Analyzing Capital Replenishment Funds in Terms of Tax Law
Introduction
Through the promulgation of Law No. 7394 on the Amendments of Treasury-Owned Immovable Property Valuation and the Value Added Tax Law and on the Amendments of Certain Other Laws and Decrees (“Law No. 7394”), published in the Official Gazette dated 15 April 2022 and No. 31810, significant amendments have been made to certain tax laws. One of the essential amendments was that capital replenishment fund amounts transferred by the shareholders of companies to replenish diminished capital as per Article 376 of Turkish Commercial Code No. 6102 (“Article 376 of TCC”), will be excluded in the determination of corporate income. Prior to this amendment, the situation that the shareholders transfer the amount that would cover the balance sheet deficit to the company (namely, capital replenishment fund) was considered a risky TCC Article 376 measure in terms of taxation. In this article, it will be briefly explained in which cases the capital replenishment fund is a measure that can be applied. In addition, the tax risk before the implementation of Law No. 7394 will be briefly explained.
Capital Replenishment Funds
TCC Article 376 is one of the laws aiming to protect company shareholders, company creditors, and other capital market actors as well as general economic interests of companies. The terms of capital loss and insolvency are regulated in Article 376; and, considering the current economic conjuncture; some additional regulations regarding implementation have been introduced with the Communiqué on the Principles and Procedures for the Application of Article 376 of the Turkish Commercial Code No. 6102 (“Communiqué”).
One of the measures that the company can take in case of capital loss and insolvency is the capital replenishment fund. This fund is also namable as the “loss compensation fund” in the literature and in the tax world.[1] Capital replenishment funds have always been an important measure for companies under Article 376, but there were hesitations in practice until today.
The reasons for this were how the way that a payment made unilaterally by a shareholder without any counteraction would be evaluated in the company records and the risk of incurring a tax burden on the company by being criticized by the tax administration via a tax inspection.[2]
Pursuant to Article 9 of the Communiqué, capital replenishment fund is defined as amounts transferred to companies by shareholders to eliminate the balance sheet deficit. The amounts transferred by the shareholders in this context are uncovered gains. Accordingly, the shareholders who transfer these amounts to the company will not be deemed to have lent or made a capital commitment to the company. These payments cannot be considered as advances in terms of subsequent capital increases. With this method, the funds transferred from the shareholders are accounted for in the capital replenishment fund account within the equity. The capital replenishment fund followed in this account can only be used by offsetting losses.[3].
Tax Risks Associated with Capital Replenishment Funds Before Law No. 7394
Prior to the issuance of the Communiqué and the entering into the force of Law No. 7394, the approach of the tax administration was that these amounts paid as capital replenishment funds should be included in the corporate income and subject to corporate tax and value added tax (“VAT”). As a matter of fact, in the ruling of the Revenue Administration, numbered B.07.1.GIB.0.06.49-010.01-11 and dated 01.06.2012[4], the following is stated in summary: since there is no regulation in the TCC regarding the capital replenishment fund, the capital replenishment fund cannot be added to the capital of the company, and there is no exception provision in the tax legislation regarding this issue, these amounts should be included in the corporate income. In fact, it has been argued that these transfers made by the shareholders were the performance of services and therefore should also be subject to VAT.[5] The said opinion was also given with the ruling of the Large Taxpayers Tax Office Directorate, numbered 64597866-KDV-1/1-21 and dated 12.02.2013.[6] Although the issue was brought to the judiciary, a uniform approach to the issue could not been reached before the courts.[7]
It should be noted that these payments made by the shareholders to replenish capital loss are not related to the purchase or sale of any goods or services, but are uncovered. Since this issue was also regulated by the Communiqué, it was an erroneous approach of the Revenue Administration to include the capital replenishment fund in the determination of corporate income and calculate VAT.[8] However, although the capital replenishment fund is a measure given to companies that are in the scope of Article 376, it is not generally preferred because it carries a risk in terms of taxation.
Capital Replenishment Funds within the scope of Law No. 7394
Pursuant to Article 23 of Law No. 7394, the capital replenishment fund amounts transferred by the shareholders of the companies to replenish diminished capital as per TCC Article 376 will be excluded from the determination of corporate income.
The preamble of the article states that the amounts transferred by the shareholders as capital replenishment funds will not be considered capital investment or lending within the framework of the TCC and are in the nature of an uncovered payment.
Thus, there is a legal basis for that these capital replenishment funds should not be taken into account when determining the corporate income in the relevant period and should not be subject to corporate tax. Law No. 7394 does not include any explanation on VAT in relation to the capital replenishment fund. However, we are of the opinion that this amendment definitively ends the above-mentioned criticism of the Revenue Administration regarding corporate tax; and there is not any service rendered in Turkey in case of capital replenishment fund application.
Although it has actually been fairly clear that capital replenishment funds should not be included in the corporate tax base and should not be subject to VAT since the publication of a Communiqué on 15.09.2018, it is important for taxpayers that the issue has been further clarified in accordance with principle of legality.
Conclusion
The various measures that can be taken in case of technical insolvency in the balance sheets of companies are listed in TCC Article 376 and the relevant Communiqué. One of the alternatives for the elimination of a company's balance sheet deficit is the capital replenishment fund. Under the provisions of Law No. 7394 and the Communiqué, the capital replenishment fund amounts transferred by the shareholders will not be taken into account in the determination of corporate income, and the tax risk that existed before is eliminated. However, companies should be aware that the tax consequences of all of the measures will differ from one case to another. Before the implementation of these alternatives, a study should be conducted to determine which alternative will be more tax-effective, based on the company's balance sheet data.
- Kaynar, Ufuk: “Sermaye Tamamlama Fonu ve Şirketlerin Söz Konusu Fon Uygulamalarına Getirilen Vergisel Eleştiriler”, Vergi Dünyası, September 2014, pp. 128-134.
- Bakiler, Yunus Emre; Kelecioğlu, Aykut: “7394 sayılı Kanun ile Sermaye Tamamlama Fonlarının Vergilendirilmesinde Yapılan Düzenleme – TTK 376 ve Zombi Şirketler”, April 2022, p. 4.
- Doğan, Zeki: “Sermaye Tamamlama Fonunun Muhasebeleştirilmesine İlişkin Öneriler”, Vergi Sorunları, February 2020, p. 15.
- The ruling of Revenue Administration No. B.07.1.GIB.0.06.49-010.01-11 and dated 01.06.2012.
- Kaynar, p. 133.
- The ruling of Large Taxpayers Tax Office Directorate No. 64597866-KDV-1/1-21 and dated 12.02.2013.
- The decision of Presidency of 3rd Division of the Council of State numbered E.2016/3630, K.2017/9305 dated 14.12.2017; The decision of Presidency of 4th Division of the Council of State numbered E. 2011/7060, K. 2013/1477 and dated T. 28.3.2013; The decision of Presidency of 4th Division of the Council of State numbered E. 2011/7057, K. 2013/1474 and dated T. 28.3.2013.
- Doğan, p. 24.
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