New Turkish Corporate Income Tax Code Effective
The new Turkish Corporate Tax Code includes a number of significant changes to the rules governing companies by amending previous rules and introducing new concepts, such as transfer pricing and controlled foreign company (CFC) rules.
The rules also include a reduction in the corporate income tax rate, a broadening of the foreign tax credit and significant amendments to the thin capitalization regime. Most of the new rules apply retroactively from January 1, 2006 although the transfer pricing provisions do not become effective until January 1, 2007.
I. Corporate Tax Rate
With effect from January 1, 2006 both the corporate income tax and the advance corporate income tax rates are reduced from 30 percent to 20 percent.
II. Dividend Witholding Tax
With effect from July 23, 2006, the dividend withholding tax rate is increased from 10 percent to 15 percent on distributions of profit to non-resident shareholders and amounts repatriated by a branch to its head office. Dividends distributed by a Turkish entity to another resident entity continue to be exempt from dividend withholding tax.
III.Investment Allowance Exemption
The investment allowance exemption calculated on eligible investment expenditure and deducted from the income/corporation tax base is abolished with effect from January 1, 2006. Any investment allowance amounts that were available and unused at December 31, 2005, however, continue to be available for deduction from corporate taxable income of the following three years (i.e., 2006, 2007 and 2008). Investment expenditure incurred in 2006, 2007 and 2008 will be eligible for the investment allowance provided:
- The expenditure is incurred based on investment incentive certificates issued on or before April 24, 2003; or
- The expenditure is technically and economically an integral part of an investment project that commenced before January 1, 2006 with or without an investment incentive certificate.
IV. Foreign Participation Exemption
Dividends received from foreign participation will be exempt from corporate income tax in Turkey if the following conditions are satisfied:
- The foreign company paying the dividend is a corporation or limited liability company;
- The Turkish recipient owns at least 10 percent of the paid-in capital of the payor company for at least one year;
- The profits of the foreign participation out of which dividends are paid are taxed at a rate of at least 15 percent ( 20 percent where the profits are derived from financial leasing, insurance or investments in securities);
- The dividends from the foreign participation are remitted to Turkey by the deadline for filling the corporate tax return for the year in which the dividends were derived.
V. Capital Gains Taxation
A. Turkish Holding Companies
Under new rules, with effect from January 1, 2006, capital gains derived from the sale of foreign participations that have been held for at least two years by an international holding company resident in Turkey are exempt from corporate income tax. To qualify as an international holding company, the following requirements must be met:
- At least 75 percent of the total assets (excluding cash items) must comprise foreign participations held for a continuous period of at least one year;
- The Turkish company must hold at least 10 percent of the capital of each foreign participation; and
- The foreign participation must be a corporation or limited liability company.
B. Sale of Participation Shares and Immovable Property
Under amendments to the capital gains rules, as from June 21, 2006, a corporate tax exemption is granted for 75 percent of capital gains derived from the sale of participations and immovable property that have been held for at least two years if the gains from such transactions are recorded in a special fund under “Shareholders’ Equity” and the consideration for the sale is collected by the end of the second calendar year following the year of sale.
VI. Foreign Tax Credit
A Turkish company is entitled to a foreign tax credit for tax paid abroad by foreign subsidiaries thathave distributed dividends to their Turkish parent company. Any foreign tax that cannot be offset against advance corporation tax if the foreign source income is derived within the quarterly advance tax period concerned. The credit may not exceed the Turkish corporate tax calculated by application of the Turkish corporation tax rate to the foreign source income.
VII. Anti-Abuse Rules
The new Corporate Income Tax Code includes several anti-abuse provisions, including Turkey’s first ever CFC regime, which applies to foreign subsidiaries resident in low tax jurisdictions and transfer pricing rule that will apply to transactions with related parties. Additionally, the thin capitalization rules have been amended to be more objective.
A. Controlled Foreign Companies
The CFC rules, which apply from January 1, 2006, will be triggered where a Turkish resident company controls, directly or indirectly, at least 50 percent of the share capital, dividends or voting power of a foreign entity and the following conditions are satisfied;
- 25 percent or more of the gross income of the CFC is comprised of passive income, such as dividends, interests, rents, licence fees or gains from the sale of securities that are outside the scope of commercial, agricultural or professional income;
- The CFC is subject to an effective tax rate lower than 10 percent in its country of residence; and
- The annual total gross revenue of the CFC exceeds the foreign currency equivalent of YTL 100,000.
If the above requirements are met, the profits of the CFC will be included in the profits of the Turkish company in proportion to the Turkish company’s share in the capital of the CFC, regardless of whether such profits are distributed, and will be taxed currently at the Turkish corporation tax rate of 20 percent.
B. Transfer Pricing
The new Corporate Income Tax Code introduces transfer pricing rules that are in the line with the OECD Guidelines. The transfer pricing rules will be effective from January 1, 2007.
The transfer pricing rules will apply when transactions (i.e., the sale or purchase of goods and services) between related parties (both resident and non-resident) are not determined in accordance with the arm’s length principle. In such cases, the profits arising from the transaction will be deemed to be “constructive dividends” subject to both corporate income tax and dividend withholding tax.
The rules provide for three traditional transfer pricing methods listed in the OECD Transfer Pricing Guidelines: the comparable uncontrolled price method. Profit-based methods (e.g., the profit-split method and the transactional net margin method) will also be acceptable. Further, taxpayers may adopt other transfer pricing methodologies based on their particular circumstances. Taxpayers will be required, however, to maintain documentation to support the transfer prices determined and used.
Taxpayers will have the option of concluding a unilateral advance pricing agreement (APA) with the Turkish Ministry of Finance to determine the transfer pricing method. The selected method would apply for a maximum of three years, provided the conditions effective at the time the APA is entered remain unchanged.
C. Anti-Tax Haven Rules
Transactions with parties located in jurisdictions specified as countries/regions that allow “harmful tax competition” (taking into account the possibilities for the exchange of information) will be treated as “related-party transactions” for transfer pricing purposes.
Any cash/accrual payments for services, commissions, interests and royalties to parties located in jurisdictions to be specified by the Council of Ministers as those engaging in harmful tax competition (usually tax haven countries) will be subject to a 30 percent withholding tax regardless of the type of income derived by the party resident in a country deemed to be engaging in harmful tax competition. However, if the transactions involve the import of a commodity or the acquisition of participation shares or dividend payments, the withholding tax will not be imposed if the pricing is considered to be at arm’s length.
D. Thin Capitalisation Rules
The thin cap rules have been amended to clarify the rules and provide more objective criteria. The rules will be triggered where loans from shareholders or related parties exceed a debt-to-equity ratio 3:1 at any time in an accounting period. Loans from related party banks or financial institutions will not trigger the rules unless the amount of the borrowing exceeds six times shareholder equity. Related parties for these purposes are defined as shareholders and persons related to shareholders that own, directly or indirectly, 10 percent or more of the shares, voting rights or the right to receive dividends of the company. The equity amount to be determined in accordance with the tax Procedures Code at the beginning of the accounting period will be the equity considered for puroses of determining whether the thin capitalization rules apply.
A comparison of the old and new thin capitalization rules is provided in the table.
Where the debt-to-equity ratio is exceed, interest and any relevant related expenses will be deemed to be “hidden profit distributions” or a “remittance of profits” (in the case of non-residents operating in Turkey trough a PE) as of the last day of the accounting period in which the conditions for application of the thin cap are satisfied. Such expenses will be non-deductible and subject to dividend withholding tax at the rate of 15 percent with effect from July 23, 2006.
The Following loans will not be considered to constitute hidden capital:
VIII. Cost Sharing/Cost Allocations
Costs incurred by headquarters located abroad may be allocated to Turkish branches and deducted trough distribution keys to be determined in accordance with the arm’s length principle, provided the costs incurred abroad are directly to the commercial activities of the Turkish branch.
The new Corporate Tax Code brings Turkey more in line with international norms and allows the country to fully address international tax issues of multinational companies as well as issues relevant to Turkish companies with extensive trade and manufacturing operations in foreign countries.
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