Semih Korkmaz
Serbest Muhasebeci Mali Müşavir
semihkorkmaz@gmail.com

Foreign Subsidiary Gains Exemption And The Conditions For Deduction Of Foreign Dividend Witholdings In Turkey

According to Article 5/1-b of the Corporate Tax Law numbered 5520 of Turkey; if the conditions below are realized, foreign subsidiary gains are exempted from Corporate Tax. The conditions for this exemption are below:

1. Foreign Subsidiary (FS) must be a capital based entity (limited or joint stock company)
2. The legal or business centre of the foreign subsidiary must not be in Turkey.
3. The company in Turkey holding the FS shares must have at least %10 percentage of total shares of the foreign entity.
4. The Company in Turkey must have the shares at least 1 year uninterruptedly by the time the dividend obtained.
5. The total income and corporate tax-like income tax burden of the gain of the FS must be at least %15 including taxes paid on the proceeds of the profit share distribution. If the main activity of the foreign institution is funding entities, insurance services or investment in securities; tax burden of the FS mentioned above must be at least the corporate tax ratio of Turkey (%22 in 2018)
6. Dividend amount must be transferred to Turkey before the last day of the Corporate Tax Declaration. (It’s currently 25 April)

 

The tax burden is calculated in the country where the FS is located, including the tax that is accrued in the relevant period and paid over the earnings that are the source of the profit share distribution.

The total income and corporate tax-like income will be calculated by the ratio of the total distributable corporate income earned during this period to the total of the accrued income and corporation tax.

While calculating the FS’s distributable corporate income, the provisions set aside from the period profit and the reserve funds shall be considered as an element of the distributable profit. Reserves which are obligatory to be allocated according to the legislation of the FS’s country will also be considered as distributable profit. On the other hand, the expenses which are not accepted as deductible expenses in accordance with the tax legislation of the FS’s country should not be added to the distributable corporation gain.

Not the rate of the corporate tax rate but the actual burden must be taken into account in calculating the tax burden on FS earnings. Since the distribution of profits can be made from previous years' profits or reserves, foreign subsidiaries have to decide for themselves which year (or period) they are distributing the dividends. Therefore, the tax burden will be calculated separately for the periods when the retained earnings or reserves are related.

If there is an exceptional gain within the profit of the FS, the tax calculated on the basis of the tax base after the tax exemption is applied shall be taken into consideration in determining the tax burden. On the other hand, if there is no or a little tax amount remained after the deduction of FS’s previous year losses, the tax amount after the deduction of previous year losses will be considered and the tax burden will be determined according to that tax amount.

The withholding amount which is deducted from the foreign subsidiary’s distributable amount is also added to the tax base while calculating the tax burden of the FS.

The exemption can be benefited in terms of quarterly tax periods if the dividend amount is transferred to Turkey until the date of the declaration of relevant quarterly tax periods.

There is an example below about the issue:

Example: X LTD has %100 shares more than 1 years of the abroad Y LTD. Y LTD’s main activity is manufacturing.

Y LTD has 300 USD commercial (PL) profit, has 100 USD undetectable expense, its 260 USD gain is taxable exemption and has 80 USD deductible previous year losses. There’s a 20 USD withdrawal cut from the exemptional gain of Y LTD according to its country’s legislation. The corporate tax rate of Y LTD exposed to is %25. The income withdrawal ratio of Y LTD (According to Preventing Double Taxation Agreement between two countries): %15. Y LTD will distribute the whole distributable amount to X LTD.

So the income tax burden of Y LTD can be calculated as below:

 

a) PL profit (Before Corporate Tax): 300 USD

b) Taxable Base Amount: 60 USD (300+100-260-80)

c) Corporate Tax: 15 USD (60*%25)

d) Total Corporate Income Tax Y LTD Paid: 35 USD (15+20)

e) PL Profit (After Corporate Tax): 285 USD (300-15)

f) Distributable Amount: 185 USD (300-15-20-80)

g) Withholding Amount From Dividend If Distributed: 27,75 USD (185 * %15)

h) Net Dividend Amount To Be Transferred: 157,25 USD (185 – 27,75)

i) Total Income Tax Based For Tax Burden: 15+20+27,75 = 62,50 USD

j) Distributable Amount + Income Taxes: 220 USD (185+15+20)

k) Income Tax Burden: 62,50 / 220 = %28,41

 

Since the tax burden of Y LTD is above %15, if it distributes any gain to their shareholder (to Turkish company X LTD); there will be an exemption in Turkey for that amount. X LTD will deduct 300 USD from its PL Profit in the related line of the Corporate Tax Declaration. So 66,00 USD (300*%22) tax will not be calculated and will not be paid because of this exemption. (With the conjecture of the example is about 2018 fiscal year’s incomes, corporate ratio is %22 in Turkey) The withholdings amount paid abroad (27,75 USD) for X LTD will be the final tax for that FS gain. (The withholdings amount cannot be deducted if the exemption is applicable)

The deduction of withholdings that Y LTD cut from X LTD if the exemption conditions are not met:

According to Article 33/1 of the Corporate Tax Law of Turkey; corporate and similar taxes paid abroad for the profit from the foreign countries can be deducted from the tax paid in Turkey if they are transferred. So for our example, if the exemption conditions are not met; X LTD will deduct only 27,75 USD from the tax calculated on the Corporate Tax Declaration. And because of 300 USD FS gain not deducted in the PL profit; 66,00 USD will be additional tax for the term of 2018 and finally 66,00 USD will be paid for the FS gain. (66,00 + 27,75 - 27,75)

The share percentage ratio of the FS must be at least %25 percentage in order to deduct related withholdings amount according to Article 33/3 of the Corporate Tax Law of Turkey; but that article is seems meaningless in all the conditions because Article 33/1 is adequate for the deduction. That confusion should be resolved by the legislator.

The deduction amount cannot reach 66,00 USD (300*%22) in any case. In our example since 27,75<66,00; all the amount is able to be deducted.

Evidencing the taxes paid abroad

The tax paid abroad must be validated by Turkish embassy or consulate or if they are not exist, by the embassy or consulate preserving the Turkish interests in order to deduct this amounts in Turkey. Without the validation, no amount can be deducted.

Also if there is an “Avoidance of Double Taxation Arrangement” between the countries; the articles of the arrangement must be applied first.

Hereby; for FS earnings for Turkish companies,

Firstly “Avoidance of Double Taxation Arrangement” articles must be reviewed and realized;

Secondly the conditions for the foreign subsidiary gains exemption must be reviewed whether they are met or not;

Lastly if the conditions for the exemption are not met; the withholdings amount paid abroad will be deducted from the tax calculated on the corporate tax declaration if the dividend is validated and transferred.

I want to add that the provisions of “controlled foreign company gains” and the provisions for “disclaiming from the exemption” are beyond this article.

References

[1] Corporate Tax Law numbered 5520.

[2] Communiques of Corporate Tax Law.

23.02.2018

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