the G20 Meeting in November 2014, with the first consultation likely to have been held in December 2014 or January 2015. In this context, there are currently no 13. OECD, supra n. 5, at 76. IBFD INTERNATIONAL TRANSFER PRICING JOURNAL JANUARY/FEBRUARY 2015 57

Ramazan Biçer and Mehmet Erginay developments from a Turkish transfer pricing practice perspective. These Actions are more related to establishing a more transparent environment while promoting increased certainty. In order to do so, taxpayers could do more (e.g. an additional documentation obligation regarding the management fees and/or pass-through costs, and CUP analysis on commodity transactions might be required) in the future when compared to their present obligations. In many countries, multinational companies use management fees, headquarter expenses and other payments with or without the intention of base erosion. Another issue under these Actions concerns profit splits in the context of global value chains. The Turkish tax authorities will question the functions of Turkish entities and challenge the profit level if it is not reflective of value creation. Therefore, the profit split method is expected to be used more frequently by the Turkish tax authorities to challenge risk and capital allocations by multinationals. In this context, these types of payments and profit levels of Turkish entities in the value chain are the main points of inspection by the Turkish tax authorities (as in many countries). Accordingly, mandated information disclosed by taxpayers will increase with regard to value creation. However, these information disclosure processes should be established in a more effective way by the tax authorities in order to be in line with the main goals of the BEPS Action Plan. These Actions are also closely related to requirements regarding transfer pricing documentation, which provides essential information about related-party transactions. Although there are no explicit regulations from the perspective of the Turkish tax authorities, mandated disclosures by taxpayers in the BEPS context could be increased in accordance with the outcome of the Action Plan. 2.10. Action 11: Establish methodologies to collect and analyse data on BEPS and the actions to address it The BEPS Action Plan states that the scale and economic impact of BEPS is to be measured, and the economic impact of the actions taken to address BEPS on an ongoing basis is to be monitored and evaluated. This action aims to clearly reveal the whole picture of BEPS. Turkey s role at this point would be merely to support action by the OECD. Therefore, the OECD requested that each member country provide an analysis of the economic impact of BEPS. To the best of the authors knowledge, the Turkish tax authorities (like some others) are in the process of preparing a report to be submitted to the OECD BEPS Working Party. The Turkish tax authorities are utilizing existing data sources (especially the VEDOP data storage program), including financial statements and tax returns of Turkish corporate taxpayers. Naturally, this might also trigger the Turkish tax authorities to develop methodologies at both macro and micro levels. Also, Turkey will most certainly benefit from the OECD s studies while improving its methodologies to measure and monitor BEPS. 2.11. Action 12: Require taxpayers to disclose their aggressive tax planning arrangements The OECD is planning to develop recommendations regarding the development of mandatory disclosure rules for aggressive or abusive transactions, arrangements or structures. These recommendations will need to be incorporated into domestic law. Therefore, each member country could possibly apply different recommendations or follow a different path in the implementation phase, as the urgency of addressing BEPS issues varies from one country to the next. Accordingly, Turkey is expected to develop new methodologies to prevent BEPS, as the Turkish tax authorities do not currently have comprehensive and relevant information on tax planning strategies of Turkish multinationals and local entities of multinational groups. Nonetheless, currently, all related parties that are Turkish corporate taxpayers must prepare a Transfer Pricing, CFC and Thin Capitalization Form that can be used as a basis for commencing a tax audit. The Form must be completed by all corporate income taxpayers and submitted to the relevant tax office as an attachment to the annual corporate income tax return. Corporate income taxpayers are required to complete this Form only if they have one or more transactions related to transfer pricing, CFCs or thin capitalization. The Turkish tax authorities could expand the current form so as to require more detailed information on aggressive tax planning by corporate taxpayers. Existing work by the Turkish tax authorities is in line with this, and the authors contemplate that the Turkish tax authorities could add new sections to the Transfer Pricing, CFC and Thin Capitalization Form within the scope of BEPS Actions. Action 12 will also involve designing and implementing enhanced models of information sharing for international tax schemes between tax administrations. That will also increase the capability of the Turkish tax authorities, and the exchange of information on BEPS issues between the Turkish tax authorities and their counterparts in other jurisdictions is likely to increase. One sign of such movement is that Turkey has concluded eight agreements on the exchange of information with other jurisdictions in the last two years. 2.12. Action 13: Re-examine transfer pricing documentation Discussions regarding this action item began before the OECD BEPS Project was initiated specifically with regard to intangibles. A Discussion Draft on transfer pricing documentation and country-by-country reporting 14 was released on 30 January 2014, followed by the release of Guidance on Transfer Pricing Documentation and Country-by-Country Reporting Action 13: 2014 Deliverable on 16 September 2014. The Guidance 14. OECD, Discussion Draft on Transfer Pricing Documentation and CbC Reporting (OECD 2014), International Organizations Documentation IBFD. 58 INTERNATIONAL TRANSFER PRICING JOURNAL JANUARY/FEBRUARY 2015 IBFD

Turkish Perspective on OECD Action Plan on Base Erosion and Profit Shifting states that [t]his document contains revised standards for transfer pricing documentation and a template for country-by-country reporting of income, earnings, taxes paid and certain measures of economic activity. 15 It is argued that when chapter V of the OECD Transfer Pricing Guidelines was first adopted in 1995, tax administrations and taxpayers had less experience in creating and using transfer pricing documentation. 16 In the almost two decades since then, countries have passed their own transfer pricing documentation rules and requirements. While these developments have taken place, the volume and complexity of the intra-group transactions also increased, consistent with globalization. However, the Guidance on Country-by-Country Reporting states that: [h]eightened scrutiny of transfer pricing issues by tax administrations has resulted in a significant increase in compliance costs for taxpayers. Nevertheless tax administrations often find transfer pricing documentation to be less than fully informative and not adequate for their tax enforcement and risk assessment needs. 17 Within this context, three objectives have been determined in this Action. These objectives are as follows: allowing the tax authorities to properly assess transfer pricing risk. This objective is related to ensuring that tax authorities have relevant and reliable transfer pricing documentation in order to properly assess transfer pricing risk; allowing taxpayers to assess their compliance with the arm s length principle. The taxpayer s consideration of available data and analysis of consistency with the arm s length principle is also critical in providing assurance to tax administrations as regards the taxpayer s assessment; and affording tax administrations with useful information for transfer pricing audits. Tax administrations need appropriate transfer pricing documentation in order to conduct thorough audits. The Guidance indicates that it is clear that tax administrations must have the ability to obtain, within a reasonable period, all relevant documents and information in the taxpayer s possession. 18 Within this context, a three-tiered approach has been stipulated in the Guidance, and three types of documents to be prepared by taxpayers are proposed: a master file transfer pricing report containing standardized information on a company s (or multinational group members ) global transfer pricing policies and positions (Annex I to chapter V); a local country file that supports material controlled party transactions and analyses whether a specific country s tax base was determined in line with the arm s length principle (Annex II to chapter V); and a template that would provide worldwide details, among other things, of the location of employees, assets and taxes paid by multinational groups and their affiliates by specific countries and business lines. (Annex III to chapter V). 19 It is clear that increased documentation obligations will be imposed on taxpayers in order to comply with the new rules under chapter V. However, when the proposed annexes are evaluated, although assurance is given by the Guidance, it is understood that some confidential information may be required to be disclosed by taxpayers. 20 Additionally, during the discussion draft process, many taxpayers expressed concerns that the scope of information requested in the discussion draft template suggests that countries could use the data to move to a formulary apportionment model which is not in line with the arm s length standard, as country-by-country reporting requires aggregated information relating to the global allocation of income, taxes paid and certain indicators of the location of economic activity among all tax jurisdictions in which the multinational group operates. However, this approach is not supported by OECD countries, as the OECD Guidance on Country-by-Country Reporting explicitly stated that it should not be used by tax administrations to propose transfer pricing adjustments based on a global formulary apportionment of income. 21 This is especially crucial for developing countries in which transfer pricing legislation has not been sufficiently developed, as the tax authorities in such countries might approach this grey area by using a global formulary apportionment model rather than the arm s length principle. On the other hand, there are other points which may have an effect on local documentation, such as time frame, materiality, frequency of the updates and language. The materiality section points out that: transfer pricing documentation requirements should include specific materiality thresholds that take into account the size and the nature of the local economy, the importance of the MNE group in that economy, and the size and nature of local operating entities, in addition to the overall size and nature of the MNE group. 22 Regarding compliance issues connected to a time frame, the Guidance on Country-by-Country Reporting states that [t]he best practice is to require that both the master file and the local file be prepared no later than the due date for the filing of the tax return for the fiscal year in question. 23 Regarding compliance issues connected to the frequency of documentation updates, the Guidance on Country-by- Country Reporting states that: [i]n general, the master file, the local file and the country-bycountry report should be reviewed and updated annually. [...] In order to simplify compliance burdens on taxpayers, tax administrations may determine, as long as the operating conditions remain unchanged, that the searches in databases for compar- 15. OECD, OECD/G20 Base Erosion and Profit Shifting Project, Guidance on Transfer Pricing Documentation and Country-by-Country Reporting, Action 13: 2014 Deliverable, (2014), at 9. 16. OECD, supra n. 15, at 13. 17. OECD, supra n. 15, at 13-14. 18. OECD, supra n. 15, at 14. 19. OECD, supra n. 15, at 9. 20. OECD, supra n. 15, at 24. 21. OECD, supra n. 15, at 19-20. 22. OECD, supra n. 15, at 21. 23. Id. IBFD INTERNATIONAL TRANSFER PRICING JOURNAL JANUARY/FEBRUARY 2015 59

Ramazan Biçer and Mehmet Erginay ables supporting part of the local file be updated every 3 years rather than annually. 24 Regarding compliance issues connected to language, the Guidance on Country-by-Country Reporting specifies that [c]ountries are encouraged to permit filing of transfer pricing documentation in commonly used languages where it will not compromise the usefulness of the documents. 25 In this context, it is helpful to evaluate Turkish transfer pricing documentation from the perspective of the Guidance on Country-by-Country Reporting. Transfer pricing provisions set forth in article 13 of the Corporate Income Tax Law (Law 5520) (effective from 1 January 2007) were drafted taking into consideration the OECD Transfer Pricing Guidelines and international developments. Turkish transfer pricing legislation introduced two types of documentation requirements: related parties and related-party transactions must be declared by indicating the type, amount and method of transaction, using the transfer pricing form attached to the corporate tax return; and an annual transfer pricing report must be prepared throughout t relevant fiscal year. While there is no submission requirement for the annual transfer pricing report, it must be presented, upon request, to the tax authorities or to those who are authorized to perform tax audits. In addition, the annual transfer pricing report must be prepared in Turkish, and any appendices prepared in a foreign language must be translated into Turkish. Considering the concerned paragraphs of the Guidance on Country-by-Country Reporting and the above-mentioned explanations, it is evident that, in some regards, Turkish taxpayers will have additional different documentation obligations in preparing their local files. For instance, previously, taxpayers were required only to complete local documentation and submit it to the local tax authorities. However, as the discussion draft suggests, they will be expected to support the documentation of the multinational group and may be obliged to take part in some aspects of master file or country-by-country reporting. This will create a further obligation for local entities of multinational groups in Turkey. The Guidance on Country-by-Country Reporting addresses the application of a threshold to local regulations. 26 Currently, there is no materiality threshold under Turkish transfer pricing rules, and taxpayers must document each cross-border transaction without any amount limitation. From the perspective of the Turkish tax authorities, it is not clear whether this regulation would be acceptable. However, it might be a better approach to apply a materiality threshold (i.e. for intra-group service transactions, a percentage could be determined as to the ratio of this related-party transaction to the total amount of operating expenses) by both the taxpayer and the tax authori- 24. OECD, supra n. 15, at 22-23. 25. OECD, supra n. 15, at 23. 26. OECD, supra n. 15, at 21-22. ties. In this way, taxpayers will focus on transactions which might create more risks and prepare their supporting documentation accordingly. In addition, the tax authorities will be able to focus on risky transactions from their perspective and could conduct more detailed and thorough analyses thereof. Additionally, there is no difference in the time frame approach of the Guidance on Country-by Country Reporting and Turkish transfer pricing rules, as they both seem to agree that the due date for documentation should be no later than the due date for filing the tax return for the relevant fiscal year. However, this might be a bit more burdensome for taxpayers, as they will have to coordinate both the master file and local documentation simultaneously. Finally, as noted in the implementation section of the Guidance on Country-by-Country Reporting, transfer pricing documentation requirements should continue to be a feature of local law. 27 The implementation of threetiered transfer pricing documentation (i.e. master file, local file and country-by-country reporting) requires that countries modify their domestic transfer pricing documentation rules. This approach is also supported by the Turkish transfer pricing rules. However, there is no publicly available disclosure by the Turkish tax authorities regarding this ongoing process. On the other hand, as noted in the Guidance on Country-by-Country Reporting, along with other emerging market economies, 28 Turkey specifically stated that additional transactional data regarding relatedparty interest payments, royalty payments and especially related-party service fees will be needed in the countryby-country reporting. 29 As seen especially during the last few years, the Turkish tax authorities have specifically focused on these subjects from a transfer pricing perspective. It is obviously anticipated that the main effect of Action 13 on Turkish transfer pricing practice will be an increased and more focused tax audit, as these new changes could pave the way for this. On the other hand, taxpayers will be more prepared for possible transfer pricing audits, and the eventuality of being scrutinized by the tax authorities could decrease. Therefore, interesting developments in Turkish transfer pricing practice can be expected in coming years. 2.13. Action 14: Make dispute resolution mechanisms more effective The number and complexity of cases dealt with by the competent authorities of states have sharply increased in the last decade, and effective dispute resolution by competent authorities under existing tax treaty procedures has become a pivotal aspect of international tax law (even though not always effective). The BEPS Action Plan promotes the development of solutions to address obstacles that prevent countries from resolving treaty-related disputes under mutual agreement procedures (MAPs). 27. OECD, supra n. 15, at 10 28. Other emerging markets taking the same approach are Argentina, Brazil, China, Colombia, India, Mexico and South Africa. 29. OECD, supra n. 15, at 10 60 INTERNATIONAL TRANSFER PRICING JOURNAL JANUARY/FEBRUARY 2015 IBFD