Turkey: CIRCULAR Number 77 - Corporation Tax General Communique No. 54 Concerning The Li

Last Updated: 6 December 1996
Subject: Corporation Tax General Communique No. 54 concerning the limitation imposed on expenses applicable on the tax liables who valuate their year end inventories according to LIFO method, or who apply revaluation over their fixed assets.

In sub-paragraph 8 incorporated to Article 41 of Income Tax Law through Law No. 4008, it has been stipulated through a provision that a portion of the expenses and cost items that incur in connection with the borrowed funds used in enterprises that valuate their year end inventories according to the LIFO method, or that apply revaluation over their fixed assets under such names as interests, commissions, due date differences, profit shares paid to Islamic finance institutions, translation losses and other similar names, shall not be accepted as deductible expenses.

In Article 15/3 of the Corporation Tax Code, it has been stipulated that entities other than banks, insurance firms and finance institutions, will not be able to deduct the expenses that they have calculated within the framework of the principles referred to in the Income Tax Law, during the calculation of the taxable corporate profit.

The Ministry of Finance as the competent authority in the regulation of the procedures and principles governing this issue, has finally exercised the authority bestowed on itself, and has promulgated Corporation Tax General Communique No. 54 regulating the applicable principles, in the Official Gazette dated December 12, 1996.

According to the General Communique in question, the applicable principles governing the subject matter have been determined as follows :

A) Tax Liables Included Within the Scope of the Limitation Imposed on Expenses Relating to Borrowed Funds

1) Tax Liables Included Within the Scope

According to the Tax Procedures Code, the provisions of the Law in question shall gain applicability on the income tax and corporate tax liables who valuate their year end inventories according to Last In First Out (LIFO) method, or who apply revaluation over their depreciable fixed assets. The fulfilment of any of the above conditions shall be deemed as sufficient for the applicability of the limitation on expenses.

Meanwhile, tax liables who do not apply either of the two methods, in other words, who do not valuate their inventories on the basis of the LIFO method, and who do not apply revaluation over their depreciable fixed assets, will not become subject to any limitations .

2. Tax Liables Not Included Within the Scope of Limitation

a) The implementation of limitation on the expenses and cost items incurred over the borrowed funds used by manufacturers registered in the industry registry in their production activities, will be out of question.

In order to remain outside the scope of the expense limitation, the concerned tax liables are required to apply to the concerned Ministry for the receipt of an Industrial Registration Certificate, and SHOULD receive the certificate in question until the deadline specified for the filing of tax returns.

The expenses of those tax liables who are not registered in the industry registry incurred within the framework of this article SHALL NOT BE deducted, even if they are producers.

Meanwhile, provisions relating to expense limitation shall be applied on the expenses and cost items of the producers registered in the industry register relating to their activities other than their production activities.

b) The above provisions relating to expense limitation shall not be applicable for BANKS, INSURANCE FIRMS and FINANCE INSTITUTIONS that are corporation tax liables. Meanwhile, it has also been stipulated that the term Finance Institutions shall imply Private Finance Institutions established through receipt of special permission as the communiques issued by the Undersecretariat of Treasury, and Financing Firms and Factoring Firms as defined in Article 3 of the Law Concerning Money Lending Operations.

As could be marked from the above explanations, FINANCIAL LEASING COMPANIES and INTERMEDIARY INSTITUTIONS have not been included within the scope of exemptions. However, during our contacts with the officials of the Ministry of Finance, we have been informed that financial leasing companies could be considered to be included within the scope of the exemption.

However, we would also like to remark that we have not been able to understand why the financial leasing companies that have been included within the scope of exemption in the draft text of the communique has been omitted from this scope at the last moment. In our opinion, the legal arrangement that has been enacted in its present form, is erroneous.

B) Expenses and Cost Items Included in the Scope of Expense Limitation

According to the Communique, in documents that are drawn up by entities in connection with the borrowed funds they have utilized, all types of INTERESTS, COMMISSIONS, DUE DATE DIFFERENCES, PROFIT SHARES PAID TO THE ISLAMIC FINANCE INSTITUTIONS, TRANSLATION LOSSES, DISCOUNT CHARGES paid to factoring companies and all other expenses and cost items that have incurred depending on the period of utilization of the borrowed funds, will become subject to expense limitation, disregarding whether or not they have been separately disclosed.

However, it was also indicated that other expenses and cost items such as Banking and Insurance Transactions Tax and Stamp Duties paid on the occasion of loan agreements that do not depend on the period of utilization of the borrowed funds in the entity shall not become subject to limitations imposed on expenses.

Whereas, it is also obvious that the BITT reflected on the entities using borrowed funds, are treated as financial expenses by such entities. Hence, it is assumed that this issue has probably been overlooked during the preparation of the communique, and a legal arrangement has been thus formulated to the benefit of the tax liables.

In cases when the financial expenses incurred on behalf of the entities are not disclosed on the documents that have been drawn up, the amount of the financial expense in question should be calculated by taking as basis the interest rate implemented during the application of rediscount on notes receivable and payable, determined by the Turkish Central Bank, and currently applied as 57%.

In cases when the financial expenses incurred on behalf of entities in connection with the borrowed funds are not disclosed on the documents that are drawn up during the application of limitation on expenses, the expenses and cost items relating to borrowed funds shall not be differentiated from the transactions that have a due date of a maximum period of one month as of the date of invoice or the concerned document, and thus, shall not be evaluated within the framework of expense limitation.

Whereas, in cases when expense or cost items relating to borrowed funds are disclosed on the documents that have been drawn up, expense limitation shall be applied, disregarding the due date period.

However, remaining confined to the expenses incurred in 1996, the Ministry of Finance has declared that the financial expenses incurred over borrowed funds that are not disclosed separately on the documents drawn up, will be allowed to be exempted from the expense limitation.

In the said Communique, it has been stipulated that the expenses and cost items incurred over the borrowed funds utilized by manufacturers registered in the industry registry in their production activities, shall be included within the scope of expense limitation, and a reference has been made to the Tax Procedures Code that regulate the items that are included within the cost of the manufactured item.

According to the above provision, the cost items relating to the borrowed funds (liabilities) that are required to be included within the cost of the manufactured merchandise, shall not be included within the scope of expense limitation. However, according to Article 275, the taxpayer shall be free to assign a share from the general administrative expenses to the cost of the finished product, or record these general expenses directly as expense.

In the event that the manufacturer chooses not to assign any share to the cost of merchandise and exercises his right to record such expenditures directly as expense, the portion that is expense recorded shall be included within the scope of expense limitation.

Accordingly, the status of firms that are manufacturers and that are non-manufacturers (or that do not own Industry Registry Certificate) against the expense limitation application, will be as follows :

Manufacturers that own Industry Registry Certificates shall not become subject to expense limitation, in cases when they include their financial expenses that incur until the date on which the merchandise are recorded in the inventories, within the cost. However, if they chose to record such financial expenses directly as expense, such financial expenses shall be included within the scope of expense limitation.

Meanwhile, all financial expenses of the non-manufacturer firms shall be included within the scope of expense limitation, disregarding whether or not the carry forward of such expenses to the cost of the merchandise is obligatory.

As could be marked, there will be no discrimination even in cases when it is clearly indicated that the financial expenses are relevant to the production process , and the only focus will be on whether or not the financial expenses have been carried to the cost of the merchandise.

In the communique, it has been stipulated that in cases when the optional financial expenses are chosen to be recorded directly as expense, they will be valuated as general administrative expenses instead of cost items. Accordingly, if the taxpayers wish to assign shares to the cost of the merchandise from the financial expenses, they will assign shares not only from the financial expenses, but also from the general administrative expenses as a whole. However, it becomes evident that such an application will be in contrariety with Article 275 of the Tax Procedures Code, as well as with Communique Series No. 238 issued after the same Law. Since, the distribution of a given expense among the cost of the merchandise should not be considered as an factor that would modify the nature of the expense incurred. Whereas, according to the communique, financial expenses shall be deemed to have become general administrative expenses, if they are not reflected to the cost of the merchandise.

Consequently, in order to avoid the financial expenses to become included within the scope of non-deductible expenses, such expenses, as well as all the general administrative expenses will be, by obligation distributed to the cost of merchandise instead of recording them as expense directly. This in turn, will obviously reduce the advantages to be derived from the LIFO method and revaluation to a great extent.

Meanwhile, the amounts to be added to the cost of investment shall remain outside the scope of the expense limitation. In the Communique, it has been clearly indicated that the term investment as used in the law shall imply the investments concerning all types of depreciable fixed assets (whether or not they are supported by incentive certificates) and a reference has been made to Article 262 of the Tax Procedures Code for the determination of the cost of investments. According to the relevant general communiques concerning this article, expenses and cost items incurred over borrowed funds that have been added to cost mandatorily or upon the choice of the taxpayer, shall not become subject to expense limitation, whereas, the costs relating to borrowed funds that have been recorded as expense directly as of the birth of the optional right, in other words, as of the period following the period of capitalization of the fixed asset, shall become subject to expense limitation.

Meanwhile, in Article 41/8 of the Income Tax Law wherein the relevant provision has been stipulated that 25% of the portion to be calculated through the application of the following rate of deduction on the total expenses and cost items, shall be treated as non-deductible expense.

According to the information received from the concerned authorities, the rate of discount shall be determined through the division of the rate of revaluation to the average commercial loan interest rate to be determined by the Ministry of Finance for that year.

Hence, the non-deductible expense (NDE) total shall be calculated based on the following formula;

NDE = Financial Expenses x Rate of Revaluation x 25%
      ----------------------------------------------
         Average Commercial Loan Interest Rate

Of the items shown in the formula, although the rate of revaluation has been quoted as 72.8%, the average commercial interest that has not been announced yet. Therefore, it will be necessary to wait for the announcement of the average commercial interest rate for the calculation of the financial burden to occur as the result of this new rule.

Although a communique has been issued regarding this matter, a number of uncertainties nevertheless exist. For example, whether the LIFO method will be applied periodically or perpetually, or whether tax base advantage to be derived from LIFO will be merely shown on the declaration without any revisions in legal books, are still not very clear.

As it is known, according to Article 30/d of the Value Added Tax Law, the value-added tax paid for expenditures that are not deductible in the determination of profit as specified in the income and corporation tax codes are disallowable for VAT deduction.

Therefore, if there are any value added taxes incurred over financial expenses that have been previously deducted, but that considered as non-deductible expense items, such taxes should be written off and recorded as Non-Deductible Expenses.

However, in order to avoid any probable conflicts, it will be necessary to wait for a ruling by the Ministry of Finance concerning these transactions.

C) Explanations Regarding Taxpayers Whose Special Account Period Ending in 1996

1. For entities having special account period ended in 1996, the rate of discount shall be calculated through the division of the rate of revaluation for 1995 which is 99.5% by the annual commercial loan interest rate determined for the same period as 116%, which is (99.5 / 116 =) 85.7%.

Hence, for a financial expense of 100, the Non-Deductible Expense subject to expense limitation will be calculated as :

100 x 85.7% x 25% = TL 21,425.

In other words, 21.425% of the financial expenses shall be taken up as Non-Deductible Expense.

2. Taxpayers whose special account period end in 1996, will be allowed to deduct all of the expenses and cost items that have incurred prior to 01.01.1996, and 21.425% of the cost items and expenses incurred after 01.01.1996 shall be treated as Non-Deductible Expense. Here, the important issue for the applicability of expense limitation is not the year of acquisition of the borrowed funds, but the fact that the expense limitation becomes in question if the expense or cost item is incurred after 01.01.1996.

3. Taxpayers who apply special account periods and who submit tax returns prior to December 6, 1996, shall be required to re-prepare their tax returns within the framework of the above explanations until January 6, 1996, and submit them to the concerned tax office in accordance with the revision provisions stipulated in the Tax Procedures Code. Penalties and delay surcharges shall not become applicable on the tax and fund impositions to be made on the revision declarations.

To summarize, it is clearly evident that the expense limitation application regulated through Corporate Tax Communique No. 54 issued in an effort to regulate an issue that is both unfair and unjust, and that explicitly contradicts the principle of jurisprudence in taxation as a structure, presently contains a great number of uncertainties.

Therefore, we would like remind you once again that you will be welcome to consult our tax managers for any problem which might occur until the relevant clarifications are introduced by the Ministry.

Please do not hesitate to contact us, should additional information be required regarding the issues covered herein.

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.

For further information contact Mustafa Camlica, Tax Manager on tel: +90 212 232 1210, fax: +90 212 230 8231, or e-mail mustafa.camlica@arthurandersen.com or enter a text search 'Arthur Andersen' and 'Business Monitor'.

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