Developments in Turkish tax legislation, disputes and adjudication

Zeki Gündüz PwC

Recent revisions in tax and customs legislation are significant as they indicate the adoption of a taxpayer rights-centric approach. On the one hand, the legislature sought to meet criticisms regarding the principles of equality and the rule of law. On the other, it sought to reform the tax administration to make it more efficient and to bring it under stricter control.

Within this framework, important revisions were made in the Tax Procedure Law and the customs legislation. These revisions can be basically examined in two parts. One part of the revisions is directly aimed at securing the constitutional rights of the taxpayer and enabling the rule of law, while the other part is directed at reducing tax revenue loss and tax evasion, and getting the most efficient results with the most competent staff in the shortest time. For instance with the secondary legislation that was enacted, the tax inspection process was regulated in detail, especially the commencement, the procedural principles and the elements of the tax inspection report.

Evaluation of the inspection reports by the report review commission is a particularly important and novel development in Turkish law.

Within the framework of the revisions made in the Tax Procedure Law, an approach in which taxpayers are grouped according to their areas of activity and volume of business was adopted to realise planned and strategic inspections.

Subsequent to the abovementioned developments that enabled the tax administration to specialise in the inspection processes, the administration embarked on a series of aggressive inspections. This series of aggressive inspections concern a wide variety of issues covered by the related body of law, and thus it is not possible to say that a particular issue is of overriding importance. Nevertheless, it may be noted that the more prominent inspection subjects in terms of total value concern transfer pricing.

The same kind of aggressive stance can be seen in the approach of the Customs Administration. In this context, the hot inspection subjects may be categorised as customs value inspections, inspections regarding import controls and permits, inspections regarding price difference invoices, and inspections regarding VAT tax bases in imports.

The subject of transfer pricing, a legal framework for which was established with Corporate Tax Law No 5520, is one of the most controversial and most appealing topics in Turkish law.

Although the statutory provision and related secondary legislation, drafted according to OECD principles, seems to afford the taxpayer a degree of convenience, this proves not to be the case in practice.

The related legislation, which entered into force in 2007 and which prescribes novel practices, unsurprisingly gave rise to perception and interpretation differences between the taxpayer and the tax administration. Among the inspections that were conducted in almost all industries, those that targeted the pharmaceutical industry – especially those concerning active ingredient purchases – distinguished themselves because of the high value assessments which they resulted in.

A lot of controversy concerning the inspection processes arose from the use of classified comparable prices. As a result of this approach, which violates the taxpayers' constitutional rights, legal action was taken regarding many tax disputes. However, all was settled with a tax amnesty law that was enacted before any court decision was delivered.

Consequently, it is not possible to refer to a significant number of court decisions which could be considered as precedential regarding transfer pricing. That being said, a large fraction of the small volume of established precedent seems to be in favour of the taxpayer. Whether in favour of the taxpayer or not, the approach of the courts in transfer pricing cases is another matter of debate. Some courts opted to share the details of the classified comparable prices with the taxpayers in acknowledgement of their right to a fair trial and legal certainty, while other courts opted not to disclose the classified details. These circumstances were widely criticised in legal literature, particularly with regards to the right to a fair trial.

The introduction of advance pricing agreements (APA) with Corporate Tax Law No 5520 is another important development regarding transfer pricing. While APAs, which are regulated in line with the relevant OECD principles, offer an alternative solution for taxpayers who do not want to face transfer pricing disputes in the future, in practice very few agreements were signed. The legal character of these agreements – a novelty for the taxpayers and the tax administration – is subject to debate in tax law literature, especially with regards to administrative and constitutional law.

Advance pricing agreements enter into force immediately upon signing. The agreement application evaluation procedure takes between 18 to 24 months depending on whether it is a unilateral, bilateral or multilateral agreement and according to the level of complexity of the relevant transactions. All of these factors being considered, it is of the utmost importance to prepare thoroughly, use time wisely and create a proper strategy.

In practice, the tax administration is known to suggest that taxpayers subject to continuing inspections apply for APAs and agreements have indeed been made for inspections regarding past tax periods. Such an approach on the part of the tax administration reflects the administration's eagerness to engage in continuous agreement negotiations. Accordingly, there are many agreement negotiations that are in progress.

It goes without saying that the most basic dispute resolution mechanism in legal systems is going to court. Nevertheless, this does not mean that going to court is always the best way, considering the costs and risks it entails. It is for this reason that Turkish law, like other continental civil law systems, provides for out-of-court administrative dispute resolution mechanisms. The institution of reconciliation is one of the most significant of these mechanisms.

Substantial law stipulates two types of reconciliation meetings, that is, the pre-assessment reconciliation and post-assessment reconciliation procedures. The benefits for the taxpayer depend on the type of reconciliation chosen.

The basic difference between the two reconciliation applications is the scope. In pre-assessment reconciliation, all kinds of tax, duties and fees which the tax offices have power to assess based on inspection reports written by authorised tax inspectors, as well as related tax loss penalties, irregularity and special irregularity fines, are included in the scope of the reconciliation. Meanwhile, in post-assessment reconciliation only the tax, duty and fees which are assessed according to the additional assessment, ex officio assessment and administrative assessment procedures are included.

Pre-assessment reconciliation applications are made in writing to the inspectors conducting the tax inspections or to the team or group presidencies, while post-assessment reconciliation applications are made to the authorised reconciliation committee or to the tax office that holds the taxpayer's records.

The applications, which are made to organically different authorities, cause significant variation in terms of value in the results of the reconciliation meetings. In practice, it is observed that significant discounts are made both in the tax principle and tax penalty in pre-assessment reconciliations. Neither type of reconciliation is applicable in cases involving tax fraud.

In practice, the legislative body, taking note of the successful results and effectiveness of the mechanism, introduced reconciliation for customs disputes. The reconciliation mechanism was formally available from September 2011 as per Law No. 6111, amending Article 244 of Customs Law No. 4458. Taxpayers who are notified of additional tax and customs penalties may use their rights to reconcile by applying to the administration within 15 days of notification.

Statistics related to reconciliation meetings for the year 2012 have been posted on the Ministry of Customs and Trade website. Within the framework of the Customs Reconciliation Regulation which entered into force in 2011, 3,351 reconciliation meetings were held by the Central Reconciliation Commission and the Customs and Trade District Directorate Reconciliation Commissions, out of which 3,228 resulted in reconciliation, and a mere 123 resulted in no agreement. Though statistics regarding reconciliation meetings held within the framework of the Tax Procedure Law were not published, it is known that a great number of reconciliation applications have been made.

As is evident, the reconciliation mechanism, which is quite young with regards to customs legislation, has been widely adopted by taxpayers and the tax administration. It is expected that the numbers given above will greatly increase in the coming years.

It should be remarked that besides reconciliation, the mutual agreement procedure (MAP), which is significant for transactions of a cross-border nature, but unfortunately seldom utilised in Turkish law, is also an important dispute resolution mechanism.

Though Turkey has been otherwise cooperative in OECD efforts, it is not showing the same commitment to the MAP process.

The mutual agreement procedure is set out in article 25 of the OECD Model Convention, and Turkish tax agreements are made based on the OECD model.

According to statistics published by the OECD, by 2009 the MAP was used in only three disputes involving Turkey. Criticism was made regarding the low number of attempts to use the procedure and calls were made for an increase in its use and for the sharing of the status of the procedure with the public.

Moreover, the fact that the arbitration procedure – which is a complementary part of the MAP – is inapplicable in Turkey proves to be another problem. There are two important reasons to why the arbitration procedure cannot be applied in Turkey. The first reason is that Turkey has not included the arbitration procedure in any of its tax agreements. The other reason is that, even if it did, there would be a constitutional obstacle to its implementation.

According to article 125 of the Constitution of Turkey "dispute resolution through national or international arbitration may be prescribed for concession provisions and concession agreements with regards to the provision of public services. International arbitration can be used only for disputes comprising a foreign element."

In this sentence it is stipulated that arbitration can be used for certain administrative contracts, but that tax disputes are not included. Undoubtedly, removing the obstacles that prevent the use of the arbitration procedure is quite important, especially for disputes based on cross-border transactions that include a foreign element.