Category: Turkiye

“Politics are nowadays mostly behind the scenes, and there aren’t a lot of recent highlights about typical topics of tension,” says Dogan Eymirlioglu, Partner at the Balcioglu Selcuk Ardiyok Keki Attorney Partnership in Istanbul. “The entire focus is now on how to tackle the impact of the pandemic and deriving lock-down.”

“Making the political headlines recently,” Eymirlioglu says, “is the tension between the Government and opposition controlled municipalities around aid programs and donations to support municipalities’ pandemic-fighting schemes.”

The main question and all stakeholders’ focus, according to Eymirlioglu, is how to limit the hits on the economy. He describes several different mechanisms employed for that purpose. “In terms of corporate law, a new regulation temporarily prohibiting companies from distributing more than 25% of dividends that were previously undistributed has been adopted in order to maintain and solidify the cash positions and balance sheets of companies.” He continues. “Stricter monitoring rules were also adopted by the Ministry of Finance in terms of transfers of funds to foreign countries in order to prevent weaknesses in policies against money laundering and illicit financing due to the increased use of online banking transactions as a result of the pandemic.” In addition, Eymirlioglu says, “employers are prohibited from firing employees for the next three months but alternative measures such as reduced working hours backed by Government payments to the employees put on reduced hours.”

Eymirlioglu says companies in industries such as construction and tourism that have been heavily impacted by the pandemic re allowed to delay paying taxes. Courts are closed – with the exception of urgent cases – and no pre-judgement collection procedures can be initiated until June 15th.

“Additional measures have been adopted in relation to possible manipulations in capital markets in order to limit the impact of the lock-down on the prices of financial products and the value of Turkish Lira,” Eymirlioglu says.

”Generally, people aren’t panicking. Most firms were able to get organized quite quickly and carry on working from home,” he reports. There was no panic in the legal market either, he says, as “the measures that are being considered and applied are very similar to other markets – there have been no mass layoffs and the main principle is to keep the jobs. Use of accrued leaves, delay of 2019 bonuses, and salary cuts are on the table for some firms. While everyone acknowledges that this may not be the best year, there is also optimism that it might not be as terrible as the market initially thought.”

Indeed, he says, the legal market is still quite busy. “We haven’t yet seen any major drops in business. There are a lot of restructuring and refinancing projects, although some of the M&A deals are going through a slower negotiation process, as investors want to see the performance of companies in this new era.”

Eymirlioglu says that the collective effort by all parties involved will help flatten the curve so the economy can eventually return to normal. “Plans of easing the lock-down are already in place and we expect a gradual opening of businesses in the second half of May,” he says. “The pandemic made everyone realize that we can work differently and still be as productive. As more companies discover this through time, the future might hold colossal change to the ways we see things around us and surely a new normal will arise.”

The economic impacts of the new coronavirus (“COVID-19”) occur at an unprecedented level comparing to the crises experienced before. For many industries, both the supply chain has been interrupted and customer demand has shrunk at the same time. Restructurings and changes in transfer pricing policies will be inevitable for the continuity of businesses and activities since COVID 19 crisis has caused an unforeseen global risk realization which could not be predicted at the time when the intra-group contractual relationships were established and the group operation model was designed. Although the existence of conditions that require the need for policy changes is often considered as negative, it can also be turned into an opportunity by the multinational enterprises.

INTRODUCTION

The economic impacts of the new coronavirus (“COVID 19”), which emerged in Wuhan, China in December 2019 and spread to the world in a short period of time with the contribution of inter-dependency among countries, occur at an unprecedented level comparing to crises experienced before. For many industries, supply chain has been interrupted and customer demand has shrunk at the same time. Moreover, this bilateral pressure differs not only from industry to industry, but also from country to country, and even from region to region within the same country.

To say the least, transfer pricing principles aim to allocate the overall profit in proportion to the value created among the group members. However, as COVID 19 began to show its impacts, the main issue is evolved from how the profit is allocated among group companies to the problem of risk realization and how the loss should be allocated. Although factories are closed and distributors are unable to sell due to the diminishing demand and supply chain disruption, they keep bearing the idle capacity and operating costs which are unavoidable. As it is known, the revenue that the companies in the group should obtain is determined by considering the functions performed, the risks undertaken and the assets owned. However, in the case at hand, there is usually no revenue to be attributed to any addressee. As a matter of course, restructuring and changes in transfer pricing policies will be inevitable for the continuity of businesses and activities since COVID 19 crisis caused an unforeseen global risk realization which could not be predicted at the time when the intra-group contractual relationships were established and the group operation model was designed.

The purpose of this article is to address the impacts and problems that the COVID 19 crisis may trigger in terms of transfer pricing, to present the OECD and EU approach, and to brainstorm on what can be done by multinational enterprises and tax authorities. 

I. RISK REALIZATION AND ITS IMPACT ON THE FINANCIALS OF THE GROUP COMPANIES

In the simplest form, the structure of multinational enterprises is comprised of a parent company that holds all intellectual property rights, contract manufacturers or full-fledged manufacturers which carry out the production function in the countries with low labour costs, and the limited or full-fledged distributors that sells the finished goods in various markets and conducts market researches in their countries of operation (depending on the circumstances).

Before deciding on how much share the companies in the business model should receive from profit or loss, the matter of who controls the risks should be reviewed. OECD Guidelines defines the control on the risk as, 

• “the capability to make decisions to take on, lay off, or decline a risk-bearing opportunity, together with the actual performance of that decision-making function and
• the capability to make decisions on whether and how to respond to the risks associated with the opportunity, together with the actual performance of that decision-making function.” 

 If the business model of the multinational enterprises comprise of low risk level distributors or contract manufacturers which do not have impact on decision-making mechanism, the relevant businesses are expected to have a routine return determined by either cost plus or transactional net margin method. Due to their low level of risk, it cannot be expected that those companies get a share from neither high profitability nor unpredictable losses of the group. The expressed idea can be substantiated by an example given under the OECD Guidelines;

Case: “Company B manufactures products for Company A. Capacity utilisation risk and supply chain risk have been identified as economically significant in this transaction. The functional analysis provides evidence that Company B built and equipped its plant to Company A’s specifications, that products are manufactured to technical requirements and designs provided by Company A, that volume levels are determined by Company A, and that Company A runs the supply chain, including the procurement of components and raw materials. Company A also performs regular quality checks of the manufacturing process. Company B builds the plant, employs and trains competent manufacturing personnel, and determines production scheduling based on volume levels determined by Company A. Although Company B has incurred fixed costs, it has no ability to manage the risk associated with the recovery of those costs through determining the production units over which the fixed costs are spread, since Company A determines volumes. Company A also determines significant costs relating to components and raw materials and the security of supply. The evaluation of the evidence concludes that Company B performs manufacturing services. Significant risks associated with generating a return from the manufacturing activities are controlled by Company A. Company B controls the risk that it fails to competently deliver services. Each company has the financial capacity to assume its respective risks.” 

Conclusion: “In the circumstances explained above, the significant risks associated with generating a return from the manufacturing activities are controlled by Company A, and the upside and downside consequences of those risks should therefore be allocated to Company A. Company B controls the risk that it fails to competently deliver services, and its remuneration should take into account that risk, as well as its funding costs for the acquisition of the manufacturing plant. Since the risks in relation to the capacity utilisation of the asset are controlled by Company A, Company A should be allocated the risk of under-utilisation. This means that the financial consequences related to the materialisation of that risk including failure to cover fixed costs, write-downs, or closure costs should be allocated to Company A.”

As mentioned in the example, in a business model where high risks are mainly undertaken by the parent company and affiliates are subject to routine returns, the losses incurred by the affiliates due to COVID 19 can be criticized by the tax administration of their country of residence. It is possible to observe the most typical example of this point in the position of  People’s Republic of China in 2008 financial crisis. Tax Administration of China published a guide stating that it would not allow single-function and low-risk organizations to make loss.

Although subsidiaries that undertake low risk will not suffer a major loss, problem arises on whether these subsidiaries must apply their usual profit margins in case of a force majeure event that affects both supply and demand such as COVID 19. For example, in case the factory of a contracted manufacturer whose routine returns are determined to obtain a net cost plus profit margin of 6% is closed due to the lockdown, the shipment of the necessary raw material for the production cannot be made and therefore the service can be partially performed or not performed at all, shall 6% margin still be added to the costs incurred and invoiced to the parent company? The obvious answer in this regard is that multinational enterprises should act in the same way as independent enterprises would act in a similar situation. Although it is not directly predictable or attainable how independent firms would react in case of force majeure, transfer pricing policies of the firms undertaking limited risk can be revised in the period when the effects of the COVID 19 crisis are in force. In this context, it will be appropriate to draw attention to the following issues;

• While conducting benchmark analysis, idle capacity expenses and those arising directly related to the given extraordinary situation might be adjusted.
• By selecting a lower point in the arm’s length range, the accumulated profit can be transferred to the parent company that assumes the burden of the loss.

However, postponing this process and completing the process through issuing additional adjustment invoices may create additional costs in terms of customs duties. As a matter of fact, in the Hamamatsu decision made by the European Court of Justice, it is stated that the changes to be made in the transfer price will not lead to a decrease in the customs value in a way to require a refund.

• Idle capacity expenses that are not incurred as a consequence of a service performance, might be directly recharged without adding any margin.
• While testing the periods when effects of COVID 19 are present, the multi-year data approach can be abandoned and the annual approach that best reflects the fundamental change can be adopted.
• The cautious approach of the Turkish Tax Authority to the comparable companies from different markets will be deepened due to the fact that each country is affected differently from the crisis and accordingly, special attention should be paid on market differences while choosing a comparable company. Also, since the size of the stimulus packages guaranteed by each state is different, it is obvious that a health comparison cannot be made without making the necessary adjustments in the financial statements.

Making loss in low-risk affiliates may not be preferred in terms of tax risk as well as financial reasons because the related affiliates operating with limited net working capital may ultimately fall into technical bankruptcy position and may have to use intercompany loans if they cannot invoice their fixed costs such as employee salaries and rent payments. Considering the tax burdens on intercompany loans such as resource utilization support fund, reverse charge value added tax, withholding tax on interest payments, and stamp duty, it is more efficient to transfer the necessary cash to the subsidiary with a limited operating margin (in some cases without adding any margin) which is also in compliance with the arm’s length principle.

While this is the case for low-risk affiliates, full-fledged distributors and manufacturers are expected to assume a significant share in the loss, as they have control over the risk.  The OECD Guidelines clearly states that, associated enterprises can sustain genuine losses similar to independent enterprises due to heavy start-up costs, unfavorable economic conditions, inefficiencies, or other legitimate business reasons. When markets operate in normal course, the usual practice is to exclude the loss maker companies from the comparability set. However, in the comparable company sets to be established for the periods in which COVID 19’s effects continue, loss maker companies should also be included in order to prove that the loss of full-fledged distributors and manufacturers are in accordance with the arm’s length principle. In the upcoming periods, what is tested will not be the profitability levels, but the level of loss.

II. THE REALIZATION OF THE RISK AND FINANCIAL NEEDS

As noted above, full-fledged distributors and manufacturers are expected to make considerable amount of loss due to the pandemic. Therefore, capital increases, loss compensation funds and loan utilization will be on agenda of multinational companies in the upcoming periods.

Loss compensation fund is a cost element for the parent company making the payment, and an increase in equity for the acquiring company. As it is known, it is stated in various rulings issued by the Turkish Revenue Administration that the loss compensation fund should be added to the taxable corporate income. Whether the loss compensation funds should be subject to tax is not within the scope of this article because it is a highly controversial issue that has recently been taken to another dimension thanks to the Communiqué on the Procedures and Principles Regarding the Implementation of Article 376 of the Turkish Commercial Code dated 15.09.2018. However, the important point to be mentioned here is that the relevant payments can be taken into account as an expense in the country where the payee is a resident, to the extent that the legislative regulations permit and the conditions described below are met. A possible hybrid mismatch can result in favour of the group. 

• The subsidiary needs this payment,
• Economic justification of the determined amount can be made,
• The benefit of payment to the subsidiary can be proved and measured.

Due to the effects of COVID 19, multinational enterprises might merge companies, transform their full-fledged entities into the ones with limited risks or shut down businesses entirely through restructurings. During this restructuring process, by taking into account the cost-benefit analysis in the middle or long term,  the former opinion on the loss compensation fund to be transferred by the investors to the full-fledged distributors and manufacturers might be revised by Turkish Tax Administration in a way parallel with the regulations made under Turkish Commercial Code in order to prevent shut downs or downsizing functions.

Considering the extra costs of intra-group loans, another way to finance full-fledged distributors and manufacturers for the parent company is to be a guarantor for the third-party bank loans. Customarily, the guarantor company collects an arm’s length remuneration in return for the risks undertaken and benefit provided to the related party. In order to guide the implementation in this matter, we believe it is necessary to refer to the interesting and unexpected Hornbach decision of the European Court of Justice. In the referred case, the German resident parent company named Hornbach DE, in order to enable its Dutch subsidiary (with negative equity) to use bank loans, had acted as guarantor without charging any remuneration for this explicit benefit. German Tax Administration criticized this practice, and increased the taxable earnings of Hornbach DE at the amount of arm’s length guarantee service fee. Hornbach DE took the matter to the European Court of Justice. Accordingly the Court has held that “In a situation where the expansion of the business operations of a subsidiary requires additional capital due to the fact that it lacks sufficient equity capital, there may be commercial reasons for a parent company to agree to provide resource on non-arm’s-length terms” and then concluded that there is no need for remuneration if there is a commercial and economic justification for the non-arm’s length behaviour. It is inevitable that the COVID 19 crisis will create similar and even more solid economic grounds. Although the Hornbach decision can be binding only for members of European Union, the flexibility to interpret Turkish Tax Laws which are based on substance over form principle and the compatibility with economic, commercial and technical requirements, in the same manner should be allowed in times of crisis. 

III. TRANSFER PRICING ADJUSTMENTS

In a related party transaction, setting the price at the time of the transaction and testing the arm’s length nature of the prices at the date of reporting are different concepts.  Whereas, in order to set the prices at the moment of transaction the market prices or (in the situations where transactional profit methods are used) the latest publicly available financial data of the comparable companies are considered, testing the price at the time of reporting is usually made by taking into account the financial data of the relevant year and two years preceding that year. However, as a result of the interruption in supply chain and shrinking demand caused by the COVID 19 crisis, regular market conditions do not occur, and it becomes impossible to find internal or external comparable prices and to apply the comparable uncontrolled price method. The latest published data of the comparable companies are at best the data of the previous financial periods which is not a viable way to assess transactions taking place in these strange times.

In extraordinary situations such as COVID 19 crisis, it is an undeniable fact that the prices should not be determined according to the data of the previous financial year. Therefore, it is almost certain that the prices to be determined at the time of the transaction will be subject to adjustments later. For this reason, multinational enterprises may need to issue price difference invoices in order to ensure that the COVID 19 impact is reflected to the financials of external comparable companies that meet the comparability criteria. In practice, adjustment amount can only be calculated when the financial data of the comparable companies is published in publicly available databases, in other words, in the middle of 2021.

Different discussions will come to the agenda regarding clarification of price difference amounts. The accrual basis is used in calculating the commercial income, and in order for an expense to be deducted from commercial earnings, it must become definite in terms of nature and amount. The availability of public data towards mid-2021 would create controversies regarding when the amount is actually accrued and becomes definite. If it is claimed that this expanse is related to 2020 as required by the periodicity concept, the precautionary actions facilitating the refund processes of taxpayers who reduce their tax bases should be taken or an opinion should be given by the Revenue Administration ruling that this expense has become definite in 2021 and a deduction can be made in the calculation of the tax base of 2021. On the other hand, the opinion mentioning that the finalization took place in 2021 would be appropriate in order not to add the burden of default interest to the economic burden already faced by taxpayers who increase their tax bases of 2020 as a result of the adjustment amount calculated due to the abovementioned emergency situation. In fact, the mentioned adjustments may lead the 10% limit in advance tax application to be unintentionally exceeded due to factual impossibility. Within this framework, it is recommended to take precautions in advance to reduce the compliance costs on taxpayers.

Transfer pricing adjustments would also lead to some disputes in terms of customs. While the above mentioned Hamamatsu decision has ruled that there is no need for a customs correction in case of downward transfer pricing adjustments, it is known that EU customs legislation allows upward price corrections. Uniformity should be ensured in terms of corrections occurring after the importation date and that are directly related with imported goods and return mechanisms for downward price adjustments related to imported goods should be developed. 

IV. THE EFFECT OF FORCE MAJEURE CONCEPT ON INTERCOMPANY AGREEMENTS

Companies that fail to fulfil their contractual obligations due to the unexpected results of the COVID 19 crisis may request the application of force majeure clauses or the alteration of contract terms. The concept of force majeure refers to unexpected events which develop beyond the will of the parties and cannot be prevented by them such as war, terrorist act, earthquake and epidemic illness and thus restrains borrower from fulfilling its obligations. In cases of force majeure, obligations can be suspended, postponed or entirely eliminated.

Reviewing intercompany agreements due to force majeure will have implications for transfer pricing. In the OECD Guidelines, it is stated that companies in declining economies may need commercial restructurings. As a matter of fact, it is stated in paragraph 6.184 of the OECD Guidelines that the occurrence of major events or developments unforeseen by the parties at the time of the transaction or the occurrence of foreseen events or developments considered to have a low probability of occurrence which change the fundamental assumptions upon which the pricing was determined may lead to renegotiation of the pricing arrangements by agreement of the parties where it is to their mutual benefit;

“6.184 For example, a renegotiation might occur at arm’s length if a royalty rate based on sales for a patented drug turned out to be vastly excessive due to an unexpected development of an alternative low-cost treatment. The excessive royalty might remove the incentive of the licensee to manufacture or sell the drug at all, in which case the licensee will have an interest in renegotiating the agreement. It may be the case that the licensor has an interest in keeping the drug on the market and in retaining the same licensee to manufacture or sell the drug because of the skills and expertise of the licensee or the existence of a long-standing co-operative relationship between them. Under these circumstances, the parties might prospectively renegotiate to their mutual benefit all or part of the agreement and set a lower royalty rate. In any event, whether renegotiation would take place, would depend upon all the facts and circumstances of each case.”

For example, it may be advisable to review in-group licensing contracts as a remedy to financial difficulties likely to be experienced by full-fledged distributors and manufacturers, mentioned earlier in the article. The related enterprises pay a certain percentage of their sales to the group company, which owns intellectual property rights as a result of the use of brand and technical information. These payments are called royalty fees. Due to the unexpected situation created by COVID 19, the force majeure articles of the trademark and know-how usage contracts should be reviewed and whether royalty payments would be suspended in such cases should be re-considered.

In addition, OECD clearly states that there should be no presumption that all contract terminations or substantial renegotiations should give a right to indemnification at arm’s length, as this will depend on the facts and circumstances of each case. The analysis of whether an indemnification would be warranted at arm’s length should be made on the basis of the accurate delineation of the arrangements before and after the restructuring and the options realistically available to the parties.

However, terminations that cannot be explained with the conduct of independent businesses, commercial practices and valid economic reasons will require compensation for the damaged party. According to OECD, restructuring might be a better option for an entity than going out of business altogether except the situations in which total shutdown is required.

Accordingly, the COVID 19 period creates a favourable ground for evaluating intra-group restructurings.

V. CONCLUSION

A number of problems such as interruptions in the supply chain, the diminishing demand and the termination of the activities caused by COVID 19 health crisis would lead multinational enterprises to review, change and partially or completely terminate some of their transfer pricing policies and business models. The OECD is expected to publish a guidelines, as it did in the impact of the COVID 19 crisis on tax treaties, on how loss caused by global risk realization should be shared among the companies within a group, the effects of possible restructurings and impact of financing instruments on the arm’s length nature of the intercompany transactions. Ministry of Treasury and Finance should take steps in order to prevent Turkish economy from possible damages resulting from potential restructurings and should introduce regulations and guidelines for this purpose when necessary.

Although the existence of conditions that require the need for policy changes is often considered as negative, it can also be turned into an opportunity by the multinational enterprises.

In the stable periods of the economy, structural changes that are put on the table attract more attention and are scrutinized in detail by the tax authorities. However, rare periods where fluctuations and predictability are minimal such as COVID 19 period, are suitable for producing a solid rationale for paradigm shifts. In addition, it would be reasonable now to sell out tangible and intangible assets which have been planned to be transferred between related companies as market values would be lower, if exists, than it is in the stable periods.

By Pınar Solyali, Senior Tax Manager, Nazali Tax & Legal

Former Herguner Bilgen Ozeke Partner Bige Yucel has joined Siemens as its Deputy General Counsel in Istanbul.

Yucel worked for almost 15 years for Herguner Bilgen Ozeke and was made Partner in 2016 (as reported by CEE Legal Matters on November 14, 2016). Before Herguner Bilgen Ozeke, she worked for one and a half years at the Bicakci & Tanverdi law firm.

 

Former Paksoy Partner Selin Barlin Aral has joined Getir as its Chief Legal Officer in Istanbul.

Getir is an Istanbul-based technology company founded in 2015 that allows users to order a wide range of products and promises an average delivery time of ten minutes. 

Early in her career, Aral worked as an attorney at the Solmaz Customs Consultancy Co. In 2010 she moved to Paksoy, where, in 2018, she became a Counsel. In 2019, she was promoted to Partner (as reported by CEE Legal Matters on January 8, 2019).

“I am very happy and excited to be joining Getir,” Aral said about the move, “which is one of the few Turkish start-ups on the verge of becoming a unicorn!”

 

Turkey’s Turunc law firm has advised Yu-Ce Medical and its shareholders, Cengiz Balcik and Yumnu Balcik, on the acquisition of the remaining 28% of Yu-Ce shares from the Anatolia Growth Capital Fund. Yuksel Legal advised Anatolia Growth Capital Fund on the deal.

As a result of the acquisition, Cengiz Balcik and Yumnu Balcik now own 100% of Yu-Ce Medical. 

Turunc’s team was led by Managing Partner Kerem Turunc.

Yuksel Legal’s team was led by Partner Sinan Yuksel.

The new coronavirus (“COVID-19”), which emerged in the city of Wuhan, China in December 2019 and spread around the world in a short time with the contribution of interdependence between countries, continues to have significant effects in many areas of life. One of these areas is international tax law, and potential disputes should be expected in the near future regarding taxation rights, which are demarcated by Avoidance of Double Taxation Treaties (“DTT”).

Some articles in DTTs that define the taxation rights of the countries refer to the current physical presence and number of days. Practices limiting the movement of persons such as travel restrictions and lockdowns under COVID-19 precautions, have led many employees to operate on behalf of a resident enterprise outside the country where they are supposed to work at normal times, and all face-to-face meetings to be held on digital media. In order to satisfy some doubts about the impact of this extraordinary situation on the principles set out in the tax treaties, the OECD Secretariat has published an analysis in April 3^rd, 2020 entitled “Tax Treaties and the Impact of the COVID-19 Crisis”. The main purpose of the text is to protect employees and employers from unforeseen tax burdens resulting from exceptional circumstances and to reduce compliance costs.

This article aims to evaluate the impact of the precautions taken during the COVID-19 crisis on the periods in DTTs, the OECD approach and the steps taken by the countries.

I. HESITATIONS REGARDING THE CONCEPT OF PERMANENT ESTABLISHMENT

Article 5 of DTTs defines the concept of “permanent establishment”, and other articles that examine different types of income, such as commercial income and self-employment income, make reference to commercial activities through that permanent establishment while determining the taxation right of the source country. While the physical areas such as place of management, branch, office, factory, etc. are determined as permanent establishments, in some cases the existence of a PE depends on the time spent in the source country.

It is stated in Article 5/3 of DTTs that a building site, construction, assembly, installation project or relevant supervisory activities constitute a permanent establishment only if they last more than a certain period time. Such period usually ranges from six to twelve months. Many construction activities have come to a standstill due to the COVID-19 crisis. Under these circumstances, some hesitations emerged whether the time period when the activities are interrupted should be taken into account in the calculation of the time required for the construction sites to constitute a permanent establishment.

The response of the OECD Commentary on the Articles of the Model Tax Convention to this hesitation does not fit in taxpayers’ pre-COVID-19 plans. In Paragraph 55 of the commentaries of Article 5, it is stated that temporary or periodic interruptions in the periods should be taken into consideration while determining the life of a construction site.

“Seasonal or other temporary interruptions should be included in determining the life of a site. Seasonal interruptions include interruptions due to bad weather. Temporary interruption could be caused, for example, by shortage of material or labor difficulties. Thus, for example, if a contractor started work on a road on 1 May, stopped on 1 November because of bad weather conditions or a lack of materials but resumed work on 1 February the following year, completing the road on 1 June, his construction project should be regarded as a permanent establishment because thirteen months elapsed between the date he first commenced work (1 May) and the date he finally finished (1 June of the following year).”

Another hesitation may realize in the concepts of “Service Permanent Establishment” and “Home Office”. Some companies are concerned about the creation of a permanent establishment that will expose them to new certification requirements and tax obligations as their employees regularly work from home in countries other than the country in which they work.

In some DTTs (DTT signed between Turkey and Germany can be cited as an example), it is stated that consultancy services performed by an enterprise in a contracting state through its employees or other personnel assigned for this purpose and continuing for a period or periods exceeding six months in any twelve-month period shall constitute a permanent establishment. In other types of treaties, the activities and periods referred are included in Article 14, which regulates the taxation of income from self-employment activities.

One of the most important criteria in the determination of the source country’s right to taxation in services permanent establishment or self-employment activities is the calculation of 183-days period. The document “Tax Treaties and the Impact of the COVID-19 Crisis”, published by the OECD, did not specifically address how COVID-19 would affect the 183-days rule. However, it is understood from the statements that  OECD considers that the temporary work of employees in an area or country due to unusual reasons should not create a workplace on behalf of the employer. According to OECD’s approach, it can be assumed that a permanent establishment exists only if the place for the relevant work has a certain degree of continuity, i.e. only if it does not have a temporary nature. Therefore, the fact that an employee works from home in the other country because of force majeure and the closing of borders per se does not constitute a permanent establishment.

However, OECD did not mention in its document about the impact of COVID-19 on the calculation of 183-days covered by self-employment activities. Generally, OECD countries use the “physical presence” method in the calculation of 183-days. This method is quite straightforward in terms of application. In OECD Model Tax Convention, Paragraph 5 of Article 15, which regulates dependent personal activities, describes how to calculate 183-days and can also be adapted to Article 14 because it reflects the general OECD approach.

“Although various formulas have been used by member countries to calculate the 183 day period, there is only one way which is consistent with the wording of this paragraph: the “days of physical presence” method. The application of this method is straightforward as the individual is either present in a country or he is not. The presence could also relatively easily be documented by the taxpayer when evidence is required by the tax authorities. Under this method the following days are included in the calculation: part of a day, day of arrival, day of departure and all other days spent inside the State of activity such as Saturdays and Sundays, national holidays, holidays before, during and after the activity, short breaks (training, strikes, lock-out, delays in supplies), days of sickness (unless they prevent the individual from leaving and he would have otherwise qualified for the exemption) and death or sickness in the family. However, days spent in the State of activity in transit in the course of a trip between two points outside the State of activity should be excluded from the computation. It follows from these principles that any entire day spent outside the State of activity, whether for holidays, business trips, or any other reason, should not be taken into account.”

As can be understood from the above explanation, the periods spent due to the cessation of activity in the other state are included in the calculation of 183 days. For example, if an Irish resident company’s employee who came to Turkey for 4 months to perform engineering services stops working for 3 months due to COVID-19 and does not return to Ireland, withholding tax deductions may be made from the payments to the Irish resident company as the idle 3 months will be taken into consideration in the calculation of 183-days. However, as mentioned above, due to the uncertainty in the current reaction of the OECD, it was not possible to make a complete evaluation.

II. HESITATIONS REGARDING THE TAXATION OF EXPAT WORKERS

In Paragraph 2 of Article 15 of DTT, meeting any of the following conditions is deemed sufficient for the income derived from the employment contract to be taxed in another state; 

a. The recipient is present in the other State for a period or periods exceeding in the aggregate 183 days in any twelve month period commencing or ending in the fiscal year concerned, or

b. the renumeration is paid by, or on behalf of, an employer who is a resident of the other state, or

c. the renumeration is borne by a permanent establishment which the employer has in the other State.

In the document titled “Tax Treaties and the Impact of the COVID-19 Crisis” published by the OECD, the amounts paid to the employee due to stimulus packages granted by the governments in some countries aiming at maintaining employment are resembled to payments related to termination of the employment contract and it is emphasized that the source country should not lose its right to taxation. In Paragraph 2.6 of Article 15 of the OECD Commentary, it is explained that the mentioned payments should be attributed to the country in which the employee would continue to operate if such a situation had not occurred. In most cases this country refers to where the employee was working before the COVID-19 crisis.

How to calculate 183-days was explained in detail in the section titled “Hesitations Regarding the Term Permanent Establishment”. Accordingly, short interruptions and all other days spent in the state where the activity is carried out will be taken into consideration while calculating the time period. According to the Article 15 of DTTs, if the expats resides in the same contracting state for less than 183 days, the right of taxation would belong to country of residence if the other conditions are also met. The disadvantage of expats is that they cannot benefit from the related article of DTT, due to the fact that their physical presence is in the other contracting state. Since the expression “in any 12-month period beginning or ending within the relevant fiscal year” is included in the aforementioned clause, it is highly likely that this negative effect will extend to more than one year.

III. HESITATIONS REGARDING RESIDENCY

Another issue that the COVID-19 crisis may affect is the concept of residency. Residency is firstly determined according to the internal legislations of the countries. When a person is deemed to be resident of more than one state, the Article 4 of DTTs which regulates the concept of residency is examined. According to the mentioned article:

“a) A person shall be deemed to be a resident only of the State in which he has a permanent home available to him; if he has a permanent home available to him in both States, he shall be deemed to be a resident only of the State with which his personal and economic relations are closer (center of vital interests);

b. if the State in which he has his center of vital interests cannot be determined, or if he has not a permanent home available to him in either State, he shall be deemed to be a resident only of the State in which he has a habitual abode;

c. if he has an habitual abode in both States or in neither of them, he shall be deemed to be a resident only of the State of which he is a national;

d. if he is a national of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.”

OECD’s stance on the effects of the COVID-19 crisis on residency is clearer than the other issues. According to the approach of OECD, relatively short periods of residency, is unlikely to affect the center of the individual’s vital interest. In addition, even if the next criterion is considered, according to the Paragraph 19 of Commentary on Article 4, while determining the house in which the person has stayed habitually, not only limited number of days spent in a certain period is taken into account,  but also frequency, duration, and continuity of the residency which are parts of the individual’s established routine are taken into account.

Two types of problems may arise regarding the concept of residency. These are:

• The person may have travelled abroad for a vacation or a short-term work and be stuck in quarantine in the country of travel because of the lockdown or travel restrictions. In that case, generally, the person is not deemed as a resident of that state according to the local legislation of the country of destination. However, even in rare cases where residency may occur according to the domestic legislation, COVID-19 is not expected to affect the country in which  the person is a resident since the right of taxation under the provisions of DTT would belong to the country where the person can stay permanently and where she/he has vital interests.
• Secondly, the person may have had a residency status in the country where she/he has been working for a while, but after COVID-19, she/he may have gone back to the country she/he used to stay due to the family reasons. In this case, deciding on the residency status is more difficult and uncertain than the first case. The main reason for this is that, the bond with the country where the person was born, or spent many years, but has not lived for a while is much stronger. In such cases, habitual abode is referred in order to determine where the person is resident,. As stated above, temporary accommodations should not be taken into consideration in the determination of the residency status.

Therefore, it is not expected that COVID-19 would affect the country where a person is tax resident.

IV. PRECAUTIONS TAKEN BY SEVERAL COUNTRIES

In order to eliminate the hesitations mentioned above, revenue administrations of some countries have made explanations. The Irish Revenue Administration published a guideline and stated that the presence of employees, directors, service providers who remain in quarantine due to COVID-19, and are working for a company which is resident in another country are disregarded in deciding on whether the limited taxpayers are going to be taxed or not. In addition, according to the statement in the same guideline, if a person cannot leave Ireland due to a force majeure, the time spent from the scheduled departure day onwards will not be taken into consideration in determining residency status.

In the guide published by Her Majesty’s Revenue and Customs, it is stated that the fact that the meetings of an institution’s board of directors are taking place within the borders of UK due to COVID-19 cannot lead to the claim that the central management is in UK and therefore the company should be counted as tax resident. In the statement, it is added that even if the central management of a company is located in UK, this does not mean that the company will be a taxpayer because the company may also be resident in another country that has signed a DTT with UK, and in such cases, as a result of applying the tie-breaker rules, the company may not be considered as a UK resident. In addition, a detailed guide has been published on whether the time spent in the UK due to unforeseen extraordinary situations will affect the tax residency of real persons.

Australia has made the most comprehensive explanations about the hesitations described above. The Australian Tax Administration has published a source of frequently asked questions regarding the management of taxation rules in response to COVID-19 crisis. In the mentioned resource, following points draw attention:

“Individuals who are not Australian tax residents and are in Australia temporarily because of COVID-19 will not become Australian tax residents provided that they usually live overseas and intend to return there as soon as they are able to. Their paid leave from a foreign employer and foreign employment income earned while working in Australia solely as a result of COVID-19 will not be assessable in Australia. Non-resident companies that are required to hold board meetings in Australia, or directors attending meetings from Australia, solely due to COVID-19 will not be deemed to have the central management and control (one of the corporate residence tests) in Australia. The unplanned presence of employees of nonresident companies in Australia due to COVID-19 travel restrictions will not by itself give rise to a determination that the company has a permanent establishment in Australia. Further, where a nonresident employee of a non-resident company works in Australia as a result of COVID-19 travel restrictions, the employer will not be expected to register for PAYG withholding.”

Other countries that have taken steps in this regard are Germany, Luxembourg, Belgium, France, and Switzerland, which have geographical proximity and therefore have many mobile workers. Belgium and Luxembourg introduced a rule called “24-days Rule” in 2015. For example, Belgian employees working in Luxembourg will be able to work outside of Luxembourg for 24 days a year, but can benefit from exemptions in Belgium. Belgium’s and Luxembourg’s tax authorities have acknowledged that the COVID-19 crisis created a force majeure event in which days worked in Belgium (for example home office activities) are not counted under the 24-days rule. In addition, Belgium’s and France’s tax authorities have also applied this force majeure approach for French workers on the border who live and work in different countries, and have to work from their homes in France instead of Belgium due to COVID-19. With a joint press release dated March 19, 2020, the situation of working from home due to COVID-19 has been clarified. Germany, Belgium, France, Switzerland, and Luxembourg reached an agreement and considered the necessity of mobile workers to be at home as a force majeure and guarantee that this will not affect taxation.

On the other hand, the Swiss Federal Tax Administration has declared that working from home in another country will not create a permanent establishment due to COVID-19, as a forced residency does not present continuity. However, if working from home takes longer than six months, each case should be examined on an individual basis. Besides, in most cases, even in long-term activities, the permanent establishment does not occur because the employer does not have the disposal over the premises and this space is not used exclusively for business purposes.

V. CONCLUSION

The lockdown and travel restrictions caused by COVID-19 health crisis have brought about a number of problems in all areas of life. In the area of international tax law, there has been some hesitations about how the terms of the DTTs should be implemented. In order to prevent real persons and corporates from facing double taxation in the future, incremental increase in their tax burdens or grappling with bureaucratic processes such as refunds, the OECD has published a document which includes some recommendations. However, the relevant document does not solve the problems on its own, in fact it does not address some hesitations such as the 183-days calculation. The guidelines mentioned above and published by the countries’ own revenue administrations shed light on the implementation, and no steps have been observed so far which has taken by Turkey in this regard. It will be useful for Turkish Revenue Administration to share its opinions that would guide the implementation as soon as possible.

By Pınar Solyali, Senior Tax Manager, Nazali Tax & Legal

Turkey’s Penezoglu Law Firm has merged with BTS & Partners, with Gokhan Penezoglu assuming leadership over the BTS & Partners’ Tax department.

Penezoglu has more than 25 years of experience, including three years at Arthur Andersen Business Consulting, 15 years at Ernst & Young. He left EY in 2016 to join KPMG and to found and manage Penezoglu Hukuk Burosu. He studied at Istanbul Bilgi University and Dokuz Eylul University.

According to BTS, “Penezoglu has comprehensive experience on tax law as he has been providing extensive services to his local and international clients in all tax-related issues for many years. He advises clients on a wide range of issues and represents them during tax inspections and tax dispute resolution processes.”

“As Penezoglu Law Firm, we are highly confident that our cooperation with BTS & Partners will bring us and our clients very successful outcomes,” said Gokhan Penezoglu.

I can pinpoint the exact moment when my interest in the law first flourished: I was 13 years old and my mother had given me a book called The Courage of their Convictions by Peter H. Irons, about 16 Americans who had fought for their rights and taken their cases all the way to the Supreme Court, and what I read resonated deeply within me. It later turned out that my mother had only given me the book to improve my English. But it opened the door to so much more.

During my time at Ankara University I had the opportunity to study under numerous respected scholars, and, perhaps because both of my parents were university professors, my initial plan was to make my career in academia; it actually still is. Once I started practicing law, it was due to this abiding desire that I continually tried to expand my knowledge by researching and writing about legal theory and practice, as well as by teaching classes as a guest lecturer at three universities – this has kept me motivated and “fresh.” Every year, in my final lecture, as they prepare embark on their legal careers, I tell my students the same secret to success: keep a keen eye on global developments, seek out uncharted territories and expand, and connect with people from all walks of life.

It was these considerations that led me to continue my academic journey by studying for my Master’s degree in the US, and later, by working in New York and Brussels, before returning to establish my own practice in Istanbul. At the time, in the early 90s, although the EU Commission had been ruling on competition law matters since the second half of the 1960s, Turkey had only recently adopted its competition legislation and established its Competition Authority; the area was ripe with opportunity. The rulings of the Commission, the US antitrust literature, and the decisions of the European national competition authorities were all indispensable and highly educational for a fledgling Turkish competition law practitioner. 

The early 1990s was also a time in which Turkey flourished economically and foreign investments poured into the country. As in other CEE countries, a new market (in its case, with a population of 75 million) with a relatively inexpensive but well-educated work-force was attractive for investors, especially since Turkey could be a regional hub to gain access to both the European market and the Middle Eastern and African countries. Being a new market necessitated the creation of an investment arena with attractive investment incentives and transparent regulations, usually in line with EU acquis due to Turkey’s pending application for membership. The presence of a familiar regulatory foundation that allowed for efficient risk assessment was appealing for investors. Unsurprisingly, many global law firms that detected a business opportunity opened offices in Turkey and set up partnerships with local law offices, both due to regulatory reasons and to take advantage of the home-grown expertise of those office’s partners.

However, such economic and political interconnectivity between countries has not always been positive: the overly nationalistic and populistic winds which have now swept throughout most of CEE, as evident in recent electoral winners in Hungary, Poland, and Turkey, and of course Brexit, portend serious challenges. Fear of the “other” on both sides of the pond has unfortunately brought negative implications for human rights, whether they concern the rights of immigrants, foreign investments, or simply the freedom of expression, which is an issue that is especially close to my own heart. Although, to give credit where it is due, most countries that are at risk of veering toward nationalism/authoritarianism have not gone as far as implementing a total access ban on Wikipedia for over two-and-a-half years, which is more than I can say for my own country.

I firmly believe that, aside from all the exciting discussions of new areas of law that would stem from advances in artificial intelligence or the emerging business models of the “sharing economy,” we, as lawyers, may still need to fight on all fronts to ensure and protect basic human rights around the world. While we certainly do take courage from our convictions, just like the ordinary heroes I first read about 30 years ago, twenty-five years of legal education and practice have convinced me that it will also be our connections and collaboration that will ultimately ensure our success in not only our legal battles, but in our righteous causes.

By Gonenc Gurkaynak, Partner, ELIG Gurkaynak Attorneys at Law

This Article was originally published in Issue 7.2 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.

 

Turkish lawyers Mehmet Ipek, formerly of Ipek & Akin, and Ceyda Akbal Schwimann have joined forces to launch the new Ipek | Akbal Schwimann law firm in Istanbul. Ipek’s former partner at Ipek & Akin, Tansu Akin, has set up Akin | Legal.

Ipek established the Ipek Law Firm in 1990, then co-founded the IKMS Law Firm in 2007. In 2016 he partnered up with Akin to create Ipek & Akin. 

Splitting her time between Vienna and Istanbul, Schwimann has worked with Wolf Theiss and as Head of the Turkey Practice at Specht & Partner. She began her career in White & Case’s Istanbul office. CEE Legal Matters interviewed Schwimann for the Expat on the Market section of the magazine in 2015, when she was still with Specht & Partner.

Tansu Akin started his legal career as a law clerk with Attorney Ibrahim Akin in 1999. From 2000 to 2002 he was a legal intern with Altheimer & Gray, and from 2002 to 2006 he worked as a solo practitioner and then joined Mercedes-Benz Turk AS, where, by the time he left almost ten years later, he had become the Corporate Secretary, General Counsel & Compliance Manager. In addition to setting up Akin | Legal, he also acts as the Chief Administrative Officer of Getron, a company that develops software solutions in the fields of artificial intelligence, predictive analytics, predictive intelligent, demand forecasting, inventory optimization, prescriptive analytics, and retail.

“We are excited to have formally established our partnership after more than ten years of collaboration on Turkey-related matters,” Schwimann said. “Together we have already successfully handled a number of complicated cross border matters and with the new structure, which ensures independence and flexibility, we are confident that we will add even more value to our clients’ businesses.”

Nowadays, alternative methods of dispute resolution, not involving the courts, are increasing. Since disputes are getting ever-more complicated, and general peace between parties is preferable, parties now prefer to solve disputes with more peaceful and flexible alternative dispute resolution methods instead of litigation – and judicial systems are encouraging parties to employ these methods. In this context, mediation has in recent years become the most preferred and fastest-growing alternative dispute resolution method.

Mediation is a voluntary dispute resolution method. Since the origin of all alternative resolution methods is the parties’ desire to solve their disputes with negotiation and free will instead of binding and compulsory court processes, one of the core aspects of mediation is its voluntary basis. Disputes are solved with the assistance, contribution, and navigation of a third-party “mediator,” upon the application of parties regarding the disputed matters.

There is also a mandatory mediation system, which requires an application to a mediator as a mandatory preface to filing a lawsuit. This is common in many countries like the United States, England, and Australia, as well as many European countries. Mediation also became mandatory for labor and commercial lawsuits in Turkey in 2019. This rule has been criticized in Turkey for converting a voluntary system to a mandatory requirement, and many wonder if this system is really going to decrease the workload of courts without obstructing people’s right to access the courts.

Mandatory Mediation and Notions at Turkish Law

Fundamentally, mediation is not new – it has a history as long as mankind, although integrating mediation into law is more recent. For this reason; even though mediation systems have many benefits, there are some problems in both theory and practice. Due to mediation’s expected ability to reduce the workload of courts, its mandatory use has been welcomed as a savior.

Under one view of the doctrine, however, mandatory mediation conflicts with the core aspect of mediation – its voluntary nature. Rules forcing parties to attempt mediation before filing a lawsuit raises concerns about the possibility that parties will be forced to settle. By definition, many argue, if mediation is mandatory it becomes less voluntary. As a result, many claim, mediation in Turkey is transforming into an unproductive and bureaucratic obligation.

On the other hand, many note that Article 26 of Turkey’s Constitution secures each citizen’s right to make an application to judicial bodies. Mediation simply replaces the way of making this application; it is not an alternative to the judicial bodies themselves. This view also states that because mandatory mediation supplements traditional judicial remedies parties should be willing to attempt it. If one or both parties are not willing to join mediation, the chances of coming to a settlement decrease. In accordance with this view, even though the voluntary basis of mediation is damaged with mandatory mediation system, because parties still have the free will to settle or not and they can decide for themselves on the conditions of settlement, criticisms of the mandatory mediation system are exaggerated. To sum up, this view defends the notion that parties can be forced to apply for mediation because since it will not be possible to force them to make a settlement, the main principles of mediation are not damaged.

Conclusion

As a result, when positive and negative outcomes of mandatory mediation are evaluated together, it is safe to say that the benefit it brings in decreasing the workload of the courts does not come at the cost of obstructing people’s right to access justice.

By Demet Yilmaz Utkaner, Executive Partner, and Zuhra Acar, Attorney, Sezer & Utkaner

This Article was originally published in Issue 7.2 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.