Ercüment Erdem Att. Canan Doksat

Taxation of Capital Decrease

January 2019

Introduction

The legal procedure regarding capital decrease transactions of joint stock companies is regulated, in detail, between Articles 473 and 475 of Turkish Commercial Code No. 6102 (“TCC”). Turkish tax legislation has no specific provision regarding the taxation of capital decrease transactions. However, the Turkish Revenue Administration (“Revenue Administration”) has the tendency to accept that capital decrease transactions should, firstly, be made through taxable funds and items, regardless of the form and reason for the capital decrease.

On the other hand, in its current decisions, tax courts generally accept that the Revenue Administration’s above-mentioned approach asserting that capital decrease transactions should be made, firstly, from taxable funds is contrary to the law due to the fact that the tax legislation does not include such a specific taxation rule.

This newsletter article evaluates the current approach of the Revenue Administration and tax courts in relation to the taxation of capital decrease transactions[1].

The Approach of the Revenue Administration

As a general rule, it is essential that capital not be taxed within the scope of the Turkish tax system. Thus, the Turkish tax legislation does not include any specific provision regarding taxation with respect to capital decreases.

However, the general approach of the Revenue Administration regarding the taxation of capital decreases may be summarized as follows:

  • Capital decreases should be made, firstly, from the accounts that are subject to corporate tax and dividend withholding tax as result of the distribution of the profit after tax,
  • Afterwards, the account that is subject only to dividend withholding tax should be accepted to be withdrawn from the company,
  • Finally, capital in cash and in kind contributions that will not be taxed through withdrawal from the company should be accepted to be used for the capital decrease[2].

In line with the above-mentioned approach of the Revenue Administration, the taxation of a capital decrease transaction should be made as follows:

  • Firstly, it should be accepted that taxable funds, such as inflation adjustment differences revaluation funds and cost increase funds, are withdrawn from the company and, accordingly, corporate tax should be calculated over the referenced withdrawn funds. Subsequently, the profit, after taxes, should be made subject to dividend withholding tax depending on the legal structure of the party receiving the dividend.
  • Afterwards, retained earnings and legal reserves formerly added to the capital should be accepted to be withdrawn from the company and dividend withholding tax should be calculated over the referred amounts depending on the legal structure of the party receiving the dividend.
  • Finally, capital in cash and in kind contributions should be accepted to be withdrawn from the capital and no withholding and/or corporate tax should be assessed on the referenced amounts.

Despite the fact that the Revenue Administration’s approach is as stated above, the Turkish tax legislation does not contain any provision indicating a specific taxation order for capital decreases.

Additionally, there is no general communiqué or circular indicating a specific order of taxation for capital decrease transactions, as stated above. Therefore, the referenced legal gap, and the taxation aim of the Tax Administration regarding capital decrease transactions, causes many disputes and tax controversy issues.

First Instance Tax Court Decisions

During tax cases initiated with the cancellation claim of the tax assessments, including tax loss penalties, or following the declaration with reservation, in relation to capital decrease transactions (especially regarding the revaluation funds formerly added to the capital), the first instance tax courts began to render their decisions in favor of the taxpayers (these decisions are dated 2017 and 2018) on the following grounds:

  • Turkish tax legislation does not include any specific provision stating that revaluation funds should be accepted to be firstly withdrawn from the company and subject to taxation during a capital decrease transaction.
  • The acceptance of taxation of capital decrease transaction through only interpretation and the usage of the legal gap by the Tax Administration is contrary to the law.

It should be noted that the above-summarized favorable decisions are held by first instance tax courts, and have not yet been finalized. However, we are of the opinion that the referenced decisions may constitute important precedents for any future claims, by taking into account the emphasis made to the legality of the tax principle regulated under Article 73 of the Turkish Constitution.

Conclusion

As stated in this article, Turkish tax legislation does not include any specific provision regulating the resources of capital decrease transactions.

However, in its rulings, Turkish Tax Administration accepts that capital decrease transactions should be accepted to be made firstly from taxable funds and items. Accordingly, corporate and/or withholding tax liabilities should be fulfilled as a result of capital decreases.

On the other hand, it is observed that first instance tax courts held decisions in favor of taxpayers on the grounds that the Revenue Administration’s approach regarding the taxation of capital decrease transactions has no legal basis within the scope of the tax legislation.

In line with our above-mentioned explanations, taxpayers may consider to initiate tax litigation procedures against tax assessments, including tax loss penalties, and/or following the declaration with reservation, in relation to capital decrease transactions.

[1] The taxation principles of capital decrease transactions made through the reduction of the losses will be evaluated in a separate newsletter article.

[2] Emre Yıldırım, Sinan Kaplan: Anonim Şirketlerin Türk Ticaret Kanunu Hükümlerine Göre Yapacağı Sermaye Azaltımının Muhtemel Vergisel Sonuçları, Yaklaşım Dergisi, February 2018.