Turkey: A New Era In Taxation Of Capital Reduction

ABSTRACT

Article 32/B titled "Taxation in Reduction" has been added to the Corporate Income Tax Code No. 5520 ("CITC"), in line with Code No. 7420 on the Amendment of the Income Tax and Some Codes and Decree Codes ("Code No. 7420") published in the Official Gazette dated 9 November 2022 and No. 32008. The Ministry of Treasury and Finance has incorporated this regulation in Corporate Tax General Communiqué Serial No. 21 on Amending the Corporate Tax General Communiqué ("Communiqué").

INTRODUCTION

The realization of the capital reduction is regulated within Article 473 and other articles of the Turkish Commercial Code No. 6102 ("TCC"). Moreover, significant changes have been brought to tax legislation with Article 32/B titled "Taxation in Capital Reduction" added to the CITC.

However, the aforementioned Article lacks sufficient clarity on how taxpayers will be taxed in various scenarios. In the face of this, which was frequently mentioned in the commission meetings when Code No. 7420 was being evaluated, the Department of Revenue Administration stated that the necessary arrangements would be made with the Communiqué in order to resolve the conflict. Communiqué also seeks to clarify the amendment regarding the taxation of capital reduction.

The capital increase can be made from various sources. These sources can be shown in the capital clause of the Articles of Association. The amendments to the Articles of Association were published in the Turkish Trade Registry Gazette after it had been submitted to the authorized trade registry office. Thus, companies can increase capital from any source, which will be announced in the Turkish Trade Registry Gazette.

In this respect, there were different opinions regarding the taxation of capital reduction since there was a gap in regulation about the source of such reduction.

I. SITUATION PRIOR TO THE AMENDMENT IN THE TAXATION OF CAPITAL REDUCTION

Before Code No. 7420 was introduced, there had been no special regulation on the taxation of capital reduction in the Turkish tax legislation. Therefore, taxation of capital reduction was one of the most controversial issues between the Tax Administration and taxpayers. As a matter of fact, the approach of the Tax Administration on the subject was to accept that the reduced capital would primarily consist of elements subject to taxation, examples of which are given in the following sections of our article. According to this approach, the amount reduced in the capital reduction was primarily met from the accounts that would be subject to corporate tax and profit distribution tax deductions, then from the accounts that would only be subject to withholding tax based on profit distribution, and finally, it was withdrawn from the capital in kind and in cash, which would not be taxed if it was withdrawn from the company.

As can be seen from the advance rulings given above, the opinion of the Administration is that the reduction is made primarily from the sources that can be taxed. In this direction, the taxpayer is not given any freedom regarding the source from which the reduction shall be made. Contrary to the advance rulings, the Council of State has made decisions in favour of taxpayers against this unlawful approach.

In the decision of the 3rd Chamber of the Council of State, dated 26.09.2022 and numbered E.2019/2393, K.2022/3333, it is stated that taxation by the Tax Administration without a legal regulation is unlawful for the following reasons;

II. SITUATION AFTER THE REGULATION WAS IMPLEMENTED BY CORPORATE TAX LAW NUMBER 7420

With Article 32/B added to the Corporate Tax Law, the items that are subject to capital reduction shall be handled according to the date of their addition to the capital. The item from which the reduction is to be made shall change depending on whether 5 full years have passed from the date of addition to the capital. In other words, if all of the equities added to the capital were included in the capital for 5 full years from the date of addition until the date of capital reduction, the amounts of the elements listed in the law article are to be reduced by the proportioning method. In the Communiqué the following calculation was given as an example; the taxation of the 400,000 TL reduction to be made in the capital consisting of 600,000 TL cash, 300,000 TL inflation adjustment positive differences and 100,000 TL retained earnings are calculated in the table below:

"(*) It is assumed that the corporate tax rate in 2023 stays at 20%.

(**) It is assumed that the tax withholding rate based on profit distribution in 2023 stays at 10% and that the partners are natural persons."

According to the Communiqué, if equity items added to the capital have not completed 5 full years from the date of addition on the capital reduction, the reduction shall be made from the items listed below respectively;

1. Equity items that will be subject to corporate tax and tax withholding depending on the amount transferred to another account other than capital addition, withdrawal from the business or transfer from the capital account to other accounts, and
2. Equity items that will be subject to tax withholding based only on the amount transferred to the profit distribution/headquarters
3. are transferred to another account or withdrawn from the enterprise, it shall be accepted that they are made of capital in kind and cash, which shall not be taxed, and taxation shall be made accordingly.

With this regulation, the implementation of the Administration has gained its legal basis in terms of equity items that have not been completed 5 full years, and it is accepted that among the items that shall be subject to reduction, those that are subject to the most taxation shall be withdrawn from the capital.

However, if the amount of the reduction is more than the amount of equity that have not been completed 5 full years from the date of addition to the capital, then it shall be accepted that the reduction shall be made primarily from these resources. Then, in determining the remaining reduction amount, the reduction shall be made by using the ratio method introduced with article 32/B and taxation shall be realized over this ratio.

In the event that some of the equity elements are held for more than 5 full years and some of them for a short period of time, it shall be assumed that the reduction is made primarily from the elements that do not complete 5 full years, and then from those that have completed 5 full years.

Other matters explained in the Communiqué can be summarized as follows:

• Since there is no payment made to the partners in the event of a capital reduction by deducting the previous year's losses, there shall be no tax withholding, but if there are elements that may be subject to corporate tax during this reduction, taxation shall be in question as explained before.
• In case of capital reduction in transfer and spin-off transactions, there is no taxation, but in case of withdrawal of capital from the transferee or a newly established company, taxation shall be made in the ways described, and in this case, in the evaluation of the criteria for completing 5 full years of assets, it shall be calculated together with the period that the capital element is in the capital of the transferor company.
• In the event that capital companies acquire their own shares and acquire the assets they have acquired, a tax deduction shall be applied, and this deduction shall be made over the negative difference between the acquisition price and the nominal value of the shares or partnership shares, and this deduction is separate from the scope of regulation 32/B.

CONCLUSION

The legislative amendment introduced by Code No. 7420, Article 32/B of the Corporate Tax Law shall be applied in the taxation of capital reduction. The new Article provides different methods that have been adopted depending on whether 5 full years have passed since the addition of the resources to be subject to the reduction in capital reduction.

In this respect, as can be seen from the justification of the code and the minutes of the commission where the text of the code is discussed, companies are supported in the tax context to hold their equity for 5 full years and companies are encouraged to protect their equity. Additionally, the ongoing approach of the Administration regarding equity items not exceeding five full years has now been given a solid legal foundation.

With the Communiqué published by the Revenue Administration, it is aimed to clarify the new regulation and sample calculations are included in order to clarify the implementation of the regulation.

Footnote

1. In the same direction:

• Gaziantep Tax Office Directorate of Tax and Agreements Implementation Directorate dated 30.12.2011, numbered B.07.1.GİB.4.27.15.01-11-515-56-77 and the advance ruling on the tax situation of the revaluation value increase fund added to the capital and the previous year's profits as a result of capital reduction
• Major Taxpayers Tax Office, Taxpayer Services Group Directorate dated 24.09.2013, numbered 64597866-125[19-2013]-155 and the ruling on "Whether the extraordinary reserves previously added to the capital can be considered as withdrawal from the operation in the capital reduction due to partial division"
• Van Governorship Revenue Office Revenue Directorate dated 25.12.2014, numbered 60757842-5520-28 and its ruling on "Distribution of profit reserves to the shareholders of the Company through capital reduction"

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.