Limitation on Financing Expense Deduction through the Updated Draft Communiqué
Introduction
With the Article added to Corporate Tax Law No. 5520 (“CTL”) through Law No. 6322 promulgated in the Official Gazette dated 15.06.2012, the limitation on financing expense deduction was re-introduced into our legislation. According to the regulation whose first effective date was 01.01.2013, for the taxpayers whose foreign liabilities exceed their equity capital, except for credit institutions, financial institutions, financial leasing, factoring and financing companies, a portion of the financial expenses (exclusively for the exceeding part and excluding those added to the cost of the investment) to be determined by the President (the Council of Ministers on that date), not more than 10% has been considered as the payment not deducted as expense in the determination of the tax base. The President has been authorized to differentiate the rate by sector; whereas, the Ministry of Treasury and Finance has been authorized to designate the procedures and principles of the limitation.
The limitation on financing expense deduction has not come into effect for eight years since the Council of Ministers and the President did set the limitation rate. However, through Presidential Decree No. 3490 published in the Official Gazette dated 04.02.2021, the limitation rate was determined as 10% from the highest rate without any differentiation by the sector. Thus, the practice of the limitation on financing expense deduction has been permanently implemented since the taxation periods starting from 01.01.2021.
In the previous practice, the limitation on financing expense deduction was introduced in 1996 for taxpayers who made use of the methods to eliminate the effect of inflation in the determination of the tax base, and it was abrogated in 2004 after the inflation adjustment provisions were included in the tax legislation.[1] In today’s practice, all of the enterprises without any differentiation are encouraged to finance their financing needs with capital equity instead of borrowing and, thus, to keep their capital structures strong.
The limitation on financing expense deduction imposed during the pandemic when most of the businesses in our country were experiencing financial drought resulted in heated discussions. While the scope of damages that are not included in the technical bankruptcy calculation is expanded with the Communiqué promulgated in the Official Gazette dated 26.12.2020, in order to prevent companies from falling into bankruptcy due to loss of capital, and considering the meltdown in equity capital, timing of the limitation on financing expense deduction was found to be confusing.[2]
Draft Communiqué on the Limitation on Financing Expense Deduction
The Presidential Decree on the limitation on financing expense deduction has raised many questions. Some of these questions were answered with the Draft Communiqué on the Amendment of the General Communiqué on Corporate Tax (Serial No: 19) (“Draft Communiqué”) published on the website of the Turkish Revenue Administration on 24.03.2021. The Draft Communiqué was revised in line with the opinions and recommendations from the public, and was re-shared under the title of the Draft Communiqué on the Amendment of the Corporate Tax General Communiqué (Serial No: 18) (“Updated Draft Communiqué”) on 22.04.2021.[3]
Definitions
Pursuant to the Draft Communiqué, financing expense refers to all kinds of interest, commission, maturity difference, dividend, exchange difference, and discounts given to factoring institutions, and similar expenses and cost elements arising from the period of use of foreign liabilities. In another words, in order for the limitation to be applied, “the foreign liabilities must have a maturity date” and “the financing expenses must arise from the lifetime of the foreign liability”. Through the Updated Draft Communiqué, it is regulated that if the sales price includes a maturity difference, a part of the sales price will not be subject to the application of the limitation on financing expense deduction, unless financing expense is calculated for accounts “sellers” etc. in the balance sheet.
According to the Updated Draft Communiqué, foreign liabilities is the sum of short-term liabilities and long-term liabilities on the balance sheet. In other words, foreign liabilities consist of not only financial debts, but also trade debts; no distinction is made between domestic-foreign / related-unrelated debt. This definition gives rise to debates in terms of the principle of legality of tax. While the definition of foreign liability is not included in the tax law, it may be deemed contrary to the principle of legality of the tax that its scope is kept so wide against the taxpayer by an administrative regulation, and the issue is open to discussion.[4]
Pursuant to the legal regulation, amongst the financing expense and cost elements, those added to the cost of investment are excluded from the scope of the expense limitation. While the definition of the investment is not provided in the Draft Communiqué, in the updated Draft Communiqué, investment is defined as the assets subject to all kinds of depreciation (with or without incentive certificate), including the amounts monitored in the "Investments in Progress" account for investment projects until the relevant fixed asset is ready to be used. Accordingly, the expenses and costs of foreign liabilities added to the cost, mandatorily, or at the discretion of the taxpayer, will not be subject to expense limitation. Financing expenses incurred until the end of the period when the investment is capitalized shall be included in the cost of the investment. Including financing expenses arising in the following periods to the cost is optional.
Period to be Applied
The limitation on financing expense deduction is applied as of the first temporary taxation period of 2021. The balance sheets dated December 31 of the taxpayers whose accounting period is the calendar year-end, and the balance sheet of the taxpayers using the special accounting period, which is issued on the last day of the accounting period, is taken as the basis. With the updated Communiqué Draft, it is clarified that this balance sheet will be prepared “before the limitation on financing expense deduction”.
Whether or not to be subject to the limitation on financing expense deduction in both temporary taxation periods and annual periods is determined on the basis of the balance sheet to be issued as of the last day of the fiscal period in accordance with the Tax Procedural Law before the limitation on financing expense deduction.
Foreign Liabilities Entering the Enterprise Before 01.01.2021
The implementation of the expense limitation as of 01.01.2021 with the Presidential Decree dated 04.02.2021 has partial retroactivity. In the Draft Communiqué, it is regulated that the expense and cost elements finalized as of 01.01.2021 in terms of nature and amount, regardless of the year in which the financing service was provided, and in which year the loan agreement was made, shall be subject to the expense limitation. When this regulation had reactions on the principle of legality of tax, in the Updated Communiqué Draft, borrowings made before 01.01.2013 are excluded from the scope of the limitation. Emphasizing that the CTL Article entered into force on 01.01.2013, it is stated therein that the financing expenses arising from procurement of the financing services or signing the loan agreements as of this date (including this date) will be considered in the calculation of the limitation on financing expense deduction.
Although the effective date of the Article is 01.01.2013, the limitation was not put into practice due to the fact that the rate was not determined for eight years. In this regard, through the Presidential Decree dated 04.02.2021, incorporating the foreign liabilities that entered into the enterprise as of 01.01.2013, might be evaluated to be contrary to the legal security and certainty principles amongst the constitutional taxation principles. In fact, the regulation in the same direction, which was implemented in the years between 1995-2004, was canceled by the Council of State due to “damage to the principles of trust in the law and stability” .[5] Therefore, if the updated Draft Communiqué is published in this way, it may be brought before the Council of State with a claim of cancellation.
Foreign Exchange Differences
In accordance with the Draft Communiqué, the exchange rate difference expenses arising from the use of foreign liabilities are subject to the limitation with their actual amounts calculated by considering the changes in foreign exchange rates, including the determination of the income of 2021. In the face of the predominant opinion that the exchange difference income should also be regarded in the calculation of the actual amount, it is regulated in the Updated Draft Communiqué that exchange rate income and expenses may be netted, provided that they are related to the same liability. On the other hand, it is not possible to offset the foreign exchange income based on different sources and the income, such as deposit interest, from foreign liabilities. Therefore, considering the exchange difference income and expenses related to the same foreign resource, the net exchange difference expense will be subject to the limitation on financing expense deduction.
Bridge Loans
Pursuant to the updated Communiqué Draft, it is regulated that the expense of the financing provided by a company within the same group and transferred to another company should be applied to the company that took over and actually used the loan. Therefore, financing expenses related to loans transferred, intra-group, are subject to the expense limitation by the company that took over and actually used the loan.
Conclusion
The updated Communiqué Draft was open to public opinion and recommendations until 26.04.2021. Although many issues that caused controversy in the Draft Communiqué are addressed in the Updated Communiqué Draft, it is expected that discussions will continue. Indeed, the procedures and principles of the limitation on financing expense deduction, which concern the first temporary tax returns of 2021, and require important calculation and cause workload, were determined at the last moment. Moreover, it may still be argued that the application is against the legality, legal security, and certainty principles of the tax due to the reasons explained above. Considering the fact that the corporate tax rate has been increased to 25% for 2021, 22% for 2022, and the capital crisis deepens under the pandemic conditions, it could also be evaluated in the oncoming process whether the limitation on financing expense deduction strengthens the capital structures of the enterprises, and whether the purpose is realized.
[1]Yıldırım, Mehmet: Finansman Gider Kısıtlaması 17 Yıl Sonra Yeniden Yürürlükte, 05.02.2021, <https://t24.com.tr/yazarlar/mehmet-yildirim/finansman-gider-kisitlamasi-17-yil-sonra-yeniden-yururlukte,29750> (Date Accessed: 25.04.2021).
[2]Yıldırım, Mehmet: fn 1; Sağlam, Erdoğan: Finansman Gider Kısıtlamasına İlişkin Tebliğ Taslağı Güncellendi, 26.04.2021, <https://t24.com.tr/yazarlar/erdogan-saglam/finansman-gider-kisitlamasina-iliskin-teblig-taslagi-guncellendi,30762#_ftn1> (Date Accessed: 27.04.2021).
[3]Turkish Revenue Administration, Kurumlar Vergisi Genel Tebliği’nde Değişiklik Yapılmasına Dair Tebliğ Taslağı (Seri No: 18) <https://www.gib.gov.tr/sites/default/files/fileadmin/user_upload/Tebligler/Taslaklar/5520/18_serno_kvgenteb_taslak.pdf> (Date Accessed: 24.04.2021).
[4]Sağlam, Erdoğan: Finansman Gider Kısıtlamasına İlişkin Tebliğ Taslağı Hakkındaki Değerlendirmelerim, 26.03.2021, <https://t24.com.tr/yazarlar/erdogan-saglam/finansman-gider-kisitlamasina-iliskin-teblig-taslagi-hakkindaki-degerlendirmelerim,30367> (Date Accessed: 25.04.2021); Ergin, Numan Emre: Finansman Gider Kısıtlamasında Detaylar Netleşiyor, Ama…, <https://www.dunya.com/kose-yazisi/finansman-gider-kisitlamasinda-detaylar-netlesiyor-ama/616007> (Date Accessed: 25.04.2021).
[5]Council of State, 4th Chamber, 1997/636 E. 1997/3797 K. 27.10.1997.
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