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Transfer pricing

The transfer-pricing concept, which replaced the outdated disguised earnings provisions, was first introduced to Turkish legislation together with the new Corporate Income Tax (CIT) Law in July 2006. A popular discussion among tax professionals last year was the last-minute amendment to the CIT Law that led to no-transfer-pricing or disguised-earnings provisions, and remained in effect for the fiscal year 2006. According to the transfer-pricing provisions of the CIT Law, transfer-pricing rules were to be in effect from January 1 2007. In order to determine the implementation principles, the Law bestowed authority upon the Council of Ministers.

This year, although the transfer-pricing provisions of the Law have been in effect since January 1 2007, the draft Council of Ministers Decree was published only in July 2007. After receiving and analysing the comments to the publicised draft, the actual Decree was issued on December 6 2007, less than one month before the end of the general fiscal (calendar) year, with effect from January 1 2007.

The administrative irregularities concerning transfer-pricing regulations are not limited to the retrospective and late issuance of the Decree. Ambiguously, the Ministry of Finance issued a Transfer-Pricing Communiqué on November 18 2007 (again in effect from January 1 2007). The 53-page Communiqué not only explains the laws in greater detail, but also provides annual transfer-pricing reporting duties for Istanbul's 400 highest corporate taxpayers (which generate 45% of Turkey's tax revenue). Further, it provided lengthy documentation duties for the taxpayers. Although the provisions of the Communiqué are in parallel with most of the countries in the OECD, the Turkish Transfer-Pricing Communiqué lacks one minor element: a legal basis. Pursuant to the Turkish taxation principles available in the Constitution, duties related to taxation must be determined by law, not administrative documents. The Ministry of Finance neither has the authority under the CIT Law to set duties for taxpayers concerning transfer-pricing compliance, nor does it possess any authority to establish additional duties not provided under laws. Any enforcement attempted against corporate taxpayers by Turkish tax authorities for failure to abide by the transfer-pricing duties provided under the Communiqué will be challenged in the courts.

For all intents and purposes, transfer-pricing regulations were not in force for the fiscal year 2006. Combined with the premise that the retroactive application of the implementation legislation issued in late 2007 is highly vulnerable to challenge under Turkish law, the Turkish Ministry of Finance has, in essence, provided almost a two-year tax-free transition period for the transfer-pricing rules.

Despite its shaky legal footing for most of fiscal year 2007, the new transfer-pricing secondary legislation does provide detailed explanations of basic issues such as the interpretation of the related party and the arm's length principle, comparability analysis, permitted transfer-pricing methods (conventional methods – comparable price, cost plus and resale value methods; and transaction based methods – profit split and transactional net margin methods), and methods more suitable for the taxpayer's operations. For those familiar with international practice, the secondary legislation is in parallel with the US and major European transfer-pricing practices, but it does not mirror the penalties.

A new issue regulated under the secondary legislation is the subject of advanced-pricing agreements. These would provide a minimum of three years' relief from transfer-pricing disputes between the taxpayer and the tax administration. As a keynote for 2008, only the 400 highest corporate income taxpayers can apply for an advance-pricing agreement. After January 1 2009, all corporate taxpayers may apply for advance-pricing agreements concerning their cross-border transactions.

The new secondary legislation also provides annual reporting obligations for related-party transactions of Istanbul's highest 400 corporate taxpayers, and annual documentation requirements for all the remaining corporate taxpayers. Unfortunately, the long-awaited list of tax havens (any type of payments to which would be subject to a 30% gross withholding) has still not been issued by the Council of Ministers.

In conclusion, it seems that after nearly a two-year hiatus Turkey will finally start implementing stringent transfer-pricing regulations. In what may be considered an unintentional gift, for the fiscal year 2006 and for most of 2007, legal defences will exist against transfer-pricing enforcement or assessments levied by the Turkish tax authorities.

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