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What is Financing Expense Restriction?
Financing expense restriction is a law introduced to encourage companies to meet their financing needs from their own resources rather than from foreign sources. This law was enacted by the 37th article of Law No. 6322 and was added to the first paragraph of the 11th article of the Corporate Tax Law No. 5520 as subparagraph (i) to come into force as of January 1, 2013.
The legal regulation states that for businesses where the foreign resources used exceed their own resources, excluding credit institutions, financial institutions, financial leasing, factoring, and financing companies, any expenses and cost factors made under names such as interest, commission, term difference, profit share, exchange difference related to foreign resources used in the business will not be deducted in determining corporate income, excluding those added to the cost of the investment, up to 10% of the total determined by the President.
Although this situation became law in 2013, it did not find a practical application until 2021, when the rate to be applied was determined by Presidential Decision No. 3490, published in the Official Gazette dated February 4, 2021. It was stated in the Presidential Decision that this provision would be valid from the taxation period starting from January 1, 2021.
With the Presidential Decision No. 3490 published in the Official Gazette dated February 4, 2021, the rate was determined as 10%. Therefore, starting from the taxation period that started on January 1, 2021, the total of expenses and cost factors made under names such as interest, commission, term difference, profit share, and exchange difference related to foreign resources used, excluding those added to the cost of the investment, will not be accepted as a deduction in determining corporate income for companies where the amount of foreign resources used exceeds their own resources.
Additionally, expenses and cost factors made under names such as interest, commission, term difference, profit share, and exchange difference related to foreign resources exceeding the equity amount, excluding those added to the investment cost, will not be subject to this 10% restriction.
Given the legal provisions above, it is understood that the financing expense restriction came into force in 2013. However, the power to determine the amount that cannot be deducted from corporate income was left to the President, and this rate was determined by the Presidency in 2021, meaning that this law found its application field only in 2021.
However, it is worth noting that with the Corporate Tax Communique No. 18 published in the Official Gazette No. 31491 dated May 25, 2021, the implementation of the financing expense restriction was retroactively rolled back to January 1, 2013. Violations of the law regarding this matter will be detailed below.
Which Taxpayers Are Included in This Scope?
The law does not explicitly list the taxpayers that will be included in this scope, but it does state that it will be applied to corporate taxpayers whose foreign resources exceed their own resources. From this definition, it is understood that corporate taxpayers who are subject to the balance sheet principle will be included in the scope of the financing expense restriction, whereas taxpayers who are subject to the operating account principle will be excluded from the scope.
In addition, the law exempts certain businesses from the financial expense restriction. These are:
- Pension companies operating within the scope of Law No. 4632,
- Banks established in Turkey operating within the scope of Law No. 5411, including deposit banks, participation banks, development and investment banks, branches of similar institutions established abroad in Turkey, and financial holding companies,
- Insurance and reinsurance companies operating within the scope of Law No. 5684,
- Financial leasing, factoring, financing companies, and savings finance companies operating in accordance with the relevant articles of Law No. 6361,
- Institutions engaged in capital market activities within the scope of Law No. 6362,
Will not be subject to the financing expense restriction.
Period of Application of the Financing Expense Restriction
The financing expense restriction is first applied as of the first temporary taxation period of 2021, and according to the Corporate Tax Circular No. 18 published in the Official Gazette numbered 31491 and dated 25.05.2021, it is stated that the provisions of the financing expense restriction will be applied to foreign resources acquired from 01.01.2013 onwards for businesses where the foreign resources used at the end of the period exceed their own resources. This situation causes some controversial issues in practice.
Firstly, it is worth mentioning that although the financing expense restriction was legislated in 2013, the rate at which it would be applied was only determined by Presidential Decree No. 3490, published in the Official Gazette in 2021. Accordingly, applying the provisions of the financing expense restriction on foreign resources acquired from 2013 onwards is contrary to the principle of non-retroactivity of laws, a result of the principle of predictability of laws, one of the requirements of the Rule of Law.
Indeed, precedent decisions in practice also state that this provision in the Circular is contrary to the Constitution. In a precedent decision given on this issue, it is explicitly stated that: “The rate determined with the Presidential Decree No. 3490 dated 03.02.2021 regarding expense restriction came into effect to be applied to the 2021 taxation periods before the taxation period ended, accordingly, it is determined that 10% of the financing expenses specified in the Law and finalized in the 2021 taxation periods cannot be deducted from the corporate income, thus the financing expense restrection will be taken into account for the first time as of the first temporary taxation period of 2021, although the effective date of the Presidential Decree No. 3490 dated 03.02.2021 is 01.01.2021, the effective date was brought back to 1.1.2013 with the Corporate Tax Circular No. 18 published in the Official Gazette numbered 31491 and dated 25.05.2021, in this case, it has been concluded that including the loans used before the publication date of the Presidential Decree in the scope of the financing expense restriction is contrary to the principles of legal certainty and non-retroactivity of laws.”
In our opinion, although the effective date of the financing expense restriction was brought back to 01.01.2013 with the published Circular, due to this issue obstructing legal predictability, taxpayers should base their claims not on the foreign resources they acquired from 2013 onwards but on the foreign resources they acquired from 2021 onwards, which is the effective date of the Presidential decree.
Objections to The Definition of Foreign Resource
In the Corporate Tax Circular No. 18 published in the Official Gazette numbered 31491, a foreign resource is defined as the total of short-term and long-term foreign resources in the balance sheet.
While this definition in the circular covers a very wide area, accounts such as “320 Suppliers”, “335 Personnel Debts”, “340 Received Order Advances”, “360 Taxes and Funds to be Paid”, “361 Social Security Deductions to be Paid”, “370 Provision for Tax and Other Legal Obligations of Period Profit”, “371 Prepaid Tax and Other Obligations of Period Profit”, “372 Provision for Severance Pay” from short-term foreign resources and “420 Suppliers”, “440 Received Order Advances” and “472 Provision for Severance Pay” from long-term foreign resources are considered as foreign resources even though they are not expenses for financing the business. This leads to objections from taxpayers, revealing that the definition of foreign resources should be limited to financing-related debts.
Although the opinion of the Revenue Administration on this issue seems strict when examining the issued private circulars, decisions that could set a precedent in favor of taxpayers are coming from the tax judiciary. In a recent court decision, it is exactly stated; “It is understood that the concept of foreign resource should be limited to debts aimed at financing in line with the above-mentioned Law provision and its justification, 320 Suppliers Account, 335 Personnel Debts Account, 360 Taxes and Funds to be Paid Account, 361 Social Security Deductions to be Paid Account, 370 Provision for Tax and Other Legal Obligations of Period Profit Account, 371 Prepaid Tax and Other Obligations of Period Profit Account, 373 Provision for Cost Expenses Account, 381 Expense Accruals Account, etc. these accounts do not constitute financing expenses and do not lead to any interest, exchange difference, term difference or similar financing expense, therefore, it is legally impossible to accept that all accounts under the heading of “3. Foreign Resources” in the Circular are related to financing expenses, based on the Circular that brings a definition contrary to the law regarding foreign resources that will form the basis for the financing expense resterection, it is not legally accurate to include accounts that are not actually related to financing in the calculation of foreign resources for the calculation of the amount of financing expense restrection.”
In our opinion, while tax courts are making decisions per fairness in this regard, we believe that only the debts related to the financing of the businesses should be considered in calculating the financing expense restriction.
Litigation Path in Financial Expense Restriction
Although there are precedent decisions mentioned above regarding calculations regarding the financial expense restriction, in practice, the legislation in the application is still strictly applied by the tax offices, both debts that are not related to financing are accepted as foreign resources and foreign resources acquired from 2013 onwards are included in the calculation when calculating the financial expense restriction for businesses.
At this point, lawsuits to be filed with a request to stop the execution will not automatically prevent the collection of the accrued corporate tax, and if the decision to stop the execution is not given, businesses will suffer various grievances. In order not to suffer any grievances in this situation, the businesses need to pay the part related to the financial expense restriction “with objection“, and then they need to file a cancellation lawsuit in the tax courts within 30 days.
Also Read: Guide to Free Zone Company Formation in Turkey: Unveiling the Opportunities.
