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The new Turkish Corporate Income Tax Act No. 5520, wholly revising and introducing substantial amendments to the former Corporate Income Tax Act No. 5422 dated 10 June 1949 has been approved by the parliament on 13 June 2006. The Act has now been sent to the President for approval. Most of the provisions are applicable retroactively from 1 January 2006. Transfer pricing rules, however, will be applied from 1 July 2007. — Orbitax Tax News & Alerts

Basic features of the Act are as follows:

(a) Rate reduction. The corporate income tax rate is reduced from 30% to 20%.

(b) Transfer pricing rules. Transfer pricing rules are applicable both in domestic and foreign situations. Under such rules, for the transactions between a company and the related parties to be at arm's length, new pricing methods (comparable uncontrolled price method or cost price method or resale price method) are applied. Hidden profit distributions by way of transfer pricing are considered to be constructive dividends derived at the end of the taxable period in which the above conditions are met. For non-residents, such hidden profit distributions are deemed as profits remitted to the head office. In such cases, adjustments are made for previous taxes of both parties. Thus, hidden profit distributions are not tax deductible for the distributing company and, in addition, are subject to withholding tax.

(c) Controlled foreign company provisions. CFC provisions apply to foreign subsidiaries of resident companies in low-tax jurisdictions. Whether distributed or not, CFC profits corresponding to the participation ratio of the resident company are included in the corporate income tax base, and taxed accordingly in Turkey.

(d) Anti-abuse provisions. Any kind of payments made by resident corporations to corporations resident, or permanent establishments carrying activity in low-tax jurisdictions is subject to the 30% withholding tax. Such jurisdictions will be listed and issued by the Council of Ministers. Payments made to the PEs of resident companies are also covered. Loan interests and dividend payments related to credits from foreign financial institutions and insurance and reassurance payments are not subject to this withholding tax. The Council of Ministers is authorized to reduce this withholding tax rate down to zero for arm's length payments related to importation of goods, participation share sales, and sea and air transportation vehicle leasing.

(e) Thin capitalization rules. The loans from related parties exceeding a debt-equity ratio of 3 to 1 are considered to be a hidden equity capital. Interest and other items paid (except exchange rate differences realized) on loans from shareholders and persons related to shareholders in excess of the 3 to 1 debt-to-equity ratio are treated as dividends for tax purposes. For non-residents, such hidden profit distributions are deemed as profits remitted to the head office. In such cases, adjustments are made for previous taxes of both parties. Thus, the interest is not tax deductible for the borrowing company and, in addition, is subject to withholding tax applied to dividends. Loans from the following persons, however, are not considered to be a hidden equity capital:

-   loans from third parties under a guarantee in kind which is provided by a shareholder or persons related to the shareholder;
-   loans from the subsidiaries, shareholders or persons related to the shareholders, provided that the loan is obtained from banks and financial institutions or capital markets and transferred under the same conditions;
-   loans received by banks that carry on business under Banking Act No. 5411; and
-   loans received by financial leasing and factoring companies from their bank shareholders or from banks related to the shareholders.

(f) Foreign tax credits. The scope of FTC provisions is widened. Accordingly, taxes paid to foreign authorities by resident companies on their foreign source income may be credited against the corporate income tax calculated in Turkey on the company's total income. The credit may not exceed the Turkish corporate income tax calculated on the foreign-source income on an overall basis (ordinary tax credit). The foreign tax that cannot be credited in the relevant tax period may be carried forward for three tax periods. In cases where resident corporations (ASs) directly or indirectly holds 25% of the capital or voting rights of foreign subsidiaries, the underlying income or corporate income taxes paid by the subsidiary in that foreign country for the profits out of which the dividend is distributed may also be credited in Turkey. The creditable amount is limited to the fraction of such taxes related to the received dividend.

(g) Cost allocation rules.The scope of deductible expenses incurred between the Turkish PEs and their foreign head offices is widened. Accordingly, in cases where the expenses incurred abroad are related to the activities carried on in Turkey and the expenses allocated to the PE through allocation keys determined under arm's length principles, such expenses are deductible from the profits of the Turkish PEs.