According to Article 1 and 2 of the Corporate Income Tax Code (CIT Code) (Law No. 5520) (published in the Official Gazette dated June 21 2006, No. 26205), corporations are among the corporate income tax taxpayers, and both the funds established in Turkey (the Turkish funds) and the funds established in other jurisdictions (the foreign funds), which resemble to the Turkish funds subject to the regulation and supervision of the Capital Market Board, are deemed as corporation in the scope of the CIT Code. Therefore, the income of the Turkish funds and the ones of foreign funds derived in Turkey are subject to corporate income tax. However, until June 15 2012, the taxation of the Turkish funds and the foreign funds are differentiated by only providing exemptions to the Turkish funds. According to Article 5/1- d of the CIT Code, the income of the below stated Turkish funds are exempt from corporate income tax with a number of conditions:
- The securities investment funds;
- The investment funds of which the portfolio is comprised of the gold and precious metals which are treated in the market incorporated in Turkey;
- The venture capital funds;
- The real estate investment funds;
- Pension mutual funds;
- Housing financing funds; and
- Asset financing funds
However, such differentiation was resolved by adding Article 5/A to the CIT Code, entitled The Taxation of the Income of the Foreign Funds with Article 35 of the Law No.6322 (published in the Official Gazette dated June 15 2012, No. 28324) to stimulate the portfolio management companies, managing the foreign funds, to open offices and manage the foreign funds in Turkey, within the scope of the Istanbul International Financial Center Project. In general, it is stated that foreign funds do not declare the income derived from the specified sources and therefore do not subject to corporate income tax. It is also stated that the income derived by the portfolio management companies due to its shareholding interest in the foreign funds is exempt from corporate income tax. The details of the taxation status of foreign funds and portfolio management companies are explained below.
Taxation of the income of the foreign funds
According to Article 5/A-1 of the CIT Code, providing that certain conditions, which will be explained below, are met, the income, derived from:
- All kinds of securities and capital market instruments regardless of whether those are traded in an organized stock market;
- Foreign exchange;
- Commodities derivatives;
- Loans and similar financial assets; and
- Commodity transactions in precious metals stock markets.
by foreign funds with the mediation of resident portfolio management companies which are duly obtained portfolio management certificate from the Capital Market Board, shall not be declared to the tax office. On the other hand, portfolio management companies shall not be treated as permanent representatives of the foreign funds, and the place of businesses of the portfolio management companies shall not be treated as the ones of the foreign funds. If a tax return is submitted because of income derived from other sources, the income derived from the above transactions shall not be included in the tax return. With the referred regulation, it is prevented to levy corporate income tax within the scope of permanent establishment regulations both under the local and international law.
To benefit from the above stated exemption;
- The transactions made on behalf of the foreign fund shall be among the regular activities of the portfolio management companies.
- The portfolio management company, through which the income shall be derived by the foreign funds, shall be resident taxpayers in Turkey.
- In consideration of the commercial, legal and financial aspects of the portfolio management companies, the relationship between the portfolio management company and the foreign fund shall be similar to the one between independent third parties who are acted based on arm's-length principle.
- The portfolio management company shall be paid for its services based on arm's-length principle.
- The transfer pricing report shall be submitted to the Revenue Administration of the Ministry of Finance within the period in which the corporate income tax return shall be submitted.
- The portfolio management company and its related parties shall not directly or indirectly have the right to more than 20% on the income of the foreign funds, after deducting the fees received for the services. The Council of Ministers has the authority to reduce the above stated rate down to 0% or to increase it up to 40%.
If the transfer pricing report, stated above under as the condition 4, is not submitted in its legal period, the portfolio management company will be deemed as the permanent establishment of the foreign fund in Turkey for the financial year for which the transfer pricing report shall be submitted. Even though the transfer pricing report is submitted in its legal period, if the portfolio management company receives lower fees considering the arm's-
length prices, only the fees which are lower than the arm's-length price shall be criticised in terms of transfer pricing regulation, and such criticism will not breach the exemption conditions.
According to Article 5/A-5 of the CIT Code, the income derived by the foreign funds through the immovable properties in Turkey, the share certificates or shareholding interest of the corporations of which more than 51% of the assets are composed of immovable properties, or the derivative contracts in relation to the above, commodities derivatives other than the ones resulting with the cash settlement, insurance contracts and the derivate agreements in relation to the insurance contracts are not in the scope of Article 5/A of the CIT Code. Therefore, the income derived by the foreign funds from the above stated sources shall not benefit from the corporate income tax exemption provided under Article 5/A of the CIT Code. The Council of Ministers has the authority to reduce the above stated rate down to 25,5% or to increase it up to 76.5%.
It is also stated under Article 5/A of the CIT Code that the exemption provided to the foreign funds does not have any effect on the application of the withholding taxes. Therefore, depending on the nature of the payment to be made by the Turkey resident taxpayers to the foreign funds shall be subject to withholding tax according to Article 30 of the CIT Code and Provisional Article 67 of the Income Tax Code (Law No.193) (published in the Official Gazette dated January 6, 1961, No. 10700).
Participation exemption to be applied on the income received by the portfolio management companies from foreign funds
As it is stated above, in addition to the tax exemption provided to the foreign funds, a kind of participation exemption is provided for the income of the portfolio management companies in return for their investments to the foreign funds, providing that the above stated conditions, which are listed for the corporate income tax exemption of the foreign funds, are met.
In the calculation of the share of the portfolio management company received from the income of the foreign fund, the payments made by the foreign fund to the portfolio management company in return for the services, such as; management fees, incentives, premiums, performance fees are not regarded. However, if the portfolio management company directly or indirectly has the right to more than 20% on the income of the foreign funds, all of the income share of the portfolio management company received from the income of the foreign fund shall be subject to corporate income tax. Therefore, if the right of the portfolio management company on the income of the foreign fund is more than 20%, than portfolio management company shall not met the condition five stated above and cannot benefit from the corporate income tax exemption. Since the condition in relation to the 20% ratio is actually related to the exemption provided for foreign funds, the absence of such condition shall also breach the corporate income tax exemption provided for the foreign funds, as well.
The portfolio management companies should provide the Revenue Administration of the Ministry of Finance with the information of all resident taxpayers, both individuals and corporations, which are either founders or participants of the foreign fund if their income share directly or indirectly exceeds 5% of the foreign fund. The Council of Ministers has the authority to reduce the above stated rate down to 0% or to increase it up to 10%. If the above stated notification obligation is not completely fulfilled by the portfolio management company, it will be jointly and severally liable for the taxes, fines and penalties that will be assessed, in relation to the foreign fund's transactions, for the name of the resident taxpayers, both individuals and corporations, which are either founders or participants of the foreign fund.
As it is stated above in the relevant sections, the Council of Ministers is also authorised to change the above stated ratios under Article 5/A of the CIT Code, but the Council of Ministers has not used its authority so far. Therefore, all of the above stated rates are currently in force.
This article was first published in International Tax Review.