As the Turkish economy continues to attract large amounts of foreign direct investment from multinational enterprises, international business taxation and transfer pricing remain at the top of the agenda. Governments are facing increasing pressure to expand their tax base in the wake of the ongoing economic crises, which has dented public finance resources. With taxes remaining a solid source of income and Turkish tax authorities interpreting transfer pricing and tax planning as a reason for the ongoing shift of revenue overseas, it is no surprise that Turkish companies are feeling the pressure to improve their tax transparency and transfer pricing implementation.
Slow but steady growth
The Turkish economy grew by just 2.1 percent in the second quarter of this year, and despite outgrowing the eurozone for the same period (their growth was just 0.7%), it was still lower than expected. With the lira down to its lowest in more than five months, the finance minister Mehmet Simsek went as far as to warn that the 4 percent full-year growth target may be missed.
The reasons were plentiful. Drought has hit agricultural output hard and economic weakness in European export markets, combined with the seismic impact of the wars in Ukraine and Iraq, have heightened the risk of growth. In a statement, Simsek was reported as saying: “Turkey’s growth has lost some momentum in the second quarter of 2014 due to monetary tightening, the delayed impact of the macro prudential measures, slowing EU economies and geopolitical tensions.”
That said, the seeds of growth are sprouting, with Turkey experiencing the biggest credit-to-GDP growth across all emerging markets. Odeabank market strategist Erkan Dernek suggests that the economy is on track for a growth of about 3.2 percent for the year. So with GDP on the increase, albeit at a slower than desired pace, it is no surprise that the attention is now falling on the tax liability of Turkish organisations.
Transfer pricing: A double-edged sword?
Transfer pricing regulations were introduced in Turkey under Article 13 of the Corporate Income Tax Law and are effective for taxable periods, starting from January 1, 2007. Transfer pricing is defined as the price or amount of goods or services (tangibles or intangibles) which are transferred, bought or sold between related parties, individuals or associated enterprises.
The subject of transfer pricing has slowly crept up the political agenda in recent years as the Turkish economy started attracting large amounts of foreign direct investment from the multinational enterprises (MNE). From a tax evasion perspective, the Government needs to ensure that taxable profits of multinational organisations have not been manipulated or disguised via transfer pricing. However, those organisations involved in transfer pricing also face the risk of double taxation through the calculation of arm’s length remuneration for their cross-border transactions with related parties.
Disclosures relating to transfer pricing need to be prepared or submitted to the revenue authority on an annual basis. All corporate taxpayers are required to complete and attach a transfer pricing form to their annual corporate income tax returns. The information should include: the list of related parties that the taxpayer entered into the transaction with; the amounts of related party transaction by transaction type (i.e. financing, services, goods etc.); and a summary of the transfer pricing methods used for the transactions. Companies are required to prepare transfer pricing documentation for cross border related party transactions and submit upon request. Companies which have completed Advance Pricing Agreement (APA) negotiations have to prepare annual APA reports and submit them to the tax authorities upon request.
Whilst there are no specific transfer pricing penalties, a disguised income distribution is assumed to exist if the transfer prices applied in related party transactions do not meet the arm’s length standard. If disguised income distribution is identified during an audit, there are three potential consequences: firstly, for corporate income tax purposes, 20% of corporate income tax is recalculated as if the disguised distribution had not been made; secondly, a dividend withholding tax of 15% is calculated over the net amount of the disguised distribution; and finally, a late payment interest penalty (1.4% monthly) and a tax loss penalty (which is the same as the tax loss amount) are also charged to the tax payer.
Clearly, it is imperative that multinational companies implement accurate, consistent and defensible transfer pricing policies and procedures to ensure they comply with transfer pricing rules and requirements.
Tax audits on the rise
There has been a significant increase in the number of tax audits in recent years, driven primarily by the structural change in the tax audit organization of the Ministry of Finance. Since the beginning of 2007, transfer pricing has emerged as one of the main focus of inquiries by the Turkish tax authorities, and they are rapidly gaining experience in the transfer pricing area. This is fueling a rise in the amount of tax assessments taking place and the risk of being selected for an audit is considerably higher than in previous years. Companies operating in Turkey are understandably much keener to prepare robust documentation studies and strong defense roadmaps.
Building up a tax audit strategy is crucial in order to defend and avoid challenges from the tax authorities, which has been described by one industry professional as ‘a bit like playing chess’. In addition, tax payers are trying to evaluate all the viable alternatives to avoid tax risks in relation to transfer pricing. Advance Pricing Agreements (APA) are rising in popularity as a valuable, proactive solution which can eliminate transfer pricing risks which might appear in the future. In such a highly monitored tax environment, it is clear that the role of tax and transfer pricing consultants are becoming more important for Turkish organizations than ever before.
“Businesses are no longer simply looking for basic expertise and understanding of the market. It is the dynamic and proactive consultancies which add value to the business of the companies and provide pragmatic solutions that are being appreciated by the taxpayers in Turkey,” explains Başak Diclehan Ereke (Tax, Senior Manager) at KPMG Turkey.
Having more than 1000 clients, many of which are multinationals, KPMG in Turkey is one of the pioneering professional services firms in the country today providing audit, tax and advisory services to international and local clients. Having more than 700 professionals, the company currently operates in 3 cities; Istanbul, Izmir and Ankara.
The team has been recognized by many professional magazines and industry overviews as one of the leading transfer pricing advisors in Turkey. Their reputation stems from their self-motivated and results-orientated ethos, coupled with a dedication to market and clients, serving as a bridge between market, clients, people and tax authorities. It is this depth of quality and service from disciplined practitioners that has resulted in KPMG Turkey being awarded the Winner of ‘Best Transfer Pricing Firm, Turkey -2015’ in the Business Worldwide Legal Awards 2015.
“To sustain value added services, our transfer pricing team in KPMG Turkey continues to remain at the heart of all debate. The Transfer Pricing team of KPMG in Turkey, led by Abdulkadir Kahraman (Head of Tax, Partner) and myself, includes professionals dedicated to providing robust, forward-thinking advisory services that not only considers the short term needs of a client’s business, but also the longer term implications,” concludes Diclehan Ereke.