ABSTRACT
There are two fundamental methods for shareholders to extend funds to a company. The first, making a capital commitment, is where shareholders provide equity to the company, that is, contributing to the capital structure of the company, by transferring resources permanently through a capital commitment. The second method, “Thin Capitalisation” is where shareholders lend to the company on a temporary basis. With a capital commitment, the shareholder acquires shares in return for the amount of their capital committment and no refund of the capital is possible. However, where the shareholder lends money to the company, this amount can be refunded. As well as these two fundamental funding methods, there is a third, hybrid option, “Capital Advance”. The shareholder initially lends an amount to the company, and with that loan grants the company an optional right: whenever the company wishes, instead of repaying the amount in cash, the amount may go forward with a capital increase and trade-off the capital commitment debt that will arise within the framework of the pre-emptive right of the relevant shareholder with their claims from the company1 . Thus, it becomes possible to convert the shareholder’s claim in the company into capital. Although thin capitalisation and capital advance are frequently used methods in practice, both commercial and tax laws do not fully regulate these methods. For this reason, it is important to consider the subject from different viewpoints in the doctrine.
I. INTRODUCTION
The simplest equation for profit maximization, which is the main goal for companies in order to survive, is to change the income-expense balance in a positive direction by increasing the assets and decreasing the liabilities. Taxation constitutes one of the heaviest burdens faced by companies while proceeding on this path because while companies aim to maintain their own existence, states use their taxation systems to ensure a sound economy.
There are two methods for companies to reduce their tax liabilities. The first of these is tax evasion, whereby a company illegally shows the amount of tax to be paid as lower than it is, which constitutes a crime and is subject to severe sanctions in law. The alternative to the very high risk yielding crime of tax evasion is tax avoidance. Tax avoidance is reducing tax liabilities within the framework of the rules drawn up by the state. It is in this context that we come across the practice of "thin capitalisation" as a product of the efforts of companies and states to prioritise their own interests.
In Turkish Law, the concept of "capital" is defined as the set of economic values that a partners puts into a company in order for the company to begin trading. The values that can be added to a company as capital are defined in accordance with Article 127 of the Turkish Commercial Code (TCC). Capital is not the only source for companies to commence and continue trading. Foreign resources can also be used through loans2. Companies can borrow money from independent third parties as well as their own partners. Partners can obtain various benefits by lending to the company instead of financing the company through capital investment. While the main purpose is to finance the company, a kind of “hidden capital” is created in cases where the partners or the persons associated with the partners add an economic value to the company by lending money. This issue constitutes the concept of Thin Capitalisation, as defined in Article 12 of the Corporate Tax Law (CTL). Capital advance is the provision of resources to a company by shareholders, before a decision on capital increase, to be used in the performance of a capital commitment debt arising from the capital increase realized in the future. In terms of tax discipline, the amount given to the company as capital advance is included in the company's equity, in other words, its assets. However, it is often forgotten that the last stage of the commitment is a return or exchange transaction which is considered an equity item. There is an atypical loan agreement with an optional right in which the company is given the power of performance with a substitute action. If the company wishes, it can pay the claims of the shareholder in cash, or it can increase the capital and pay its debt through a trade-off.
Thin capitalisation has only been briefly and insufficiently mentioned in Turkish law, and the law maker has attempted to define what it is and its elements. Although the legal status of partners who make hidden capital payments, which are also defined as “loans that replace equity capital” in the doctrine of corporate law, was arranged for limited liability companies in the first version of the draft TCC number 6102 in Turkish law, it has not been enacted. German law stipulates that loans given by shareholders to a company will come after other claims in case of bankruptcy3. In contrast, capital advance appears neither in commercial nor tax laws. Therefore, all definitions and interpretations of capital advance are based on foreign sources and doctrine.
II. THIN CAPITALISATION
The system in which some of a companies' resource structures are based on equity capital and the rest are formed through borrowing by applying to foreign capital is called the "Mixed Financing Method4". The partners both provide equity to the company by investing capital and they can also provide foreign capital through loans. As a result of these transactions, participation in equity through shares can be made under the name of “borrowing” and thus thin capitalisation can occur5.
A. Advantages of Thin Capitalisation
In the event of bankruptcy or liquidation, since shareholders can only recieve their capital in proportion to their shares after the creditors of the company and other priority persons obtain their claims, there is a risk that the shareholders will not be able to receive the entire capital that they have brought. Since a debt-claim relationship will arise between the partner and the company through borrowing, the above mentioned risk is reduced. In addition, while the dividends to be earned by the shareholders as a result of investing capital can only be distributed if the company makes a profit, interest income on a loan can be obtained independently of the company's profit or loss. The practice of thin capitalisation is a solid guarantee in terms of ensuring the free movement and flexibility of a company’s financial resources.
Since if companies meet their capital needs through borrowing, it is possible to deduct the interest to be paid for the debt from the company's earnings as an expense, opting for the borrowing method rather than capital increase decreases the tax base of the company. The reason why a company might prefer to borrow from its partners or related parties rather than through capital increase is to create an interest expense. Paying interest for debts obtained from shareholders or related parties by accepting the said debts as ordinary debt contracts, and deducting the said interest payments from the corporate tax base reveals the existence of hidden capital and in this way, companies aim to reduce the tax assessment in the amount of paid interest6.
At this point, it can be argued within the scope of the criminal law doctrine that companies' interest payments against loans constitute the crime of usury. In accordance with the Turkish Penal Code, lending money in order to gain profit as a profession is regulated as the crime of usury. However, when a company pays the principal interest for the debt it receives, the cost of this debt is reflected on itself. Since the lending institution, which is deprived of its receivables until maturity, does not aquire the interest payment received in return with the intention of gaining a profit, the moral element of the lending transaction will be missing in the context of usury. As a matter of fact, this interest must be exorbitant in order for the interest received in return for lending to be considered within the scope of usury7.
A company’s finanaical year profit can only be distributed after the determined tax liabilities are fulfilled, that is, after the profit is taxed; thus, the profit is distributed after it is taxed, and the distributed profit share is taxed again8. When the borrowing method is chosen, the interest payments the company makes to its creditors are made from the company's untaxed profit and interest payments are taxed only at the lender9.
B. The Risks of Thin Capitalisation and Sanctions Against Hidden Capital
Although the practice of thin capitalisation is a profitable practice in many ways for the reasons mentioned above, the legislator has enacted some sanctions to prevent a tax loss to the state due to this practice.
The sanctions to be applied against thin capitalisation aim to prevent the erosion of the corporate tax base and to prevent the circumvention of legal provisions regarding the value that is protected with the rule of ‘interests calculated on equity cannot be deducted as expenditure’.
While the legislator accepts thin capitalisation as a security institution and regulates it in accordance with the CTL, by imposing certain sanctions, it aims to prevent the deduction of the profit share it will receive as corporate tax from the company's profit, with the payments to be made to partners or related persons under the names of ‘interest to be charged on capital’ etc. The prevention is not only limited to the interests to be paid on equity but also ensures that the interests calculated on debts that can be substituted for capital, that is, on hidden capital, cannot be deducted from the corporate tax base as an element of expenditure10.
Another purpose of the legislator imposing sanctions on thin capitalisation is to prevent shareholders from circumventing the provision that states "the interest on the capital cannot be written off as an expenditure" by lending the economic values that they have to invest into the company as loans, and by obtaining interest income from the said loans11.
The practice of thin capitalisation imposes a cost on the financial system of the country. National capital transferred out of the country through thin capitalisation has a negative impact on treasury borrowing. National capital that has become foreign capital by being transferred outside the country benefits from the income and corporate tax advantages provided to foreign capital and non-resident investors. Companies benefiting from these incentives also cause a tax loss to the treasury and the tax loss in question can be compensated by additional taxes or the treasury's borrowing12. In addition, the interest payments made by the domestic companies related to the multinational companies with foreign elements through the practice of thin capitalisation pose a danger of creating unequal competition.
One of the criteria used by the International Rating Agencies in determining the credit ratings of the countries is the total foreign debt and the repayability of the foreign debt in the country. As a result of national capital gaining the character of foreign capital through multinational companies practising thin capitalisation, the total amount of foreign debt of the country increases and it may seem more than the actual amount. Due to the increase in foreign debt, the country's credit rating may decrease and, more importantly, the interest payments made abroad by the country may increase, resulting in a transfer of funds from the country to abroad13.
Countries imposing various sanctions against hidden capital subjects the capital in question to various restrictions instead of completely freeing the circulation of it, especially for the aforementioned purposes of protecting the financial system of the country. For example, interest paid on hidden capital are considered dividends and the transfer of the said dividends to the head company is carried out within the framework of national legislation14.
C. Detection of Thin Capitalisation
The debt/equity ratio used for the detection of thin capitalisation is determined by law and borrowings made by companies from shareholders or related parties within the aforementioned ratio are not considered hidden capital. Interest payments on these debts can be deducted from the corporate tax base as an expense. However, interest paid for borrowing that exceeds the debt/equity ratio specified in the law are considered profit share distribution and cannot be deducted from the tax base as an expenditure15. In the German and Turkish tax systems, a fixed rate approach has been adopted for the determination of hidden capital. In the "fixed rate approach", which is also defined as the "Safe Harbor Rule", if the total debt obtained from the shareholders or related parties exceeds a certain ratio of the company's equity, the interest payments corresponding to the whole or a certain part of the said debt are not considered expenses and are subject to profit distribution provisions16.
Herein, the concept of equity within the meaning of Article 376 of the TCC should be clarified. In the determination of equity, also known as equity capital, while registered capital and items such as all legal, contractual and optional reserves, period profit and revaluation value increase funds are positively included, period loss and balance sheet loss consisting of previous year losses are deducted from the positive items as a negative item17. Essentially, equity is the numerical value found by deducting debts from total assets. If the equity value has decreased to negative as a result of losses, it means that the company is in debt according to the annual balance sheet.
D. Development of Thin Capitalisation Practices in Turkey
Regulations regarding thin capitalisation in the Turkish tax system were first included in Article 16 of Corporate Tax Law No. 5422, which was brought into force in 1949. With Article 12 of Corporate Tax Law No. 5520, which entered into force in 2006, the practice of thin capitalisation was rearranged by taking new developments into account. Pragraph 1 of the Article states that where the amount of debt provided by the mentioned persons and used inside the corporation exceeds three times the shareholders’ equity at the beginning of the corporation’s fiscal period, the excess of debt above the 3:1 ratio is re-characterized as hidden capital. The 3:1 debt and equity ratio to be taken into account in the determination of hidden capital indicates that a fixed rate approach has been adopted by the law.
E. Elements of Thin Capitalisation
With the enactment of Law No.5520, thin capitalisation has been included in a more detailed and comprehensive manner in the Turkish Tax System. As stated in the justification of Law No. 5520, “the institution of thin capitalisation has been rearranged in consideration of international developments and generally accepted principles”. Article 12 of Law No. 5520 clarifies the definition and elements of thin capitalisation, and states which types of debts will not be covered by thin capitalisation.
The main purpose of thin capitalisation, which is one of the tax security institutions included in the CTL and regulated in Articles 11 and 12 of Corporate Tax Law No. 5520, is to prevent the corrosion of the corporate tax base with the interest, exchange difference and similar financial expenses that are paid through borrowing. In addition, the purpose is to prevent the circumvention of the prohibition of deducting the interest payment on equity in Article 11 of Corporate Tax Law No. 5520 and the prohibition on the application of interest on capital in Article 509 of Turkish Commercial Code No. 6102.
While the first condition for the debt to be considered hidden capital in accordance with CTL Article 12 is borrowing the debt from the company's partners or from a real or legal person related to the partners, the second condition is that the amount of debt obtained from the related parties must exceed three times the equity capital of the company at any time during the accounting period. The requirements in order for the debts used in the business to be considered hidden capital are: · Obtaining the debt directly or indirectly from the partners of the company or persons related to the partners, · Using the debt in business, · The debt exceeding three times the company's equity measured as per the opening balance sheet at any time during the accounting period.
According to these explanations, in order for a debt obtained by corporate taxpayers to be evaluated as hidden capital and therefore for the interest, exchange difference and similar expenses calculated on said debt to be accepted as legally unacceptable expenses in the determination of company profit, the person whom the debt is obtained from and the amount of the debt are of great importance. "Partners of the company" refer to persons who have a partnership relationship with the company. According to the Corporate Tax General Communiqué serial number 1, partnership relationship refers to the relationship of a company with both the corporation it is a partner of and the real persons and corporations that are partners of the said company. In terms of the concept of thin capitalisation, according to Article 12/3-a of the CTL; "person related to the partner" refers to a company in which the partner has at least 10% voting or dividend rights or shares. If the persons associated with the partners have less than 10% of capital, voting or dividend rights in companies that use debts, they will not be considered persons related to the shareholder, and debts obtained from them and used in the corporation will not be considered hidden capital.
III. CAPITAL ADVANCE
Although the concept of capital advance is not defined in Turkish law, it is defined in the doctrine as a funding method that partners realize by transferring resources to the companies that they are shareholders in, in exchange for their capital commitment debts that will arise as a result of a capital increase to be made in the future. The shareholders make it possible to postpone the procedure required for capital increase where an equity company urgently needs capital due to the functions of economic life, by giving a capital advance to be used in a future capital increase, and they ensure that cash resources are acquired on account of the capital increase to be made by a few partners within a reasonable period of time, without placing any other shareholders, who are not eligible to pay their capital commitment, under liability.
In the concept of capital advance, shareholders are obliged to pay their capital debt arising from the capital commitment, while having a claim based on the loan agreement established between the company. These two mutual debts/credits are traded off. With the substitute action granted to it in the capital advance, the party that makes the clearing and settlement declaration by using its performance authority will be the company.
The characteristic element in determining the capital advance is that the company is initially given the authority to perform with the substitute action in terms of the performance of the shareholder's claims from the company. When establishing the loan agreement, the company is given a right of option to increase the capital if desired, and to perform the debt by allocating the newly created shares to the relevant shareholder instead of returning the loan amount in cash.
At this point, the discussion arises whether the resources transferred as capital advance should be evaluated among external resources as debt or among equities as an element of capital. Tax and Trade doctrine deviates as to where to record in the balance sheet when a capital advance is given. The capital advance, which is not actually a loan in terms of tax law but represents the part of the company's registered capital paid in advance, is shown in the equity group in the company's balance sheet18. In this context, no interest is paid for the registered capital pursuant to Article 470 of the TCC. In addition, pursuant to Article 11/1-a of CTL numbered 5520, it is not possible to deduct the interest paid or calculated on equity from the company’s revenue. Therefore, if the resources transferred by a partner to another partnership with which it is related are considered an element of equity, no interest will be accrued on the resources in question.
In contrast, the authors within the scope of the commercial law doctrine argue that it is not possible for payments made by the partners to the companies that they are partners in to be classified as capital without a general assembly resolution, board of directors resolution or a registered capital increase decision19. Accordingly, if cash values are given under the name of capital advance, since there is not a performance of the capital commitment debt but a lending transaction with the ability of clearing, these values should be specified among external resources in the balance sheet.
IV. CONCLUSION
Thin capitalisation and capital advance are funding methods that make it possible to provide resources to the capital structure of a company, apart from shareholders promising capital commitments. While companies increase their assets in order to maximize profit, governments aim to gain economic benefit from these revenues through the tax administration. Hence, different methods have emerged in practice as a result of the conflict of interest between companies and states. In order to avoid their tax liabilities, which are a heavy burden, companies transfer resources to their equity by borrowing and try to deduct some of the corporate revenue from the tax assesment by paying interest on the loans. Corporate taxpayer companies enroll the accrued interest they pay in their loans as expenditure in determining the corporate income and are not taxed on these expenditures. The legislator, on the other hand, has regulated the practice of thin capitalisation in order to prevent the borrowings, which are originally intended to be used as equity and that are made by persons related to the company, from causing the company revenue leaving the company without getting taxed to protect the state. Thin capitalisation, as a practice regulated in our legislation, is a security concern that prevents the corrosion of the tax assesment through the deduction of the borrowing costs from the total revenue and as a result from the tax base. Moreover, while not regulated in our law, the practice of capital advance is a hybrid method that emerged as a result of the speed and needs of commercial life and is defined as partners providing cash recourses to a company optionally either on account of a capital increase by converting to registered capital in the future or as a short term loan similiar in practice to thin capitalisation.
BIBLIOGRAPHY
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FOOTNOTE
1 Tolga Ayoğlu, “Sermaye Avansı Kavramı Üzerine Düşünceler”, Prof. Dr. Hamdi Yasaman’a Armağan, On iki Levha, İstanbul, 2017, s. 29-58.
2 Hasan Hüseyin Savaş, “Örtülü Sermayede Borcun Devamlı Kullanılma Koşulu ve Öz Sermayeye Oranı”, Başar Mevzuat Dergisi, Yıl:2, S:6, Haziran 1999.
3 Ahmet Türk, “Sermaye Ortaklıklarında ‘Öz Kaynakların Yerini Tutan Ödünçler’ Kurumuna İhtiyaç Olup Olmadığı Sorunu (Alman Hukukundaki Yasal Düzenleme ve İsviçre Hukuku Çerçevesinde Değerlendirme ve Yasal Düzenleme Önerisi)”, Banka ve Ticaret Hukuku Dergisi, Cilt: 32, Sayı:2, Haziran 2016, ss. 99-145.
4 Namık Kemal Uyanık, Örtülü Sermaye Kontrol Edilen Yabancı Kurum Kazancı Çifte Vergilendirmenin Önlenmesi Düzenlemeleri, Ankara, TÜRMOB Yayınları, 2008, s. 40; OECD, “Thin Capitalisation”, Nisan 2010.
5 Şükrü Kızılot, “Türk Vergi Hukukunda Örtülü Kazanç ve Örtülü Sermaye”, Ankara, Yaklaşım, 2002, s.104; OECD, Nisan 2010, a.g.e.
6 Hüseyin Işık, “Çok Uluslu Şirketlerde Örtülü Kazanç ve Örtülü Sermaye”, Ankara, 2005, T.C. Maliye Bakanlığı Araştırma, Planlama ve Koordinasyon Kurulu Başkanlığı Yayın No: 2005/370, s.39; OECD, Nisan 2010, a.g.e.
7 Emek Toraman Çolgar, Şirkete Borçlanma Yasağı, On İki Levha Yayıncılık, 2019, ss.182-183.
8 Mehmet Akif Özmen, “Gelir ve Kurumlar Vergisi Mevzuatında Vergi Güvenlik Müesseseleri”, Ankara, Yaklaşım, 2008, s.62.
9 Kızılot, a.g.e., s.103; OECD, Nisan 2010, a.g.e.
10 Rıfat Engin, ‘Kurum Kazancının Tespitinde Kabul Edilmeyen İndirimler’, Mali Çözüm, S: 80, Mart - Nisan 2007, s.143.
11 Mehmet Maç, “Örtülü Sermaye Sayılmaması Gereken Borçlanmalar”, Vergi Dünyası, Ocak 2007, s.4; Sarıcan Ağusots 2010, a.g.e., s.2; Savaş, Haziran 2009, a.g.e., s.2.
12 Kızılot, a.g.e. s.106 – 107; Uyanık, a.g.e., s.22; OECD, Nisan 2010, a.g.e.
13 OECD, Nisan 2010, a.g.e; Uyanık, a.g.e., s22
14 Kızılot, a.g.e. s.106 – 107; Uyanık, a.g.e.,s.22.
15 Uyanık, a.g.e., s.60; OECD, Nisan 2010, a.g.e.
16 Kızılot, a.g.e., s.110; Uyanık, a.g.e., s.60; Aslan, a.g.e., s.9; OECD, Nisan 2010, a.g.e.
17 Ahmet Türk, “Yeni Türk Ticaret Kanunu’nun Getirdiği Değişiklik Ve Yeniliklerle Anonim Ortaklıkta Sermaye Kaybı Ve Hukuki Sonuçları Sermaye Avansı Kavramı Üzerine Düşünceler” D.E.Ü. Hukuk Fakültesi Dergisi Cilt: 17, Sayı: 2, 2015, s. 63-112.
18 Mehmet Özkan, “Sermaye Arttırımında Şirket Ortaklarının Şirketten Alacaklarının Kullanılması” KAÜİİBFD 7(14), 2016, 663-700.
19 Mikail Okyay. “Sermaye Avansları Kavramının Vergi Kanunları ve Diğer Kanunlar Karşısındaki Durumu”. Vergi Dünyası. Sayı:424, Aralık 2016, ss.96- 103.
