Audit, tax and advisory services
The Turkish Commercial Code is evolving but at present there is no requirement for a statutory financial audit unless a company is listed, operates in a regulated market or exceeds certain size thresholds (total assets of TL75m, revenue of TL150m or number of employees of 250). Companies that do not meet this qualifying criteria do not have to be audited and prepare statutory financial statements primarily for tax purposes in accordance with the Turkish Tax Procedural Law.
Unlike with other regulatory bodies, such as Companies House in the UK, in Turkey there is no requirement to make financial statements submitted to the tax authorities publicly available. It is therefore almost impossible to access reliable financial data on a mid-sized Turkish company. We therefore see a lot of demand from our foreign clients for commercial due diligence and market investigations to help them obtain a better view of the market, its drivers and key players. Primarily research channels, such as direct interviews, are a vital source of this work.
Common deal issues
Turkish Tax Procedural Law, or Turkish GAAP, is largely a cash based accounting principle. Revenues and costs are often recognised on invoicing rather than in the period they relate to. Provisions for doubtful receivables or inventory or other committed or incurred but unrealised costs, may equally not be recognised in the accounts. Therefore understanding the true earnings of a business may not be obvious from looking only at the accounts.
The lack of audit requirement can encourage businesses to prepare their statutory accounts with a view to minimise taxable profits. It is therefore not uncommon to see out of books sales, overstated cost and certain (management) remuneration paid off book (in order to avoid related PAYE or NIC obligations). This is an areas that requires special attention during the diligence phase of a transaction.
Individual shareholders often have multiple investments and it is not uncommon to see a web of related party transactions between operationally unrelated entities. As part of an investor’s diligence, he or she will need to identify financing related balances that are not part of the normal working capital requirement and for which a purchase price adjustment should be sought.
Overall, the corporate governance and financial control environment in Turkey is weaker than in more developed economies. Management information that is used to control the business can be limited, particularly for smaller companies. Detailed management accounts including key performance indicators are often not prepared and financial information can be limited to statutory accounts or trial balances. An investor should therefore be prepared to spend more time in the pre-diligence stage to identify what information is available, and where this is insufficient, spend time with the vendors to prepare what is required.
Ca. 95% of companies in Turkey are owner managed family businesses. Owner-managers are therefore closely involved in the day-to-day running of the company, but decision making is often not strategic or with a long-term view, but rather ad-hoc. An example of this is the absence of annual budgets or even (rolling) long term business plans as part of regular business planning and reporting in many Turkish companies, a shortfall arisen at least party by a history of economic crisis and hyper-inflation. This in turn, impacts on the price expectations of a vendor, who tend towards an emotional valuation of the business which he or she has built up over the years, rather than one based on sound business plans and valuation concepts. As a result, price negotiations can be a delicate affair, with purchase price adjustment mechanism often ignored or only present in a basic form. The support of an experienced sell-side advisor can therefore be beneficial for both sides during a sale process.
The importance of the owner manager to the business
Many businesses have built strong long-standing business relationships with their customers and suppliers and often owner-managers are the key to these relationships. The strength of the relationships allows businesses to conduct transactions based on trust or informal agreements, rather than legal contracts, this is particularly the case in the service and distribution sector. Whilst this practice is a result of stamp tax imposed on contracts (and can therefore be avoided if no formal contracts exist) it stresses the importance of the owner-manager in the day to day running of the business.
The owner-manager often also provides personal guarantees to banks who provide project or working capital financing to the business. Project financing supported mainly by future cash flows of the project or business are less common in Turkey. As a result, one of the key focus areas of owner-managers is on cash flow and working capital management to protect their personal guarantees.
Doing business in Turkey
It is not without challenges, some of which this article touches upon, but with careful planning, local experience and understanding of the market and commitment to building strong relationships with local partners, successful transactions can be completed in Turkey. But don’t be surprised if you cannot arrange an appointment with a Turkish business six months in advance, you may be more successful arranging an ad-hoc introductory meeting the next day.
With its young and dynamic population and rapidly growing economy, Turkey has retained its position as one of the most attractive countries in which to invest. Although Turkey has yet to overcome a handful of macro-economic challenges, this trend is expected to continue in the near future.
Supply of cost effective labour force, proximity to Europe and Customs Union, its strategic location, large and growing domestic market, political stability, and strong banking system makes Turkey a very attractive destination for investment.
There are various tax and accounting issues that should be considered by investors who planning to enter the market or expand to Turkey that may significantly impact the return on investment.
We aim to give you a high level overview of the key local tax issues to be considered by foreign investors.
The Investment Decision
The most critical and initial decision is to decide whether to make a new investment or acquire an existing company. In case of a new investment, it becomes extremely critical to apply for tax exemptions/incentives that may be granted to investments in some specific regions/sectors/activities.
Turkey uses the option of fiscal incentives to channelize domestic and foreign investments for industrial development and rural-urban integration.
These incentives or tax expenditures are usually available to the investors for the promotion of private investment activities in selected sectors/regions depending on the scale of investment and in the following forms:
Investment incentive regime
■ Customs duty exemption
■ Value Added Tax (“VAT”) exemption
■ Reduced rate Corporate Income Taxes
■ Social Security Employer premium contribution
■ Interest support on the financing
■ Allocation of State Land
Incentives in distressed regions
■ Businesses initiated in certain distressed regions are granted certain tax incentives.
Research and development incentives
■ R&D allowance
― Income tax incentives
― Social security premium incentives
― Technological enterprise capital subsidy
― Stamp duty exemption
― Incentives for technology development zones
― Incentives for free trade zones
There are also certain corporate tax exemptions and incentives provided by Law (not limited with the below):
• Entities engaged in manufacturing activities in Free Trade Zones may be entitled to corporate tax exemption subject to certain conditions.
• Profits derived from new technology development activities in technoparks may be exempt from corporate tax.
• Companies engaged in R&D activities can enjoy a specific R&D incentive regime in Turkey, which also includes allowance for eligible R&D expenses from the corporate tax base.
Asset Purchase or Share Purchase
In case of acquiring a new company, the investor should decide on whether to acquire the assets of the Turkish company or its shares. Both alternatives have pro’s and con’s which needs to be evaluated in depth. For instance, the tax attributes (that is, tax losses and incentives) are not transferred to a buyer in an asset deal whereas they are transferred to the buyer in a share deal. On the other hand, share deals may require a tax due diligence review in Turkey as all known and unknown tax liabilities are inherited by the buyer.
The main advantages and disadvantages of asset/share acquisition is summarised below:
Choice of Acquisition Vehicle
i) Foreign Parent Company
The foreign purchaser may choose to make the acquisition itself, perhaps to shelter its own taxable profits with the financing costs. This will not cause any direct taxation problems in Turkey. However, Turkey charges withholding tax on interest and dividend payments to a foreign party; so, if relevant, an intermediate company resident in a more favourable treaty territory may be preferred.
ii) Local Holding Company
The form of a Turkey holding company is usually A.S. or Ltd. Company, or a specific holding company (as defined in the Turkish Commercial Code, which is a special type of an A.S. formed with the primary purpose of investing in other companies). There is no material taxation difference between these forms, but it should be noted that the special holding company is advantageous, because it has a higher dividend capacity than other forms.
Turkish corporate tax law also specifies a special holding company regime and related tax incentives for the purpose of holding the shares or foreign investments through a holding company in Turkey.
A Turkey holding company is not usually seen as an efficient alternative, because of the absence a tax grouping regime in Turkey, which means the acquisition costs and interest expenses at the level of holding company cannot be offset against the target’s profits. Although it is theoretically possible to achieve a deductibility of acquisition costs and interest expenses through a post-acquisition merger of the holding company into the target, such structures are under scrutiny by the Turkish tax authorities and have been challenged through the substance-over-form principle. Such structures should, therefore, be analysed carefully and professional advice should be sought on a case-by-case basis.
A Turkey holding company may be a tax-efficient option if the acquisition in Turkey is financed with equity, rather than debt, and the foreign investor intends to re-invest in Turkey. In this case, the Turkey holding company can receive dividends from the target entity without any tax leakages (that is, participation exemption rules), and may use the dividends received for re-investment in other Turkish businesses.
iii) Local Branch
It is possible for a foreign company to hold the shares of a Turkish target through a branch established in Turkey. In general, the branch (though regarded as a non-resident for tax purposes), is subject to tax rules similar to those applying to other company forms in terms of its Turkey income and transactions
However, in practice a branch is not seen as a favourable option because of the following:
- dividends paid from a Turkish target to the branch are not entitled to participation exemption;
- the remittance of profits as well as dividends from the branch to its foreign parent are subject to WHT; and
- it is an inflexible structure, because the branch cannot be legally transferred to a third party in a subsequent exit.
iv) Joint Ventures
A joint venture can be established in between a Turkish company and one or more local or foreign entities. If such a joint venture company is incorporated, it takes an ordinary legal form as discussed above (that is, A.S. or Ltd.) and is thus subject to same tax implications. An incorporated joint venture may be registered for tax purposes but it can only be used for specific contractual works and is not available as a holding company structure.
Choice of Acquisition Funding
A purchaser structuring an acquisition in Turkey will need to consider whether to fund the vehicle with debt or equity. Hybrid financing instruments are not recognized for tax purposes in Turkey, so it is usually necessary to follow the legal definition when classifying a financing structure as debt or equity, and to identify the respective tax implications.
The debt financing alternative should be evaluated in terms of thin capitalization and transfer pricing rules. Moreover, the indirect tax implications (banking taxes and/or reverse charge VAT) should be considered as well.
Transfer Pricing Regulations
Turkey introduced transfer pricing regulations to its Corporate Tax Law effective from 2007. They are generally in alignment with the OECD model. The regulations are applicable to both domestic and cross-border transactions between related parties, but a transfer pricing adjustment is not required for domestic transactions between Turkish tax-registered entities as long as there is no ultimate fiscal loss for the government.
The regulations require that prices, fees, and charges for inter-company transactions (including interest on intra-group financing) should be determined on an arm’s length basis, as determined by an acceptable methodology.
The Double Tax Treaty Network of Turkey
Turkey currently has Double Tax Treaties (DTT) with 80 countries including but not limited to; EU countries, CIS countries, Middle East countries, US, China and India.
Turkey is currently re-negotiation its old DTTs and renewing them with the aim to harmonise the DTTs within the EU countries.
The updated list of DTTs is on the Turkish Revenue Administration website at www.gib.gov.tr
The main benefit that can be derived through those DTT:
■ Elimination of double taxation of certain source of income (either through exemption or offset/ credit mechanism)
■ Elimination of capital gains tax upon sale of assets/shares in Turkey under certain conditions
■ Reduction of withholding tax on dividends (from local rate of 15% to DTT rate which can be minimum 5% in some DTTs)
■ Elimination of withholding tax on professional service fees if the services are principally performed off-shore
■ Reduction of withholding tax on royalty payments (from local rate of 20% to 10% in most of the DTTs)
How we can help you?
As KPMG Turkey, we can assist you at each step of the investment phase so that you may become confident that all considerations raised in our article have been evaluated by us and you are offered with the best appropriate options.
Tax Advisory, Director
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