Changes on Double Taxation Implementations and Potential Effects on International Holding Companies

3/26/2021

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In line with the 15th Action Report within the scope of the Base Erosion and Profit Shifting Project (the “BEPS Project”) conducted by the Organisation for Economic Co-operation and Development (the “OECD”), the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the "Convention"), stipulating amendments to the double taxation agreements has been signed by 68 countries including Turkey on 7 June 2017.
The Draft Law bearing a crucial role in terms of the introduction of the Convention was submitted to the Turkish Parliament Plan and Budget Committee on 3 June 2020, and the ratification process of the Convention is being expected in the near future. Following the completion of the internal legislative procedures of Turkey, the Convention shall enter into force on the first day of the month following the expiration of a period of three calendar months beginning on the date of submission of the instrument of ratification, acceptance or approval to the secretariat of OECD.

By including tax treaty related measures to address certain hybrid mismatch arrangements, prevent treaty abuse, address artificial avoidance of permanent establishment status, and improve dispute resolution; the Convention ensures that existing agreements for the avoidance of double taxation on income are interpreted to eliminate double taxation with respect to the taxes covered by those agreements without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in those agreements for the indirect benefit of residents of third jurisdictions). Effective mechanism will be ensured by the Convention to implement agreed changes in a synchronised and efficient manner across the network of existing agreements for the avoidance of double taxation on income without the need to bilaterally renegotiate each of such agreements.

Application of the three alternative methods in which countries may address problems arising from the inclusion of the exemption method in treaties with respect to items of income that are not taxed in the state of source are described under Article 5 of the Convention. While the first two options, Option A and B, make partial amendments to the provisions regulating exemption method; Option C stipulates deduction from taxes paid within the country where the income is earned. Recognising that asymmetrical application is commonplace in provisions relating to elimination of double taxation where different options are chosen by each party, then by default, each party would be permitted to apply its chosen Option with respect to its own residents.

Turkey has given preference to the application of Option C, namely the "credit method" of the Convention, for the avoidance of double taxation in respect of the following countries:
Albania Sweden
Azerbaijan Kyrgyzstan
Bangladesh Turkish Republic of Northern Cyprus
Belgium Latvia
Belarus Lithuania
Indonesia Macedonia
Estonia Moldova
Morocco Slovakia
India Sudan
Croatia Thailand
The Netherlands Turkmenistan

The fact that Turkey has elected the credit method will have significant tax-related impacts in terms of the taxation of the dividends to be distributed to the shareholders being resident in Turkey of the companies indicated above. For instance, pursuant to Article 23 of the Agreement Between the Republic of Turkey and the Kingdom of the Netherlands for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income; the dividend tax paid in the Netherlands according to the provisions of this Agreement shall be deducted from the amount to be paid in Turkey for the taxes imposed on dividend income. However, upon the implementation of the Convention, the mentioned dividend income will become subject to the corporate tax, (which is 22% for 2021 and for the following years, 20%) and the taxes paid for dividend income in the Netherlands will be deducted from the corporate tax calculated in accordance with the corporate tax return. On the other hand, deduction will not be made in Turkey from the taxes calculated in accordance with the declared income in terms of the corporate taxes paid in the Netherlands or any other country by the companies being resident in the Netherlands.

In this regard, in case the relevant Draft Law is accepted by the Parliament, it is likely that companies resident in Turkey making investments in the Netherlands to face significant amounts of tax payments in the upcoming period where such investments should be well evaluated.

MORAL & PARTNERS COMPLIANCE TEAM
Vefa Reşat Moral, Managing Partner
Aslı Pamukkale, Partner

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