English Translation

APPLICATION OF INVESTMENT INCENTIVE ALLOWANCE HAS BEEN ABROGATED

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I. INTRODUCTION

In his party’s group meeting held in previous November, the Prime Minister stated that the application of investment incentive allowance which the income and corporate taxpayers whose commercial and agricultural earnings are determined according to the balance sheet principle benefit from shall be abrogated, as well as informing that income and corporate tax rates may be reduced to lessen the tax burden on the investments.

Pursuant to these explanations, necessary action has been taken with the Law No. 5479 passed in the Grand National Assembly in the end of March and promulgated in the Official Gazette dated 08.04.2006 and the application of investment incentive allowance has been abrogated to be in effect as from 01.01.2006. Furthermore, with the same Law, the investment expenditures which could not be deducted as of 31.12.2005 due to insufficient earnings have been allowed to be deducted in three years’ time under certain conditions. Within this context, for the investments previously initiated, the application of investment incentive allowance shall continue for three years under the same conditions. Various regulations have also been made concerning the deduction of the income and corporate tax rates constituting another pillar of these explanations. While with the Law No. 5479, the Income Tax Tariff has been restated for all income subject to tax with no regard to whether or not these are wage income or income from other wage and the tax rates regarding income other than wages have been reduced by 5 points for each income bracket. Draft Corporate Tax Code reducing the corporate tax rate from 30% to 20% is being negotiated in the Turkish Parliament Planning and Budget Commission.

II. WHAT DOES THE REGULATION INTRODUCE?

Before moving onto what is being brought forward with the regulations mentioned, it’s worth making a brief explanation about the application of the investment incentive allowance constituting an important pillar of the regulations.

One of the measures taken until today with a view to maintain development and growth, which is one of the three main aims of the fiscal policy, is the application of tax incentives. The “application of investment incentive” which has been in the Income Tax Code for a long time, is one of these applications. Various amendments have been made in the application of the investment incentive allowance throughout the time; with the last amendment introduced in 2003, the name of the application has been changed to “investment incentive allowance”, it has been emphasized that it is an application of allowance; the application has been simplified, the obligation to obtain investment incentive certificate has been abrogated, investment incentive allowance rate has been restated as 40% for all investments with no regard to the place and type of the investment and the application of investment incentive allowance withholding levied on the earnings benefiting from the investment incentive allowance has been terminated. In the last version of the application of investment incentive allowance before it was annulled with the Law No. 5479 (Article 19, Income Tax Code), it was adopted that 40% of the costs of the financial assets which are subject to depreciation and the taxpayers determining their commercial or agricultural earnings on balance sheet principle, including those with limited tax liability (incl. ordinary partnerships, collective partnerships and commandite partnerships and corporation taxpayers) purchase or produce for their operational purposes shall be deducted from the related earnings in the determination of their tax base.

On the grounds that this application encourages tax planning and dead investments, which are not aimed with the introduction of the application, and thus prevents the rational utilization of the resources, Lawmaker has terminated this application with the Law No. 5479 to take effect as from 01.01.2006. For this purpose, Article 19 of the Income Tax Code has been annulled to come into force as from the date mentioned. On the legal ground, purpose of these regulations has been defined as to lessen the tax burden with the reduction to be made in the income tax and corporate tax rates and thus to direct the investments in economy towards efficient areas through internal dynamics of the market conditions.

As a result of this regulation, it shall not be possible to deduct the expenditures to be made as from the beginning of 2006 from the earnings declared. Undoubtedly this shall lead to increase in the tax base and then in the tax paid successively.

However, it is obvious that the impact of these two regulations, that is the termination of the application of investment incentive allowance and deduction of the income and corporate tax rates on the tax burden of the taxpayers shall vary depending on several factors. For example, an absolute decrease shall emerge in the tax burden of a taxpayer who doesn’t benefit from the application of investment incentive allowance since the tax rates have been reduced. The direction and degree of the change in the tax burden of a taxpayer benefiting from the application of investment incentive allowance shall depend on the amount of the investment incentive allowance that the taxpayer benefits. Within this context, the more the portion of the investment incentive allowance amount benefited increases in the corporate earnings, the more the positive impact of the new regulations over the tax burden shall decrease and even become negative at some point.

While terminating the application of the investment incentive allowance with the Law No. 5479, the Lawmaker has allowed that the deduction amounts which were benefited in previous years, but non-deductible due to insufficient earnings be subjected to deduction until the end of 2008. For this purpose, with the provision of the temporary article inserted in the Income Tax Code (Temporary Article 69), it has been allowed for the income and corporate taxpayers to deduct the investment incentive allowance amounts they shall calculate according to the provisions of the legislation in effect on 31.12.2005 due to;

a) investment incentive allowance amounts present as of 31.12.2005 but non-deductible from 2005 earnings,

b) the investments they shall realize after 01.01.2006 under the scope of the certificate for their investments initiated within the framework of the Additional Articles 1-6 of the Income Tax Code before being abrogated with the Law No. 4842 under the investment incentive certificates issued upon the applications made before 24.04.2003 and,

c) the investments initiated before 01.01.2006 within the scope of Article 19 of the Income Tax Code before it was annulled with this Law and pertaining to the investments completion of which requires a certain time period such as facility complexes or integrated facilities and constituting an integrity economically and technically,

from their earnings pertaining to only 2006, 2007 and 2008 under the scope of the provisions (including the provisions concerning the tax rates) of the legislation in effect as of this date. It has been stipulated that if a portion remains to be deducted from the earnings declared at the end of this three years’ period, these remaining amounts cannot be transferred to the following years; in other words, these amounts which couldn’t be deducted shall not be deducted from the earnings of the following years.

Thus, those taxpayers who substantiate that they have begun the investment before 01.01.2006 and the investment should be completed in unity with procedures such as having letter of credits issued, completing the preparations of infrastructure concerning the size of the investment, informing the District Administration in the Organized Industrial Areas and the Provincial Directorate of Trade and Industry in the other areas about the progress of these investment have been entitled to benefit from the investment incentive allowance for the expenditures they incur due to these investments as from 01.01.2006.

On the legal grounds of the Article, it has been pointed out that with the statement of “legislation effective on 31.12.2005”, the amendments in Articles 19, 103, Temporary Articles 61 and 65 of the Income Tax Code effective on 31.12.2005 together with Article 25 of the Corporate Tax Code on the same date have been referred to.

As it can be easily understood from the statements above, deduction of both the investment expenditures which could not be deducted as of 31.12.2005 and the expenditures to be incurred after 01.01.2006 concerning the investments initiated previously from the earnings declared has been left to the discretion of the taxpayer. Exercising the right of deduction is not compulsory. Taxpayers may opt for not exercising the right of deduction as well as they can subject these expenditures to deduction under the specified conditions. However, we should note that the provisions of the legislation effective on 31.12.2005 shall have to be implemented for those taxpayers who opt to exercise their right of deduction. For example, those who opt for deduction from the earnings to be obtained until the end of 2008 should know that their entire earnings within this period shall be taxed over the tax rates applied on 31.12.2005 (30% corporate tax rate, 20-40% income tax rate). This right granted with the Law No. 5479 made it more difficult to opt for the exercising the right granted under those current conditions and concerning the investments documented before 24.04.2003. As it may be recalled, while the application of investment incentive allowance is rearranged with the Law No. 4842 as we have summarized at the beginning of our article, it has been allowed for the investments initiated previously to continue benefiting from the application of investment incentive allowance under the current conditions of those days. Those benefiting from this opportunity at that time have calculated deduction amount through high deduction rates on the one hand and on the other they have continued performing withholding at the rate of 19,8% over the earnings benefiting from the application. Now, these taxpayers shall have take into consideration another factor while deciding whether or not to continue with the application: the income and corporate tax rates.

For these very reasons, what is rational for taxpayer today is to perform a detailed calculation while using the right of option concerning whether or not to continue to use the right of deduction. This calculation shall demonstrate clearly and definitely whether or not exercise of the right to opt envisaged to yield results in favor of the taxpayer at first sight shall be advantageous for the taxpayer. One of the possible results of the calculation has been provided below.

Example: The taxpayer has declared corporate earnings of 160 units for 2006 and 40 units of investment incentive allowance expenditure with the deduction rate of 100% for the same year under the investment incentive certificate obtained before 24.04.2003.

When the right of deduction is
Exercised / When the right of deduction is
not exercised
Corporate earnings / 160 / 160
Investment incentive
allowance amount / 40 / -
Corporate tax base / 120 / 160
Corporate tax rate / % 30 / % 20
Corporate tax / 36 / 32
Exemption withholding
(%19,8) / 7,9 / -
Earnings after tax / 116,1 / 128
Distributed earnings / 116,1 / 128
Profit distribution
withholding / 11,6 / 12,8
Total tax paid
in the corporation / 55,5 / 44,8

* Reserves have not been taken into consideration in order to ensure that the table is understood better.

We would like to note before concluding our article that in our opinion these amendments concerning the investment incentive allowance may lead in several legal disputes for two reasons. The first of these reasons is that although it has been promulgated in the Official Gazette dated ...., the amendment has been rendered valid 3,5-4 months in advance. The other one is that the limitation of three years’ period has been introduced for the deduction of the investment incentive allowance amount which were non-deductible due to insufficient earnings although the investment was initiated pursuant to the provisions of the legislation previously in effect and this limitation has been bound by heavy conditions. This condition has been bound by the investment incentive certificate before 2003 and is very important for the ongoing investments. The investment incentive certificates issued can be considered as a kind of commitment of the State. Abandoning this commitment shall result in the loss of the investors and have adverse influence on their reliance in the State. Increasing the tax burden, which may be the leading cost factor of an investment, through an amendment made on a date after the investment is initiated shall render the investment decision inappropriate. This will result in negative consequences for both the investor and the economy of the country.

TAXATION MATTER IN THE PRIVATE PENSION SYSTEM

Private pension system is established as the supplementary component of the current public social security system which ensures both the maintenance of the current welfare status during the retirement by facilitating regular savings of the individuals while they obtain regular income and the increase in the employment by allocating long-term funds for the economy.

The participants, within the framework of the principles specified in the contract, deposit their contributions on regular basis on the private pension account to be opened for the pension company and can decide about the distribution of the contribution among more than one funds belonging to the same company and any changes to be introduced in the retirement plan within the framework of the conditions to be stated in the pension contract.