Turkey: Articles 23/4 And 22/1/D Of The Turkey/Italy And Turkey/Spain Prevention Of Double Taxation Treaties And Their Impact On Cross-Border Transactions

Last Updated: 14 June 2011
Article by Ali Sanver

The analysis below addresses the issue of whether Articles 23/4 and 22/1/d of the Turkey/Italy and Turkey/Spain prevention of double taxation treaties offer a unique opportunity for cross-border financial structuring in relation to dividends, royalties and interest income. For the reasons set forth below, this author believes that the deemed (notional) foreign tax credit available under the Spain/Turkey and Italy/Turkey tax treaties may offer additional benefits in relation to cross-border lending and investments in debt and equity issues, provided that local tax offices can be convinced to apply the international tax treaty provisions.

OECD Model Treaty and Tax Convention Recommendations

Article 23A(2) of the 2003 OECD Model Treaty recommends the "ordinary credit"1 method for passive income from dividends (Article 10) and interest (Article 11).2 Article 23B of the OECD Model Tax Convention follows the views of the United States and the United Kingdom and recommends, in general, the use of the "ordinary credit" method for countries wanting to apply the credit system to all types of foreign income, both active and passive.3

Is the Position in the OECD Model Tax Convention Clearer?

It is remarkable that Article 23A(2) of the OECD Model Tax Convention4 does not specifically adopt the tax credit method recommended in paragraph 12 of the 2003 Commentary. Article 23 introduces, in general, methods for the elimination of double taxation and proposes two options: the tax exemption5method (Article 23A) and the tax credit6 method (Article 23B). However, within Article 23A a second paragraph has been added, exclusively prescribing the tax credit method for dividends (Article 10) and interest (Article 11).

Treaties between Turkey and most countries comply, in general, with the OECD Model Tax Convention by promulgating the application of the ordinary tax credit method on interest (see e.g., Article 23/(1) and (2) of the French Treaty, Article 23/(1) and (3) of the UK Treaty, Article 23/(1/b/ii) and (2/c) of the Dutch Treaty, Article 23/2/b of the Luxembourg Treaty, Article 23/(2) and (3) of the Italian Treaty, Article 22/1/a of the Spanish Treaty, and Article 23/(1) and (2) of the US Treaty).

For dividends, on the other hand, a number of treaties do not comply with Article 23A/2nd paragraph of the OECD Model Tax Convention and instead dictate the application of the tax exemption method (see e.g., Article 22/1/b of the Spanish Treaty, Article 23/1/c of the Portuguese Treaty, and Article 23/(1/a) and (2/b) of the Dutch Treaty).

Deemed Tax Credit under the Italian Treaty

Under the Italian Treaty, the income receiving party is entitled to a 15% foreign tax credit ("FTC") on interest and dividend income and a 10% tax credit on royalty income in his/her State of Residence (Italy) as if he/she has been taxed at these rates on such income in the State of Source (the "Deemed FTC"), provided that the interest, dividend or royalty income is exempt from taxation or is subject to a reduced rate in the State of Source, pursuant to Article 23/(4)/b-d of the Turkey/Italy Tax Treaty (promulgated by the Official Gazette numbered 21693 dated September 9, 1993) (the "Italian Treaty"). The Deemed FTC, under the Italian Treaty, is reciprocal.

Deemed Tax Credit under the Spanish Treaty

Under the Spanish treaty, the income receiving party is entitled to a 10% or 15% tax credit on interest,7 a 15% tax credit on dividend and 10% tax credit on royalty income in his/her State of Residence (Spain) as if he/she has been taxed at these rates on such income in the State of Source (Turkey), provided that the interest, dividend or royalty income is exempt from taxation or is subject to a reduced rate in Spain, pursuant to Article 22/(d)/i-iv of the Turkey/Spain Tax Treaty (promulgated by the Official Gazette numbered 25320 dated December 12, 20033) (the "Spanish Treaty"). The Deemed FTC, under the Spanish Treaty, is not reciprocal and is only available to residents of Spain (see Article 22/2 of the Spanish Treaty).

Turkish (Domestic) Law Taxation

Interest income derived by non-resident investors from private debt issues (debentures)8 issued after January 1, 2006 is subject to a zero rate tax under domestic Turkish tax law until December 12, 2015 (see temporary Article 67/(1)/b-c, (13) and (19) of Income Tax Code No. 193) (as amended by Law No. 5527 promulgated by Official Gazette dated July 7, 2006 numbered 26221).9 Likewise, interest income derived by non-resident investors from public debt issues (Turkish T-bills and government bonds)10 after January 1, 2006 is subject to a zero rate tax under domestic Turkish tax law (see Article 1/4a of Decree No. 2009/14593) (promulgated by Official Gazette dated February 3, 2009 numbered 27130). Similarly, interest collected by non-resident (and duly licensed) financial institutions on their cross-border lending to Turkey residents is subject to a zero rate withholding tax (see Article 1/5a of Decree No. 2009/14593).

Dividends received on Turkish equity by non-resident investors are, on the other hand, not covered by the zero rate under domestic Turkish law (see temporary Article 67/(1)/6th paragraph of Law No. 193) and are subject to a 15% withholding tax under domestic Turkish tax law (see Article 30 of Corporations Tax Law No. 5520 and Article 1/(12) of Decree No. 2009/14593). However, the 15% rate is reduced to 5% under the Spanish Treaty for Spain-resident corporate shareholders11 holding 25% or more share capital in the Turkey-resident company (see Article 10/2/a/(i) of the Spanish Treaty), which becomes the effective Turkish tax law rate for such shareholders. No reduced rate is available under the Italian Treaty (see Article 10 of the Italian Treaty).

Royalties received by non-residents from Turkey-resident counter parties are, in general, subject to a withholding tax rate of 20% (pursuant to Article 1/11 of Decree No. 2009/14593). A reduced rate of 10% is available under both the Italian and Spanish Treaties (see Article 12 of the Spanish Treaty and Article 12 of the Italian Treaty) but such rate is not lower than the Deemed FTC.

Tax Planning Opportunities under the Italian Treaty

An Italy-resident investor investing in fixed income securities in Turkey can claim a 15% Deemed FTC in Italy, resulting in a full 15% benefit since, as explained above, he/she is subject to a zero rate withholding tax in Turkey on the underlying interest income. In the same vein, an Italy-resident financial institution enjoys the full 15% benefit on its cross-border lending to Turkey residents.

Any dividends received by an Italy-resident investor from his/her equity investments in Turkey do not benefit as a reduced rate is not available under the Italian Treaty. Thus, the applicable domestic rate of 15% washes the 15% Deemed FTC.

Similarly, royalties do not benefit as the Deemed FTC of 10% equals the applicable withholding tax rate of 10% (as reduced by Article 12 of the Italian Treaty).

Reciprocity applies to the Deemed FTC under the Italian Treaty. Therefore, depending on and to the extent Italian domestic law grants any exemptions or reduced rates, Turkey residents investing in Italy can benefit from the Deemed FTC.

Tax Planning Opportunities under the Spanish Treaty

A Spain-resident investor investing in fixed income securities in Turkey is also in a position to claim a 15% Deemed FTC in Spain, which results in a full 15% benefit since, as explained above, he/she is subject to a zero rate withholding tax in Turkey on the underlying interest income. A Spain-resident financial institution enjoys a 10% benefit on any of its cross-border lending to Turkey residents as the Deemed FTC under the Spanish Treaty on bank lending is only 10%.12

Any dividends received by a Spain-resident investor from his/her equity investments in Turkey benefit as a reduced rate of 5% is available under the Spanish Treaty and a spread of 10% (the difference between the 15% Deemed FTC and 5% reduced withholding tax rate on Turkish dividends) is available.

Similar to the Italian Treaty, royalties do not benefit as the Deemed FTC of 10% equals the applicable domestic withholding tax rate of 10% (as reduced by Article 12 of the Spanish Treaty).

Since Turkey does not recognize any Deemed FTC under the Spanish Treaty, Turkey residents investing in Spain are unable to derive any of the aforementioned benefits.

Implementation of Deemed FTC

Under Turkish tax law and practice, any type of foreign tax credit is only accepted by Turkish tax offices if verifying documentation, duly issued by the related foreign country's tax authority and ratified by the incumbent Turkish Consulate, can be presented at the time of the filing of the related tax return (pursuant to Article 33/(6) of Turkish Corporations Income Tax Act). The practitioner, however, should be ready to face significant difficulty in obtaining such verifying documentation for the Deemed FTC, which rests on a withholding tax that is notional. Furthermore, in our Firm's experience, it takes years of struggle with local tax offices until they are convinced to apply even much simpler treaty benefits. Finally, considering case law is yet to develop in relation to Deemed FTCs, Turkey-resident investors should seek an affirmative opinion (ruling) of the Turkish Revenue prior to their making use of any benefits in relation to the Deemed FTC.

By the same token, Spain- or Italy-resident investors must seek Spanish and Italian tax experts' advice and eventually affirmative rulings by the Spanish or Italian tax authorities before they make use of Deemed FTCs.


1. State of Residence allows the deduction of the total amount of tax paid in the other State ("full credit") or the deduction by the State of Residence is restricted to the amount of its own tax which would apply to the underlying income taxed in the other State ("ordinary credit") – please refer to Article 23B(2) of Commentary on OECD Model Tax Convention © OECD 2008.

2. ©OECD January 28, 2003.

3In support of this view, see Dick Molenaar (2005), on p. 178.

4. In this respect, see also Dick Molenaar (2005), at 241-242.

5. Income that may be taxed in the State of Source or Permanent Establishment is not taken into account by the State of Residence at all ("full exemption") or only when determining the tax to be imposed on the rest of the income ("exemption with progression") – please refer to Article 23B(1) of Commentary on OECD Model Tax Convention © OECD 2008.

6. See footnote (1) above for the definition and different levels of tax credit.

7. The rate of the Deemed Tax Credit would be 10% on interest income in relation to bank lending or (commercial) trade account balances (see Article 22/1d/ii and Article 11/2a of the Spanish Treaty) but 15% on any other type of interest income, e.g., income in relation to fixed income securities (see Article 22/1d/iii and Article 11/2b of the Spanish Treaty).

8. In general, Temporary Article 67/(13) defines these debentures as securities isssued in Turkey and listed as such with the Turkish Capital Markets Board.

9. Please note, in this respect, the Constitutional Court has decided to cancel such zero rate withholding tax applied by Temporary Article 67/(1) of the Income Tax Law (No. 193) to non-resident investors trading in Turkish securities on the basis of unequitability with resident investors who are subject to a 10% withholding tax rate. The cancellation of the zero rate withholding tax will become effective on October 8, 2010, by the end of the 9th month starting from the publication of the Court's decision in the Official Gazette on January 8, 2010 (see the Official Gazette dated January 8, 2010 numbered 27456). In the meantime, the Turkish Inland Revenue has already started testing public opinion by spreading rumours regarding a single withholding tax rate of between 1.5% and 3% for both resident and non-resident investors in relation to their (non-dividend) income under Temporary Article 67/(1) of Law No. 193 (we further quote the Minister of Finance informing reporters that they intend to promulgate the rate to replace the zero rate soon so that investors can plan for the period after the expiry of the zero rate on October 8, 2010). The 1.5% to 3% domestic rate, if the expectations hold and such rate enters into effect, would still facilitate a significant spread of 12% to 13.5% with the Deemed FTC of 15% on interest income derived from Turkish private debt issues by Spain and Italy resident investors under the Spanish and Italian Treaties. Please note that the benefit of 15% in relation to interest derived from public debt issues and cross-border lending would not be affected by the aforementioned resolution of the Constitutional Court since such resolution only cancels the Temporary Article 67/(1) of Income Tax Law No. 193 pertaining to Turkish private debt issues (as defined in footnote 8 above).

10. Save for Eurobonds (Temp Article 67/(1)/6th paragraph), which are not subject to taxation in Turkey, and therefore, do not produce an FTC.

11. Excluding (non-incorporated) partnerships.

12. Please refer to Footnote (7) above.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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