New Tax Law Provisions on Debt Push Down for Merger Transactions
Introduction
Through Article 20 of Law No. 7440 on Restructuring of Certain Receivables and Amending Certain Laws (“Law No. 7440”), published in the Official Gazette dated 12 March 2023 and No. 32130, significant and new tax regulations regarding debt push down financing structure for merger transactions are introduced. In this article, the situation of debt push down in mergers and what the regulation introduced by Law No. 7440 changes in tax terms are explained.
Debt Push Down in Merger Transactions
It is common in business life for companies to participate in the target company they wish to acquire as a parent company or through special purpose vehicles (“SPV”) established for this purpose and to realize such share purchases by obtaining loans.
In this context, “debt push down” may be defined as follows: (i) acquisition to be financed through loan takes place through the purchase of the target company’s shares by the parent company or an SPV established specifically for this purpose, (ii) then the acquired company and the parent company/SPV are merged as the tax-neutral merger within the scope of Article 19 of the Corporate Tax Law No. 5520 ("CTL"), (iii) thereby the loans obtained for the share purchase can be transferred to the acquired company. As a result of the structure mentioned above, the interest on the loan obtained for the share purchase can be deducted from the taxable income of the acquired company. The said merger can take place downwards (within the acquired company) or upwards (within the acquiring company).
The question may arise as to why SPVs do not recognize the interest on these loans as a deductible expense and seek to transfer this burden through the merger. To answer this question, the purpose of the establishment of SPVs can be taken into consideration. SPVs are generally established for the sole purpose of acquiring the target company and have no other activities.[1] Therefore, it is not possible for these companies to generate taxable income in the short and medium term due to the nature of the business. At this point, through the “debt push down” model, the SPV merges with the target company, and the financing expenses can be deducted from the acquired and profitable company.
Situation Before Law No. 7440
Before Law No. 7440 was published, Article 5/3 of the CTL was as follows: "Except for the financial expenses related to the purchase of participation shares, the expenses of the corporations related to the earnings exempted from corporate tax or the losses arising from the activities within the scope of the exemption are not accepted to be deducted from the non-exempt corporate income."
Pursuant to this article, it was not possible to deduct the loan interests which are obtained for the share purchase and transferred to the acquired target company through the merger from the corporate income. As a matter of fact, pursuant to Article 5/3 of the CTL, financing expenses related to share purchases were only allowed to be deducted by the acquiring company. Therefore, if the acquiring company merged with the target acquired company, it was not possible to deduct these financing expenses from the profits of the new company. In addition, this practice was disallowed by other countries’ domestic legislation either.[2]
The approach of the Revenue Administration to date has been that this deduction was not possible on the grounds that (i) there was no provision in the law that allows this deduction and (ii) there was no financial expense incurred in relation to the share purchase in case of an acquisition.[3] In practice, this issue was also criticized during tax inspections conducted before taxpayers, and tax disputes were arising between taxpayers and the Revenue Administration. In addition, most of the lawsuits filed before the Tax Courts were rendered against the taxpayers.
Tax Advantage Introduced under Law No. 7440
With Article 20 of Law No. 7440, Article 5/3 of the CTL was amended as follows “It is not acceptable to deduct the expenses related to the earnings of the corporations exempted from corporate tax or the losses arising from the activities within the scope of the exemption from the non-exempt corporate income. However, financial expenses related to the share purchases, including those incurred after the acquisition of the shares within the scope of Article 19 of the Law, may be deducted from the corporate income.” In the discussions of the Plan and Budget Committee regarding the amendment, it was stated that the amendment was made in order to encourage company mergers.
Within the said amendment, the financial expenses related to the share purchases can also be deducted from corporate income after the merger transaction within the scope of Article 19 of the CTL. Therefore, the expenses related to the loans used for share purchases can be taken into consideration as expenses in determining the corporate income tax of the new company after the tax-free merger of the target company and the acquiring company.
In this context, in cases where the acquiring company does not have sufficient income to deduct the related financial expense, the interest expense may be deductible by the acquired company with higher taxable income by transferring these expenses to this company after the merger. This regulation applies to income and earnings derived as of January 1, 2023.
It should also be noted that provisional Article 1, which was included in the proposal phase of Law No. 7440 and which provides protection against the tax assessments made or to be made and penalties imposed or to be imposed for the periods prior to January 1, 2023, was not included in Law No. 7440. Therefore, it is considered that the new regulation does not provide protection against the assessments and penalties for the aforesaid periods.
Conclusion
Pursuant to Law No. 7440, within the scope of the practice of debt push down in mergers, the financing expenses related to the share purchases are allowed to be recognized as an expense in the acquired company. Therefore, a significant tax advantage is considered to be provided for the financing of corporate restructuring and acquisitions. It is also considered that this significant regulation on company restructurings should be taken into account in companies' new investment decisions and restructuring transactions. However, since the interests of minority shareholders of the target company may be harmed in mergers through debt push down, the commercial law aspect of the issue should also be reviewed.
Güngör, A. Feridun: “Borcun Aşağı İtilmesi”, Ekonomist, 28 March 2010, p. 54.
Czardybon, Sylwia: Controversy related to debt-push-down structures, KPMG Poland, 23 March 2020.
The ruling of Revenue Administration dated 12.01.2009 and No. 00390; The ruling of Large Taxpayers Tax Office Directorate dated 22.07.2014 and No. 64597866-125[19-2014]-117.
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