Taxation of Capital Decrease Under Law No. 7420
Law No. 7420 on the Amendment of Income Tax Law and Certain Laws and Decrees (“Law No. 7420“) which was published in the Official Gazette dated 09.11.2022 introduced important amendments and regulations in the tax legislation. The addition of Article 32/B, entitled "Taxation in Capital Decrease" to Corporate Tax Law No. 5520 ("CTL") was one of these important amendments. Previously, there was no clear regulation in Turkish tax legislation regarding the taxation of a capital decrease. As a matter of fact, there was a controversy between the tax administration and taxpayers regarding the issue of which elements of capital are used for capital reduction. Law No. 7420 clarifies the position of capital decreases in tax legislation and aims to end the controversy on the subject.
The Situation Prior to Law No. 7420
Prior to Law No. 7420, there was no specific regulation on the taxation of capital decreases in Turkish tax legislation. Therefore, the taxation of capital decreases was one of the most controversial issues between the tax administration and taxpayers. As a matter of fact, the tax administration's approach to the issue was to assume that the decrease was made primarily from items subject to taxation. According to this approach, the amount reduced in the capital decrease would be considered to be withdrawn from the following items:
(i) Firstly, from accounts that will be subject to corporate tax and withholding tax due to profit distribution (such as inflation adjustment positive differences, revaluation funds, revaluation funds of subsidiaries, cost increase funds, revaluation funds of fixed assets, cost increase funds, etc.).
(ii) Secondly, from accounts that are only subject to withholding tax due to profit distribution (retained earnings, emissions premiums, gains on sale of legal or extraordinary reserves).
(iii) Finally, in-kind and cash capital that would not be taxed in case of withdrawal from the company.
However, this approach did not have a legal basis.
In addition, prior to Law No. 7420, the situation regarding the split company’s capital decrease carried out in accordance with the provisions of the TCC and the CTL as a necessity and an extension within the partial spin-off is also important to mention. In the aforementioned situation, this capital decrease transaction was not be taxed provided that (i) the capital decrease was not considered a stand-alone transaction, and (ii) the taxable items were included as an element of the capital in the capital increase to be made in the transferee company and they were seen separately.
Lastly, tax courts often ruled in favor of taxpayers on the grounds that there was no provision in the tax legislation stating that taxable items should be considered to be withdrawn from companies in capital decreases.
The Situation After Law No. 7420
Pursuant to Article 32/B, added to the CTL through Law No. 7420, the taxation of capital decreases depends on whether five full years have passed as of the date of the decrease, starting from the date of capitalization. In the event that The capital decrease is realized after the completion of five full years, the equity capital items subject to the decrease will be determined by proportioning the cash and in-kind capital and other elements added to the capital to the total capital and taxing them accordingly. The capital decrease is realized before the completion of five full years from the date of capitalization of the equity items, the decrease will be deemed to have been made in the following order, starting with the sources taxable at the highest rates:
(i) Elements of shareholders' equity that are subject to corporate tax due to transfer to another account other than capital, withdrawal from the entity or transfer from capital account to other accounts, and withholding tax due to profit distribution or the amount remitted abroad.
(ii) Elements of shareholders' equity subject to withholding tax only due to profit distribution or the amount remitted abroad.
(iii) Capital in-kind and cash which will not be taxed if transferred to another account or withdrawn from the company.
In this context, it is clear that the approach of the tax administration is included in the legislation in case the capital decrease is made before the completion of five full years.
In case the capital includes some elements that are added to the capital within five years, and some elements that were added earlier, the elements whose date of capitalization has not exceeded five years will be considered withdrawn from the capital.
In case of a capital decrease by offsetting retained losses, the capital elements subject to the decrease will be as explained above. However, withholding tax will not be applied to these amounts due to profit distribution or any amount remitted abroad. It is generally accepted that no taxation will be made in terms of withholding tax within the scope of Article 32/B of the CTL, but no arrangement has been made regarding the calculation of corporate tax. Essentially, if the capital is decreased by offsetting retained losses, there is no refund to the shareholders from the company and no cash outflow. Therefore, since it is obvious that there is no withdrawal from the business in such a case, corporate tax should not be calculated either.
Additionally, even if it is not expressly stated in the legislation, (i) in case of capital decrease made in the split company when the shares of the acquiring company are given directly to the shareholders pursuant to the partial spin-off transaction, and (ii) in case of acquiring the company's own shares, there should not be taxation under Article 32/B of the CTL.
The preamble of the article states that the elements added to the capital are encouraged to remain part of the capital for at least five years to encourage the shareholders' equity in the enterprises to remain strong. As explained in both the preamble of the article and the example given below, the elements added to the capital after five years are proportionate and subject to capital decrease:
Capital Elements and Amount (TRY):
Cash Capital: 7,000,000
Retained Earnings: 2,000,000
Inflation Adjustment Positive Differences: 1,000,000
Distribution of TRY 2.000.000 in case of Capital Decrease:
Cash Capita: 2,000,000 * 7/10 = 1,400,000
Retained Earnings: 2,000,000 * 2/10 = 400,000
Inflation Adjustment Positive Differences: 2,000,000 * 1/10 = 200,000
In case of a capital decrease of TRY 2,000,000 within five years from the addition of these elements to the capital, it is accepted that the capital decrease amounts will be met from the Inflation Adjustment Positive Differences of TRY 1,000,000 and the remaining TRY 1,000,000 TL is from Retained Earnings.
Under Article 32/B of the CTL, the status of capital decreases in tax legislation has been determined. In accordance with the new scheme, different rules are introduced depending on whether the capital decrease has been made within five years of the date of capitalization.
This regulation will also have an effect on other applications such as (i) measures to be taken in cases of technical bankruptcy and/or insolvency under Article 376 of the CTL, (ii) partial spin-off and/or merger transactions to be carried out under the provisions of the CTL and TCC, (iii) in case of acquiring the company's own shares. Therefore, we would like to emphasize that it will also need to be evaluated on the basis of other commercial decision.
In addition, we would like to emphasize that the capital increase or other legal transactions that will result in a capital increase after the date of 9 November 2022, which is the effective date of Law No. 7420, will need to be evaluated primarily in terms of a possible tax burden that may arise in the future.
- The ruling of Large Taxpayers Tax Office Directorate No. 64597866-125[6-2013]-158 and dated 26.09.2013; The ruling of Izmir Tax Office Directorate No. B.07.1.GİB.4.35.16.01-125-741 and dated 08.08.2012; The ruling of Adana Tax Office Directorate No. B.07.1.GİB.4.01.16.01-2010-611-KV-7 and dated 29.04.2010; The ruling of Ankara Tax Office Directorate No. 38418978-125[6-12/7]-809 and dated 30.07.2013.
- The decision of Presidency of the Council of State numbered E. 2020/1097 K. 2022/97 dated 02.03.2022; The decision of Presidency of 4th Division of the Council of State numbered E. 2019/3616 K. 2022/292 and dated 20.02.2022; The decision of Presidency of 9th Division of the Council of State numbered E. 2016/5536 K. 2019/907 and dated 14.03.2019, (lexpera.com.tr).
- Sağlam, Erdoğan: “Sermaye azaltımına ilişkin yasal düzenleme yapıldı, peki sorunlar çözüldü mü?”, T24 Gazetesi, Kasım 2022.
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