Author: Aslı ÇAĞLAR
Apart from loan contracts designated for financial entities, Articles 306 – 312 of the Turkish Code of Obligations (TCO) define money lending contracts (individual loan contracts). Although seemingly unpopular, the contract type for money lending becomes center of attention for shareholder and inter-company loans since that is their only legal ground when inspected thoroughly.
Under general conception, money lending business is specifically reserved for banks and financial institutions that are regulated and licensed. However individuals and companies other than banks could also benefit from loan or money lending contracts as well. The question then becomes how?
Lending by Companies
Basically the main components of the loan contract are: the creditor, the borrower, the loan and the terms of repayment including due date and interest. However this does not mean that any company may loan money to another under freely designated terms containing such components.
It is disputed in legal community whether companies may provide loans to other companies and/or individuals (most of the times their shareholders), however technically and in a very limited manner and for limited number of times which should not seemingly convert the field of activity of such company into money lending business which is regulated and licensed, they can.
There shall always be a fair interest rate and the company management authorizing such a money loan is responsible to its shareholders and to third parties based on their expectations over the loss of capital subject to their credits. Therefore the management is better off by asking for collateral as well. Since the money loaned will have to remain in company books under assets and any interest obtained or lost is subject to taxation companies do not often enter into such arrangements where they become creditors.
Companies with Foreign Investors
There is an exception to such unclear and burdensome creditor status for companies. The companies with foreign investments are allowed to lend money under a special regime provided by the 12th section of the 11th Article titled 'Loans' of a new directive dated February 28, 2008 based on the Council of Ministers' Decision No.32 on the Protection of Turkish Currency.
This section of the Directive states, "Residents of Turkey can provide loans to companies abroad that they are shareholders to, to their parent or group companies abroad in Turkish currency or any other currency".
Therefore according to aforementioned regulation, Turkish capital companies may give credit to their group companies as long as the interest is appropriate and the income is announced. Group company definition is absent in Turkish law therefore organic shareholding relation will be sought for to prove such affiliation.
In addition there is no legal obstacle in Turkish legislation forbidding the use of company funds abroad for deposits or other type of investments. This kind of a practice is used in practice for collateral for company loans abroad. Technically it is not a back to back loan arrangement but naturally the arrangement looks similar. The issue that shall be carefully considered in such a situation is the depreciation of the amount of taxation of the interest revenues paid incurring from such funds at its source from the corporate taxation that they will be subjected to here in Turkey (based on the double taxation treaties of Turkey with the country of origin of the foreign deposit holder).
Other than bank type financing, companies often use financing from their own shareholders (shareholder loans). There are many reasons for such common practice: credibility or cost efficiency problems for regular financing in Turkey, transactional swiftness compared with capital increase, availability of interest returns etc.
In case the capital is not sufficient, shareholders' running accounts are used for the expenses. But shareholders do not have the initiative for lending their money without interest therefore there are interest rates to be considered.
In addition and along with the globalization tax systems companies confront with new cases. Multinational companies profit the most from globalization and reduce countries' tax incomes, maximize their company's incomes and minimize its' outlays. The main ways to achieve those is to transfer the earnings from countries with high taxes to ones with lower taxes by shareholder loans and transfer pricing.
The problem lies here where it should be determined if a shareholder loan is simply for the good-will expense coverage or is it for tax evasion (disguised capital).
Problem of Disguised Capital
The notion "Disguised Capital" takes place within the Corporate Tax mechanism. The logic of the disguised capital is to provide fund to the corporation, especially to stock companies, such as limited liability, joint stock companies by entities with whom the company is in a close economic and legal relationship.
The loans are deemed as capital investments under disguised capital determinations. In this respect, the interest that the company paid for debt allowance is not accepted as an expense and is therefore taxed. Since, in fact, the sum of money paid to the loaning shareholder is a profit maker it is also taxed.
The Turkish Corporate Tax Law - Article 12 defines disguised capital through the application of three criteria: 1) the loan must be received from a direct or indirect related entity, 2) it should be used for administrative or other expenses of the company and 3) the debt (loan) must surpass the triple of the equity capital at the beginning of that accounting period. Simply the tax code applies a threshold and only allows loans from shareholders up to three times of the company capital.
As an outcome the capital companies such as limited liability or joint stock companies shall not record the disbursements attributed to the disguised gain that they have spent as expenditures during the tax assessments if disguised capital determinations are made. In other words, recording the disguised gain as expense shall not corrupt (decrease) corporations' tax assessments.
The secondary outcome is for the loan provider shareholders' gains subject to the loan interest. Subject to the limits announced by the Tax Administration such 'capital gains' are to be taxed via VAT and income or corporate tax depending on the identity type of the creditor.
Accordingly it is highly advised by the author to companies and shareholders willing to enter into lending and loan contracts among themselves to obtain tax and legal advice before proceeding since under Turkish laws not many definitions and understandings are similar with the common practices abroad.
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.