Arzu AKÇURA, Director (YMM) International Tax
This article summarizes the main tax implications of a loan arrangement that a Turkish borrower entity should consider together with the recently published Decrees by the Banking Regulation and Supervision Agency (BDDK) introducing limitations on new cash commercial TRY loans to be used by Turkish companies holding foreign currency cash assets at amounts and ratios exceeding certain thresholds and the restrictions on the use of the foreign currency loans introduced in 2018.
Under the Turkish tax legislation, there are two main types of financing available for companies: debt financing vs. equity financing.
Under the current Turkish tax environment, the cash share capital injections by the shareholders into the Turkish companies are encouraged. There is a minimal capital surcharge fund of 4 per ten thousand to be payable by the Turkish Company over the initial share capital or the subsequent share capital increases to the Competition Board. Additionally, Notional Interest Deduction (NID) has been in effect to encourage cash share capital injections into Turkish Companies by their shareholders under certain conditions. The NID application has been recently amended with Law No. 7417, whereby its use has been limited to 5 years starting from 5 July 2022.
On the other hand, if a Turkish Company enters into a loan arrangement, several factors including but are not limited to the type of the lender, from where the loan is obtained, i.e. a local loan arrangement vs an overseas loan arrangement, and the loan conditions must be taken into consideration to determine its potential tax implications, as summarized below;
1. Corporate Withholding Tax (WHT): As per Article 30 of the Corporate Income Tax Code (CIT Code), interest payments made in cash or on account or interest accruals are subject to WHT at the rates of 0% or 10%. If the loan is obtained by the Turkish borrower company from a non-resident company, Article 11 of the tax treaty signed between Turkey and the relevant country in which the lender non-resident company is resident, if any, shall primarily be taken into consideration. In general, the treaty provision on interest payments does not provide more favorable WHT rates than the current domestic WHT rates.
2. Value Added Tax (VAT): If the loan is obtained from a corporation other than a bank/financial institution, the interest payments are subject to 18% Turkish VAT. If the loan is obtained from outside Turkey, the 18% VAT shall be applied on gross interest payments through reverse charge.
3. Stamp Tax: In principle, loan agreements are subject to stamp tax. However, stamp tax exemptions may be available if the loan is obtained from banks, foreign credit institutions, and international corporations.
4. Resource Utilization Support Fund (RUSF): RUSF shall be applied by the intermediary Turkish banks mainly depending on whether or not the overseas loan is obtained in TRY or in foreign currency and the average maturity of the loan. While the RUSF applies on principal loan amount for foreign currency loan arrangements, RUSF applies on interest for loan arrangements made in TRY. RUSF may be eliminated if the average maturity is 3 years (inclusive) or more for loan arrangements in foreign currency, while RUSF on TRY loans may be eliminated if the average maturity is 1 year (inclusive) or more.
5. Thin Capitalization: According to Article 12 of CIT Code, if the ratio of the borrowings from shareholders or from related parties of the shareholders exceeds three times of the shareholders equity (the equity of the corporation at the beginning of the related year and determined according to the Turkish Tax Procedures Code) of the borrower company at any time within the relevant year, the exceeding portion of the borrowing will be considered as thin capital.
In such a case, foreign exchange losses and interest expenses incurred on the exceeding portion of the concerning loan are required to be treated as a non-deductible expense. As for the interest expenses, the interest amounts that are paid in connection with the exceeding portion of the related party loans shall be treated as dividend distributed as of the last day of the fiscal period and subject to 10% local dividend WHT. The WHT paid over the interest payments in the relevant fiscal year corresponding to the amount that is re-classified as dividend distributed as of the end of the said fiscal year shall be credited from dividend WHT. VAT paid over the interest that is disallowed for CIT purposes is not recoverable.
6. Transfer Pricing: As per the transfer pricing rules, transactions between related parties (both resident and non-resident) must be in line with the arms length principle. Otherwise, the related profits will be treated as having been wholly or partially distributed in a disguised way via transfer pricing and subject to both corporate income tax and dividend withholding tax depending on the tax status of the recipient of the disguised profit. Additionally, the VAT incurred on interest corresponding to the disguised profit distribution is recoverable by the borrower Turkish Company provided that such VAT has been declared and paid to the Turkish Tax Office either through reverse charge VAT if the lender is a non-resident party or through VAT if the lender is a resident corporation
7. Restriction on the Deduction of the Financial Expenses: Assuming that the borrower Turkish Company is subject to the restriction on the deduction of the financial expenses, it is required to compare the sum of the short-term and long-term liabilities with its equity as of the end of each quarter on a quarterly basis and on annual basis as of the end of the fiscal year. Such comparison will be based on the balance sheet to be prepared in accordance with the Tax Procedures Code. If the total liabilities exceed the equity of the Company, 10% of the interest, commission, delay charge, dividend, foreign exchange losses, and similar types of expenses incurred on the exceeding portion, except for the expenses that are added in the cost of the investment, will be added back to the CIT base. However, the VAT incurred corresponding to the amount that is disallowed for CIT purposes is recoverable by the borrower company.
8. Restrictions on Foreign Currency Denominated Loans: Effective as of 2 May 2018, a Turkey resident Company with earnings denominated in foreign currency is allowed to obtain loans in foreign currency. The said restriction covers foreign currency loans obtained both from Turkey and abroad, however, several exceptions have been introduced for the use of the foreign currency loans which do not require the condition of having foreign currency denominated earnings. Therefore, if a Turkish Company is considering to obtain a loan in foreign currency, then this restriction together with the exceptions should be taken into consideration. The breach of such rules is primarily subject to administrative penalties as per the foreign currency regulations. Furthermore, the secondary legislation and the statements by the Ministry of Treasury and Finance on the deductibility of foreign currency losses incurred by the borrower Turkish Company which is not allowed to obtain foreign currency loans together with the recoverability of VAT should be monitored closely.
Additionally, as per Article 38 of the Capital Movements Circular of the Turkish Central Bank, Turkish residents are only allowed to obtain foreign currency-denominated loans from banks and financial institutions and thus in principle, Turkish group companies are not allowed to extend loans to each other. However, a Turkish company is allowed to transfer hard currency to the local bank account of the borrower provided that the lender Turkish Company has excessive cash from its internal sources and the borrowing is recorded in TRY in their statutory books resulting in no foreign currency differences for both the lender and the borrower Turkish companies.
9. Restrictions Imposed on Obtaining New Cash Commercial Loans in TRY for Turkish Companies that are subject to Independent Audit with Foreign Currency Cash Assets exceeding Specific Amounts and Ratios
The restrictions were recently introduced with the announcement of two Decrees by the Banking Regulation and Supervision Agency (BDDK) dated 24 June and 7 July 2022. The application mainly restricts the use of new cash commercial loans in TRY by Turkish Companies that are subject to independent audits with foreign currency assets exceeding specified amounts and thresholds. Therefore, if the loan that is envisaged to be obtained falls within the scope of the said restriction and the borrower Turkish Company meets the three conditions mentioned below simultaneously;
- The Company is subject to independent audit,
- TRY equivalent of the Companys foreign currency cash assets exceed TRY 15 mn,
- TRY equivalent of the Companys foreign currency cash assets exceed 10% of the higher of the total of its assets based on the most recent financial statements OR the net sales revenue of the last fiscal year
the company is not allowed to obtain a new cash commercial loan in TRY from Turkish banks. The exception to this general rule is brought for companies that are also subject to the restriction on foreign currency-denominated loans as addressed under #8 above. If the Turkish Company is in such a position, then it is allowed to obtain cash commercial loan in TRY limited to its foreign currency short position. Such companies are required to support their position with the Companys declaration & commitment together with the reporting obligations that must be approved by their independent auditors or their sworn fiscal advisors on a periodical basis.
Additionally, if the Company that is considering to obtain a new cash commercial loan in TRY is not subject to independent audit or is subject to independent audit for the first time in 2022, it is required to declare and commit its position to the relevant bank. Depending on its discretion, the bank may require a letter or a report to be prepared by the CPAs, Sworn fiscal advisors or independent auditors supporting such position of the Company. Such a report is required to be submitted to the bank within 1 month starting from the date on which the loan is obtained.
Lastly, if the Turkish Company borrower is subject to an independent audit but does not meet any of the other two conditions, it will not be subject to the said restriction and will be able to obtain cash commercial loans in TRY provided that such position is declared and committed by the Company and further supported with the reporting obligations approved by either the independent auditors or sworn fiscal advisors on a periodical basis.
10. The Treatment of Financial Expenses: As per Article 262 of Tax Procedures Code, the cost value is defined as the payments made in return to acquire an asset or to increase its value together with all expenditures detached to it. With the Law No. 7338, the said Article has been amended addressing that the foreign currency differences and interest expenses relating to the loan used in financing of the fixed assets will be added to the cost of the fixed assets until the end of the fiscal year in which such assets are capitalized. On the other hand, such interest expenses and foreign currency differences incurred in relation to the acquisition of the inventories shall be added to the cost of such inventories until the date they enter into the stocks. Additionally, it is stated that other expenses incurred in relation to such loans will also be added to the cost value. Whether or not the interest expenses and foreign currency differences incurred after the aforementioned dates are capitalized as a part of the cost of the relevant assets or directly expensed is left at the discretion of the taxpayer.
In principle, the tax treatment of the interest expenses and the foreign currency differences has been applied similarly in years prior to the amendment made in Article 262 of Tax Procedures Code with Law No. 7338, in line with the explanations provided in the relevant communiques of the Tax Procedures Code. In this regard, the main difference introduced with Law No. 7338 is that expenses incurred in relation to the loans other than the interest expenses and foreign currency differences will also be added to the cost of the relevant assets.
Lastly, it should be noted that among the financial expenses addressed under #7 above, the amounts that are added to the cost of the investment do not fall within the scope of the said restriction. Provided that the asset is classified as an investment as per the explanations made regarding the Restriction on the Deduction of the Financial Expenses, the financial expenses that are added to the cost of such an investment in line with Article 262 of Tax Procedures Code either compulsorily or at the discretion of the taxpayer will not be added back to the CIT base within the scope of the restriction on the deduction of the financial expenses.
Director International Tax
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