Nowadays, many companies are frequently resorting to company restructuring transactions to increase their market value, to make the company more competitive, to overcome the already negative economic environment, to concentrate and specialize on new businesses in certain areas, to increase their financial performance, and to provide efficiency to the company. In addition to achieving these goals, with developing technology and increasingly competitive environment, company restructuring has become a necessity for many institutions, from international organizations to the nuclear family, in order to survive in this new era.
One of the methods frequently preferred by companies from amongst company restructuring transactions is a partial spin-off. A partial spin-off is a process that is directly related to both commercial law and tax law, and regulated both in Turkish Commercial Code numbered 6102 ("TCC"), Corporate Tax Law numbered 5520 ("CTL"), and Corporate Tax General Communiqué No. 1 ("Communique No.1").
A partial spin-off is the legal process to transfer of some of the assets of the transferor company to another company based on their registered values (although it is stated as capital in kind in accordance with the letter of the CTL; a partial division is not in-kind capital in accordance with the provisions of the TCC) and is the purchase of participation shares in return.1 As a result of a partial spin-off, the shares issued by the newly established company, and/or the assets that were put into the existing company through the partial spin-off, can be either given to (i) the transferor company (ii) or to the shareholders of the transferor company. If the newly issued shares are given to the shareholders of the transferor company, the capital decrease comes to the fore in the said company, since there is a decrease in the assets of the transferor company. In this article, the tax consequences of the capital decrease made within the scope of a partial spin-off are evaluated within the scope of the approach of the Revenue Administration and judicial decisions.
Partial Spin-Off within the Framework of Legal Regulations
Partial spin-offs are regulated in Article 159 of the TCC as, "In a partial spin-off, one or more parts of a company's assets are transferred to other companies. The shareholders of the transferor company acquire the shares and rights of the transferee companies, or the transferor company establishes an affiliate by acquiring the shares and rights in the transferee companies in exchange for the transferred assets."
In Article 19/3 of the CTL, a partial spin-off is defined as, "Transfer of real estate, participation shares held for more than two years, and manufacturing or service business lines that are recorded on the balance sheet of a fully liable equity company, or a non-resident equity company's workplace or permanent establishment in Turkey, to an existing or a newly established fully liable equity company, over their net book values as capital in kind."
As is clear from the above-mentioned regulations, within the scope of a partial spin-off, the assets that are subject to the transfer have been specified in a limited number. These are (i) immovables, (ii) participation shares (held for at least 2 years); and (iii) manufacturing and service business lines.
As well, partial spin-offs can be affected through two different methods. The first one is where the shares remain in the transferor company, also known as the "participation relationship method." In this method, the value of the company assets that are subject to the partial spin-off become an affiliate or subsidiary of the transferor company. Another is the giving of share certificates of the company where capital in kind is contributed to the transferor company's shareholders as a result of the partial spin-off.
Indeed, through the statement, "The transferee company shares acquired in return for the assets transferred in the partial spin-off can either remain in the transferor company, or be given directly to the shareholders of this company." In the section entitled "22.214.171.124. Giving the participation shares to the shareholders," in Communiqué No. 1, it is accepted that the share certificates of the company, where capital in kind is contributed, can also be given to the shareholders. In this method, due to the decrease in company assets, which is derived from giving the shares to the transferor's shareholders, a capital decrease is performed by the company.
Through the statement, "If the shares of the transferee company acquired in return for the transferred assets are given to the shareholders, it is natural that a capital decrease will be made in the transferor company." In Communiqué No. 1, it is accepted that capital decrease is a natural result of a partial spin-off in terms of tax legislation, as well.
Therefore, in the event that the transferee company shares are given to the shareholders of the transferor company, a capital decrease constitutes an element of the partial spin-off, and cannot be considered as a separate capital decrease transaction.
Although this is the case, the companies that make a capital decrease within the scope of a partial spin-off may face a corporate tax assessment with tax penalty and income tax assessment arising from profit distribution, because of the assumption of tax administration that the inflation correction positive differences and the previous year's profits were firstly withdrawn from the business.
Capital Decrease in Partial Spin-Off and Tax Consequences
In a partial spin-off, it is a choice whether the shares of the transferee company, which are acquired in return for the transferred assets, remain in the transfer company, or are given directly to the shareholders of the company. If these shares are given to the shareholders of the transferee company, it may be possible to balance the balance sheet of the company whose assets decreased only by reducing capital.
The decrease in the total assets in the balance sheet of the transferor company, is the reduction in the capital account. In this way, equality of assets and liabilities are ensured by the transferor company. This situation proves that it is a natural consequence of a partial spin-off to perform a capital decrease transaction in a company due to a decrease in assets of the transferor company.
Considering both the corporate tax, value added tax, stamp tax, and title deed exemptions included in the tax legislation, and the relevant legal grounds, a partial spin-off is an arrangement introduced in order to serve as a tax deferral in all company restructuring processes. It is considered that there is no basis for taxing a capital decrease transaction as a separate transaction, which is a natural result of a partial spin-off contrary to the purpose and spirit of these regulations. In summary and, in essence, the regulation for the taxation of a capital decrease as a separate transaction, and a capital decrease as a result of a partial spin-off does not exist in any law or communiqué.
The Approach of Revenue Administration
There is a critical perspective of the tax administration against a capital decrease as a separate transaction, and a capital decrease due to the transfer of the shares acquired through a partial spin-off to the shareholders of the transferor company. Although there is no legal explanation regarding this issue, the tax administration has the opinion that a capital decrease has been made from the accounts related in the following order, and that it must be withdrawn from the business:
- Accounts to be subjected to corporate tax and post-tax tax deduction due to profit distribution (such as inflation adjustment positive difference, real estate sales gain exception);
- Accounts to be subjected to tax deduction related to profit distribution (such as previous year profits); and
- In-kind and cash capital that will not be taxed in the event of withdrawal from the business (registered commodity provision, cash capital increases).
However, the current rulings issued by the tax administration contains the following comments:2
- If a company's capital is decreased because the share certificates received from the company where capital in kind is contributed are given to shareholders as a result of a partial spin-off, and there are also inflation adjustment difference accounts and previous years' profits that were previously added to capital, provided that the inflation adjustment difference accounts and previous years' profits are also included as an element of capital, and are separately seen in the capital increase to be made in the transferee company, this transaction may not be considered as withdrawal from the company and shall not be taxed; and
- However, if the inflation differences and previous years' losses which are an element of capital in the transferee company are transferred to another account in the transferee company, or withdrawn from the enterprise, or a capital decrease is applied, the amounts withdrawn from the enterprise in relation to inflation differences must be primarily subjected to corporate tax, without being associated with the profit of the period of withdrawal.
As a matter of fact, the mentioned approach of the Revenue Administration was placed on the agenda in Article 4 of the Draft Communiqué (Serial No: 13) in the Amendment of the Corporate Tax General Communiqué (Serial No: 1) published on the official website of the Revenue Administration on 24.03.2017. In this article, it is regulated that in the event the transferee company shares are given to the transferor company shareholders, the capital decrease by the transferor company will be taxed.
However, this statement in the draft text has not yet come into force. In summary, the regulation on the taxation of capital decreases has not been included in the law, nor has it been able to take its place in Communiqué No. 1.
Positive Judicial Decisions on Capital Decreases in Partial Spin-Offs
As we mentioned in the previous section, the regulation regarding the taxation of a capital decrease, which is a natural result of a partial spin-off, as well as a capital decrease as a separate transaction, is not included in any law or communiqué. However, in accordance with the principle of legality in the Constitution, and which is emphasized in every area, it is not possible to impose a tax burden on taxpayers in this manner by commenting in cases that are not explicitly written into the law.
Especially, and in accordance with Article 20 of the CTL, it has been decided that the partial spin-off process should be carried out tax-free; the same result is attributed to a capital decrease transaction, which is the natural extension of this transaction. In this context, a capital decrease transaction that is due to partial spin-off must be interpreted by evaluating the letter of the tax laws, the purpose of the issue, etc. To the contrary, taxation on a capital decrease as a result of a partial spin-off is contrary to both the principle of legality and the purpose of the provision.
As well, it is observed that in recent judicial decisions, parallel decisions3 have been rendered in line with this view. These decisions state that it was not legally possible to expand the gap in the law through comments since there is no provision in the tax laws regarding the priority of the inflation correction positive differences account, other capital reserves account, and previous year profits account in the capital decrease, and a decision was rendered in favor of the taxpayers.4
A capital decrease as a result of a partial spin-off must be evaluated by taking the function and the aim of a capital decrease into consideration. As well, considering the relevant Articles in the tax legislation, a partial spin-off is a tax deferral institution. Contrary to these regulations, creating a tax burden on the taxpayers by separating the transactions from each other in capital decreases as a result of a partial spin-off constitutes a contradiction in the aim of the legislator. Moreover, it is considered that any regulation that constitutes the basis of the said taxation does not take place either in the laws or in the communiqués, but also constitutes a violation of the principle of legality in taxation. Finally, it is recommended that companies include the details of the items forming the capital account in their balance sheet, to take care to include taxable items as an element of capital in the transferee company or the newly established company, and to be monitored separately in order not to be subject to any criticism by the tax administration regarding partial spin-off transactions.
1. Doksat, Ayse Cânan; Öcal, Öykü, "Isletmeler kismi bölünmeye konu edilebilecek mi?,", Vergide Gündem, May, 2017.
2. The ruling of Large Taxpayer Office No. 64597866-12519-2013.-155 24.09.2013 and dated 24.09.2013; No. 64597866-12519-2013.-107 and dated 23/07/2013, the ruling of Izmir Tax Office Directorate No. B.07.1.GIB.4.35.16.01-125-697 and dated 20.07.2012; the ruling of Large Taxpayer Office No. 64597866-105MÜK-298-2013.-168 and dated 05.11.2013, the ruling of Istanbul Tax Office Directorate No. 62030549-12519-2013/45.-863 and dated 11.04.2014.
3. The decision of the 12th Tax Court, K. 2018/2946, 15.11.2018 and K. 2018/2945, 15.11.2018.
4. Ülgen, Soner, "Kismi Bölünme Uygulamasinda Sermaye Azaltiminda Öncelik Siralamasina Yargi Freni Devam ediyor," MuhasebeTR, http://www.muhasebetr.com/yazarlarimiz/sonerulgen/003/ (Access date: 05.05.2020).
Originally published May 2020
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