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The Permanent Establishment Paradox in Digital Economic Activities and Underlying Turkish Tax Implications

Güler Hulya Yılmaz | Deloitte Tax Partner

Arzu Akçura Değer | Deloitte Tax Director

1. Introduction

As a result of free movement of data/information, capital and labor at an increasing pace as well as technological developments and digitalization at an exponentially increasing level on a worldwide basis, we observe that the volume of “electronic commerce” has also increased at an incredibly higher rate and that it is getting more and more diversified and also becoming more and more complicated every day.  New digital and virtual business concepts and facts have entered in our daily life, such as server, e-state, e-invoice, e-book, e-declaration, e-archive, e-pulse, digital games, virtual currency, “bitcoin”, virtual advertising, cloud computing, three dimensional printing (“3 D Printing”), hacker, crowdfunding, crowdsourcing etc.

While the virtual digital world has been improving and expanding almost at the speed of light; the tax laws and regulations appear to be falling behind these dynamic and rapid developments in the digital economic activities. With the contribution of globalization factor, this problem is getting deeper and more complicated. It is getting more and more difficult and complicated to fairly tax the income derived from worldwide electronic commercial activities, at the right time, in the right jurisdiction and in the right amount.  Under the current situation, how much of the income derived from the digital commercial / economic activities is being taxed? And, how much of it cannot be taxed? or cannot be taxed in the country in which such income should actually be taxed? Based on the Turkish Tax Procedures Code General Communiqué No. 464 which was promulgated on 24 December 2015, intermediary service providers, banks, internet advertising service intermediaries, cargo and logistics companies are obliged to notify, starting from 1 July 2016, those transactions realized in the internet with the identity information of the parties to such transactions and other requested information to the Turkish Revenue Authority, on a monthly basis. The introduction of such an obligation of notification starting from 1 July 2016 will certainly lead the interested parties to consider about the tax implications as well as the underlying risks associated with digital economic transactions (Tolga Büyükdeğirmenci – “The Reporting Requirements Imposed as from July 1, 2016”).
Prior to starting BEPS ("Base Erosion and Profit Shifting") Action Plan studies under the leadership and support of G20 group in 2013, the OECD had considered four alternative solutions regarding the taxation of income derived from electronic commerce:

1.Classification of electronic environment as a kind of "free trade area" which should not be subject to taxation,

2.Consider a taxation regime on the basis of the volume of the information transfer (measured as “byte”) realized through the digital delivery (i.e. “byte tax”) which is considered as a kind of electronics sales tax based on the volume of data transferred whereby the nature of electronic transaction is disregarded,

3.Taxation with regard to the existing local tax regulations,

4.Taxation through adoption of new provisions that will be added to both the local tax regulations and double tax treaties.


In the light of the aforementioned four alternative solutions, it is difficult to follow and ensure fairly taxation of income derived from economic activities in the electronic environment unless simple and worldwide agreed upon precise rules are introduced and applied. It is obvious that economic activities carried out in electronic environment are very much complex all over the world and they do result in tax base erosions. Accordingly, neither the complete exclusion of such income from the scope of taxation nor its taxation just through a simple “byte tax” is an appropriate solution given the complexity and diversity of such transactions as well as various other dimensions. Developed countries have primarily pursued to find solutions based on their current tax regulations.  However, the continuous increase and the diversification of the electronic /virtual commerce and shopping necessitated to consider the taxation issues of such electronic commerce separately. Therefore, the fourth alternative solution has come into prominence. Accordingly, first action in the OECD BEPS Action Plan led by G20 countries is related to the determination of taxation issues created by the digital economic activities and the solutions suggested for fair taxation of such activities all over the world.

2. Taxation Issues Created by Digital Economic Activities

The following issues are required to be resolved  for the taxpayers and for each country to ensure the fair taxation of digital economic/commercial activities that are taking place in the electronic environment such as selling of goods and services, share and transfer of information, musical products, pictures, games, concluding electronic agreements and meetings, realizing electronic money transfers:

1.Determination of the taxpayer (Who will declare and pay the taxes?)

2.Determination of the nature of the income (Commercial income, income derived from professional services, royalty income, etc.)

3.Determination of jurisdiction in which the income is derived (the country where the taxable event takes place) (Is there a permanent establishment in Turkey?)

4.Determination of the amount of income derived from such activities and the amount of tax base (in the case of existence of related party transactions, the arm’s length principles are required to be applied in determination of taxable income/tax base)

5.Determination of the tax regime (direct taxation, taxation at source etc.)

6.Application of indirect taxes such as Value Added Tax (VAT), Special Consumption Tax (SCT)

At this point, OECD’s BEPS Action Plan No.1 "Addressing the Tax Challenges of the Digital Economy” examines and evaluates the tax challenges of the digital economy and aims to identify and address the main challenges that the digital economy poses for the existing international tax rules and recommends solutions.

The three main questions that OECD BEPS Action plans including Action Plan No.1 point out and that should be answered are as follows;

1.Where is the economic-commercial activity carried out?

2.Where is the economic value created?

3.Where is the taxable event taxing the income arising from the value created?

From Turkish taxation point of view, it is important to answer the following question in respect of taxation in Turkey: whether or not  a permanent establishment is created in Turkey as a result of the economic activity?

We can analyse this subject through a real life example that can be seen frequently in practice.

3. An Example Permanent Establishment Analysis: Intermediary Activities in Electronic Environment 

In our example, ABC Company (“ABC Co.”) which is resident in country A sells its goods and services that are related to such goods through its website all over the world. ABC Co. also has a Turkish subsidiary company in Turkey namely TR A.Ş. which is 100% owned by ABC Co. Salespersons of TR A.Ş. market goods and services of ABC Co. in Turkey through visiting potential customers, sending electronic messages, making customer calls. Salespersons employed by TR A.Ş. earn a commission on such sales realized through their involvement. In case salespersons of TR A.Ş. convince a substantial number of potential customers in Turkey to purchase certain amount of goods and services of ABC Co. and Turkish customer and ABC Co.  sign a sales agreement in electronic environment and if prior to signing of such agreement, the salespersons of TR A.Ş. send the agreement covering  all conditions (including the agreed upon quantity to be purchased together with its price) to Turkish customer in electronic environment and as a result, if the Turkish customer decides to purchase goods and/or services and signs the agreement, then how much of the income derived from such sales should be taxed in Turkey and  how much should be taxed in country A? In other words, is there any taxable income in Turkey?

This particular case needs to be analyzed under both local Turkish tax rules and the relevant international tax regulations including the relevant provisions of Double Tax Treaties.

3.1. Tax Liability

As per Turkish tax regulations, ABC Co. which is a resident of the Country A is a “limited taxpayer” in Turkey (i.e. subject to Turkish tax on only the income to be derived in Turkey), whereas TR A.Ş. (subsidiary of ABC Co. in Turkey) is a resident corporation in Turkey and it has full tax liability (i.e. its worldwide income is subject to Turkish Tax) 

3.2. The Nature of Income

The nature of income is Commercial income and accordingly the principles in relation to the taxation of commercial income should be considered.  

3.3. Permanent Establishment Analysis  

TR A.Ş. is already taxed in Turkey as a full taxpayer. The critical issue to determine is whether or not ABC Co. has earned commercial income in Turkey- in other words- to determine whether or not a Permanent Establishment (PE) has been constituted in Turkey for ABC Co.  According to Article 3 of Turkish Corporate Tax Code, non-resident companies who lack both the legal headquarters and business center in Turkey, are only taxed over their earnings derived in Turkey. Accordingly, for the commercial earnings of a non-resident company to be taxable, the company must have a place of business or a permanent representative in Turkey and the earnings must have been realized either at this place of business or through this representative. Earnings of non-resident companies which dispatch goods to abroad without selling such goods in Turkey are not deemed to be derived in Turkey. “Selling in Turkey” means; either the buyer or the seller or both are in Turkey or the sales agreement is signed/concluded in Turkey. In our example, could the mere delivery of the agreement text, which is afterwards signed between ABC Co. and Turkish customers, by salespersons of TR A.Ş. in Turkey in a ready status to be signed, lead to such interpretation that sales agreement was effectively concluded in Turkey? Could the reason leading to such interpretation be the transmission of the agreement to the Turkish customer by the salespersons of TR A.Ş.?  If the sales agreement was not transmitted electronically, would there be a similar analysis? In case it is interpreted that the sales agreement has effectively been concluded in Turkey, then this might lead to another interpretation as to whether there is an income derived by ABC Co from Turkey. 

Under the Absence of a Double Tax Treaty between Country A and Turkey: In our example, whether ABC Co. constitutes a permanent establishment in Turkey or not,  or in other words, whether the TR A.Ş. is considered as a permanent representative of   ABC Co. would be evaluated in accordance with the Turkish local tax regulations.

In the case of Existence of a Double Tax Treaty between Country A and Turkey: In this case, not only the Turkish tax regulations but also the provisions of the Double Tax Treaty on “permanent establishment” and “business profits” shall also be considered. However, in case such tax treaties enter into force and supersede the local tax regulations, their provisions may still be insufficient to conclude such analysis. For example, according to tax treaties, a fixed place of business does not constitute a place of business only when it is utilized in relation with preparatory or auxiliary activities. At this point, can the transfer of the sales agreement (which contains sales price and other conditions) to Turkish customers through electronic platform by salespersons of TR A.Ş. on behalf of ABC Co. by providing explanations and convincing the customers to make the purchase, be considered as a preparatory or auxiliary activity? According to some Double Tax Treaties, although salespersons of TR A.Ş. are not given the authority to conclude contracts in the name of ABC Co., maintaining a stock of goods or merchandise continuously and carrying out the activities in relation to the sales of such goods shall constitute a permanent establishment and the profit is attributed to such permanent establishment. In order for the Turkish Revenue Authority (“TRA”) to attribute income to the Turkish permanent establishment, the TRA should prove that, even though all activities related to sales are performed in Turkey, the sales agreement is deliberately concluded outside Turkey with the sole purpose of tax evasion.. How shall this be proven? Each case will need to be evaluated based on its own merits.  (“Legal Issues in Digital Economic Activities” – by Asilhan Özkaya).

3.4. Determination of Taxable Income

In case, a permanent establishment is claimed/argued to exist, the taxation analysis and evaluations for profit attribution to such permanent establishment should differ based on whether or not there is an applicable Tax Treaty. In the absence of a Tax Treaty, the local tax regulations shall be applicable for determination of taxable commercial income. In the existence of a tax treaty, business profit will be taxed limited to the amount attributable to this permanent establishment Turkey. As in our example, if TR A.Ş. and ABC Co. are related parties, the deemed place of business (the deemed place of business constituted as a result of the intermediary electronic media transactions carried out on behalf of the non-resident company) should be attributed with a profit in compliance with the profit that would have been attributed if the such place of business and TR A.Ş. and ABC Co. were independent parties, acting in same or similar circumstances carrying out same or similar activities. At this point, the relevant Turkish rules about disguised profit distribution through transfer pricing will need to be considered. (Article regarding “Transfer Pricing in Digital Economic Activities” – by Özgür Toros).

4. What Does BEPS Action Plan Say?

One of the reasons for the development of initiatives and studies in OECD BEPS Action Plan 1 is that the current provisions of the current international Tax Treaties fail to capture the economic and commercial activities carried out in the electronic environment and are insufficient to provide the conditions of a permanent establishment and ensure fair taxation.  

4.1. What is missing in the Current Local and International Tax Regulations 

The major drawbacks and loopholes in the current local and international tax regulations in taxation of the activities carried out in the electronic and virtual environment can be summarized as below;

1. There is no definition of a fixed place of business in the electronic environment, which requires that the definition of digital economic activities are provided together with the definition of a digital permanent establishment.

2.In the current texts of the Tax Treaties, the activities that would not constitute a permanent establishment are described and provided, however, the current definitions are not sufficient when the digital economic activities are considered. For example, what type of activities in the electronic environment should be considered as “preparatory and auxiliary”? Additional explanations and amendments are required to be made in the relevant provisions of Tax Treaties.

3.In the existing Tax Treaties, it is mentioned that having and exercising the authority to sign contracts would give rise to constitution of permanent establishment. In the absence of such an authority to sign contracts, but still if the sharing, transmission and validation of  information required to conclude a contract takes place in the electronic environment, would such electronic transactions lead to constitution of a permanent establishment  by considering the roles of such functions in conclusion of an agreement? This issue also needs to be addressed from legal perspective based on each type of activity.

4.There should also be a collection of information at both local and international level in terms of a standardized format and process so as to follow up digital economic activities all over the world. 

5.In the determination of taxable income of related parties, the correct amount of income should be taxed in the correct jurisdiction and at the correct tax rates. For this reason, as per BEPS Action Plan No.13, automatic exchange of information will also take place between the Tax Authorities. In order to ensure that such exchange of information can be done safely and reliably, there must be legal regulations in each jurisdiction, including Turkey, so as to protect the trade secrets of corporate taxpayers and the personal data of individual income taxpayers in addition to securing the minimum infrastructure and standards to ensure the data/information security.

OECD’s BEPS Action Plan No. 1- “Addressing the Tax Challenges of the Digital Economy”; Action Plan No.7- “Preventing the Artificial Avoidance of Permanent Establishment Status” and Action Plan No: 13- “Transfer Pricing Documentation and Country-by-Country Reporting” provide the analyses and suggestions with regard to the aforementioned drawbacks in the current regulations and also propose the necessary actions to be taken.

4.2. Recommendations of OECD BEPS Action Plan

4.2.1. Principles 

First of all, the principles to be considered in the determination of a new taxation regime or new taxation rules are summarized as follows;

1. Neutrality: Taxation should seek to be neutral and equitable between conventional and electronic forms of commerce. Business decisions should be motivated by economic/commercial reasons rather than pure tax considerations. 

2.Efficiency: Compliance costs for taxpayers and administrative costs for the tax authorities should be minimized as much as possible.

3.Certainty and Simplicity: The tax rules should be clear and simple so that taxpayers can anticipate the tax consequences in advance of a transaction (i.e. know when, where and how the tax is to be accounted). 

4.Effectiveness and Fairness: The key issue is to tax the right amount of income in the right place at the right amount and in the right time. Tax evasion should be minimized.

5.Flexibility: The system for taxation should be flexible and dynamic enough to ensure that the rules keep pace with technological and commercial developments. 

4.2.2. Major Problems to be Addressed

The problems in relation to “Digital Permanent Establishment” from income and corporate tax point of view can be grouped under three headlines as below;

a. Nexus (Fixed Place of Business):  Digital economic activities can take place very rapidly and without a need for a specific and a fixed place of business. As a result, serious problems may arise in the definition of a permanent establishment and attribution of income to such permanent establishment.

b.The Increase in information dissemination and its rapid spread in Virtual Environments: The difficulties in the valuation of digital goods and services that is created as a result of the data increase and its rapid spread lead to problems in the assessment of whether or not the share of information is considered as a free of charge delivery, a sales or a barter/exchange.

c.The Difficulties in Determination of the Nature of Income: There are difficulties in determination of the nature of income derived from the delivery of new and a variety of digital products in various digital environments (the issue relates to whether such income should be classified as commercial income, professional services income or royalty income?)  

4.2.3. Recommendations for the solution of the PE Paradox of Digital Economic Activities  

OECD BEPS Action Plan No.1 provides the following recommendations to solve the taxation problem of income derived from digital economic activities;

a) Revising the Conditions of a PE- A significant economic presence is required for the existence of a PE.  The level of significance should be based on the level of income generated from such activities, the number of customers reached or the number of persons receiving such digital goods/services or on a key that is comprised of all such factors. Additionally, under certain conditions, a person may be deemed to constitute a PE even in the absence of exercising authority to sign contracts on behalf of the non-resident if such person negotiates the significant provisions of the agreement; or a person who, in principle, acts on behalf of a limited specified group shall constitute a permanent establishment and is excluded from the definition of independent agents.

b) Redefinition of PE Exemptions- In this context, it is mainly envisaged that the regulations in relation to the preparatory and auxiliary activities are redefined. For example, the warehouses located in other jurisdictions of entities who are engaged in on-line sales activities or artificial segregation of activities amongst the related parties should not be considered as preparatory/auxiliary.

c) Withholding Taxation over Certain Payments- It is possible that withholding taxation will give rise to certain problems. Taxation at source through withholding may be very high for some activities based on their level of profitability, whereas it may be rather low for some other activities. 

d) Equalization Levy- The main purpose is the taxation of the significant economic presence of the non-resident in the Source State. With the aim to ensure the fairness amongst the resident and non-resident taxpayers, equalization levy may be adopted.

e) Income Attribution to the PE: According to the transfer pricing guidelines to be revised, the legal ownership of the intangible right will no longer be sufficient to attribute the income generated from its usage to this person. In other words, the attribution of income amongst the entities who are undertaking significant functions, who are holding significant assets and who are undertaking significant risks should be determined based on the actual responsibilities and functions of each party in this transaction.

f) Effective Definition of a Controlled Foreign Company: The income generated from digital economic activities is included within the definition of income of the controlled foreign company and as such, the income will be taxed in the hands of the main shareholder.

A summary of some recommendations as addressed in the BEPS Action plan is provided above and it is observed that the main aim is to tax the currently untaxed income from digital economic activities neither in the source nor in the home state. This double non-taxation problem of income from digital economic activities is suggested to be resolved based on the suggestions provided in the other chapters of BEPS action plan rather than drafting a special taxation regime or defining taxation rules specific to the digital economy.

Another important taxation issue about the digital economy is the implementation of Value Added Tax (“VAT”). The detection of the taxable event, the destination place, and the taxpayer in the digital environment is almost impossible due to the reason that the order, trading and delivery of the digital products take place in the digital environment.  This problem especially emerges upon the delivery of electronical services to individual consumers and lead to significant problems in the VAT collection. Therefore, different VAT applications are suggested for electronical services that are provided to businesses (B2B) and individual consumers (B2C).

Today, it is considered that the most efficient and effective method to solve this VAT issue is that the non-resident service provider establishes its VAT registration, to declare and pay the VAT over its services delivered to individual consumers in the country of these individual consumers. There is no such application available to non-resident service providers in Turkey, however, similar amendments may be introduced in the local regulation as well. Therefore, the changes in the VAT legislation should be followed up closely. (Article about the VAT implications in the digital economy. by Erdal Dinçtürk)

The critical point is that the local regulations will need to be amended as per the recommendations provided in the BEPS Action Plan. Accordingly, we observe the initial reflections of the recommendations in the OECD BEPS reports in the draft Turkish Tax Procedures Code which is still being discussed to be finalized.

 5. BEPS Reflections in the Draft Turkish Tax Procedures Code

Article 156 of the current Turkish Tax Procedures Code defines  “permanent establishment” as a physical place by stating that “a place that is for the use of or that is allocated to the execution of commercial, industrial, agricultural or professional activity”. The examples that are given for a permanent establishment are all physical places such as branch offices, warehouses, hotels, farms, farm, garden, etc.

We can very clearly observe the reflections of BEPS Action Plan No.1 in the draft of Tax Procedures Code.

The Concept of Permanent Establishment in the Draft Turkish Tax Procedures Code

In the new draft Turkish Tax Procedures Code, the definition of "Permanent Establishment" of Article 129 includes the examples of “mobile devices, electronic environment or spaces”. Similary, Article 130 of the draft Code defines the “Place of Business in Electronic Environment” as follows:

“(1) The assignment or the use of internet, extranet, intranet or similar telecommunication environment or the tool for commercial, industrial or professional activities will lead to the constitution of electronic permanent establishment.

(2) The Ministry of Finance is authorized to determine the scope of electronic permanent establishment and to determine the taxpayer’s duties, the intermediaries for the supply of goods and services in the electronic environment or for the collection of their payment and the purchasers of such goods and services severally liable for the payment of the relevant taxes and setting rules and procedures for their application.”

As per the aforementioned draft Article;

a.the intermediaries for the supply of goods and services

b.the intermediaries for the collection of their payments,

c.the purchasers of such goods and services

may be severally held liable for the payment of relevant taxes such as Income Tax, Corporate Income Tax, Value Added Tax, Stamp Tax. (The VAT aspects of digital economic activities by Erdal Dinçtürk)

Article 131 of the draft Turkish Tax Procedures Code addressing the notification of address changes of a permanent establishment, requires that including the address changes in the electronic environment, the changes in the address of the permanent establishment is notified. Similarly, we observe that Article 133 obliges that the requirement to notify the changes in the number of business places will also include the electronic permanent establishment. As such, it is expected that upon the ratification of the draft code, the changes in the electronic permanent establishment will be required to be notified same as the physical place of businesses.

On the other hand, in the Article on “Gathering Information” of the draft Turkish Tax Procedures Code, namely Article 120, it is stated that a data center shall be established within the Turkish Revenue Authority and that all such data will be stored in this center.  The introduction of establishment of such a data center implies the effort by the Turkish Revenue Authority of forming the required infrastructure for monitoring the digital economic activities.

6. Final Remarks and Conclusion

It is observed that, certain definitions of digital economy taxation will also be provided under our local tax legislation. The Draft Turkish Tax Procedures Code includes the electronic environment and areas within the current definition of a permanent establishment and additionally, a detailed definition of an electronic permanent establishment is provided.  Moreover, the Law on Regulation of Electronic Commerce that entered into force as of May 1, 2015, regulates the commercial communication, the responsibilities of the service provider and the intermediary service providers, agreements concluded via electronic communication tools and the exchange of information liabilities  on electronic commerce and the obligations and sanctions. Turkish Tax Procedures Code General Communiqué No. 464 elaborates about the liability of a monthly notification to the Ministry of Finance of the data of those who conduct transactions electronically in relation to electronic transactions and where such regulation is also critical for the pursuit of taxation of electronic transactions.

As the Turkish Ministry of Finance stated that, Turkey supports BEPS action plan also as being a member of OECD and one of the G20 member states.  As of now, the Ministry of Finance in Turkey has not yet made any changes in the local tax regulations with regard to taxation of digital economic/commercial activities except certain new rules and definitions introduced in the new draft Turkish Tax Procedures Code. However, the studies of the Ministry of Finance on this issue still continue. In the upcoming days, we suggest that the regulations and the changes in the local tax legislation must be monitored closely. Our suggestion especially to the international tax management of the multinational corporations is that they assess the possible impact of BEPS actions regarding digital economic activities on their companies and activities and accordingly develop their own action plans and strategies.