The Legal Ground of Transfer Pricing
Pursuant to Article 13 of the Corporate Income Tax Code (“CIT Code”) (Law No. 5520) (published in the Official Gazette dated June 21, 2006, No. 26205), in case corporations purchase or sell goods and services from and to related parties at value and price contrary to the arm’s length principle, the profit shall be deemed to have been distributed in whole or in part in a disguised manner through transfer pricing.
The transactions of purchasing, selling, manufacturing and construction, renting to and from, lending and borrowing money, transactions that require payments such as wages and bonus shall, under all circumstances, be deemed as the purchase and sale of goods and services.
The Concept of Related Party
The concept of related party is defined under Article 13/2 of the CIT Code. According to this article, related party means the following: shareholders of the corporation; the natural persons or corporations that the corporations or their shareholders are associated with; or the natural persons or corporations the administration, supervision or the capital of which depend directly or indirectly on them or which are under their influence. Spouses of the shareholders, ancestors and descendants of the shareholders or their spouses, as well as their other relatives by consanguinity or affinity of third degree or less, are considered related parties.
On the other hand, any and all kinds of transactions performed with the persons living in the countries or regions that are announced by the Council of Ministers, upon considering the identity of their taxation capacity and the level of taxation of their system with the taxation capacity created by the Turkish tax system, and the availability of exchange of information, may be deemed to have been performed with the related parties.
Arm’s Length Principle under Turkish Tax Law
Under Article 13/3 of the CIT Code, the arm’s length principle means the compatibility of the prices and value which will be applied to the purchase or sale of goods and services from and to the related parties, with the prices and value that would have been formed in the absence of any such relation between them. The records, schedule or the documents of the prices or the value that are determined in accordance with the arm’s length principle must be kept as documentation of proof.
The provisions under Article 13 of the CIT Code follow the arm’s length principle established by the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines). Since Turkey accepts general transfer pricing rules of the OECD Guidelines, the general concept of the transfer pricing regulation is substantially similar to the other OECD member countries. The arm’s length principle which has been defined under Article 9 of the OECD Model Tax Convention is regulated under Article 13 of the CIT Code.
Even though the transfer pricing rules regulated under the CIT Code are in compliance with the OECD Guidelines, there are some differences in the practice of Turkish taxation. For example, despite the fact that the application of secret precedent has been forbidden under the OECD Model Guidelines, such application currently is being used in Turkish tax practice.
The Methods Applied in the Determination of Arm’s Length Price
In addition, under Article 13 of the CIT Code the concept of related party is defined in detail and the methods to be applied in the determination of the arm’s length price are stated in line with the OECD Model Tax Convention. In this respect, corporations shall determine the prices and the value that they would apply to the transactions with their related parties by using the most appropriate of the following methods:
This method is used for determining the sales price that is in compliance with comparable prices the taxpayer would apply by comparing it to the market price, which the natural or legal persons would apply that have no relationship between themselves and which enter into purchase and sale transactions of goods and services of comparable nature.
This method is used for calculating the price that is in compliance with comparable prices, by increasing the cost of the pertinent goods or services based on a reasonable gross profit rate.
This method is used for calculating the price that is in compliance with comparable prices, by subtracting a reasonable gross sale profit, from the price that would apply in case of resale of the good or the services of transaction to the natural or legal persons that has no relation among them.
The methods that shall be used for the prices or the value of the goods or services that would be purchased from or sold to the related party may be determined upon the taxpayer’s request in agreement with the Ministry of Finance. The terms and conditions of such method that would have been so decided are final and shall not exceed three years.
Transfer Pricing Documentation under Turkish Tax Law
There are two kinds of documentation that must be prepared by Turkish resident taxpayers. The first is the “Transfer Pricing Form” (the “TP Form”) which is annexed to the “Corporate Income Tax Return” and the second is the “Transfer Pricing Report” (the “TP Report”), which must be completed by the submission date of the corporate income tax return.
In cases where the corporate income taxpayers have related party transactions regardless of whether such transactions are performed in Turkey, abroad or in a free zone, such taxpayers must fill out the TP Form to be annexed to the corporate income tax return. Under such form, the transactions which are performed with related parties shall be declared with the type and amount of the transaction. In addition, the transfer pricing method which is used for the determination of the price of such transaction must be stated on the transfer pricing form. The TP Form must be submitted by all corporate income taxpayers that have any related party transaction in any given year.
The TP Report must be prepared by the submission date of the corporate income tax return. However, there is no regular submission requirement for the TP Report; tt only needs to be submitted when it is requested by the tax authority or the tax inspector. The TP Report is to be prepared annually by the following taxpayers:
If taxpayers registered as Large Scale Taxpayers have related party transactions performed in (i) Turkey, (ii) abroad or (iii) in a free zone, such taxpayers must prepare a TP Report.
If other taxpayers (except for large scale taxpayers) have related party transactions performed (i) abroad or (ii) in a free zone, such taxpayers must prepare a TP Report. In other words, taxpayers other than large scale taxpayers do not need to prepare a TP Report if they only have related party transactions in Turkey.
Tax Consequences of Transfer Pricing
In accordance with Article 13/7 of the CIT Code, income that is distributed in a disguised manner, wholly or partially, by transfer pricing shall, for the purposes of the implementation of the income and corporate income tax laws, be deemed as profit that has been distributed as of the last day of the fiscal period, during which the conditions of this Article had been realized, or for those that are subject to limited taxation (limited liable taxpayers), as the amount that has been transferred to the main head office. The previously performed taxations shall be corrected accordingly by the taxpayers that are parties thereto. However, in order to be able to make such correction, the taxes that had been assessed for the corporation distributing the disguised profits must have been finalized and paid.
If a payment within the scope of any commercial transaction is made above the arm’s length value, the overpaid amount, which is the difference between the actual payment and the arm’s length price, may be considered as a disguised profit distributed through transfer pricing. The deduction of such overpaid amount from the corporate income tax base will be rejected by the tax authority and will be added to the tax base of the taxpayer making the overpayment. As a result of such assessment, the overpaid amount will be subject to a 20% corporate income tax, tax loss penalty which is equal to the tax principal and delay interest.
In summary, disguised profit distribution through transfer pricing is regulated under Article 13 of the CIT Code in line with the OECD Regulations. There have been many tax inspections that have been conducted by the Turkish Tax Authority on taxpayers' related party transactions on the ground that those transactions are not performed in accordance with arm’s length pricing which must be determined through Article 13 of the CIT Code. Some taxpayers have filed lawsuits against the tax authority before tax courts requesting cancellation of tax assessments arising from those tax inspections. There are still numerous transfer pricing disputes pending before the first instance tax courts and the State Council. In this respect, transfer pricing applications in Turkish tax practice are being shaped day-to-day through the judgements of tax courts and tax authority rulings on transfer pricing cases.
* Mehmet Onur Çeliker is an Associate at Pekin & Pekin Law Firm specialising in tax advisory and tax dispute resolution. Onur can be contacted at email@example.com.