In this, our third and final post in our series on the newly adopted Provisional Article and the effect on financial restructuring in Turkey, we explore the considerations and recommendations of Esin Attorney Partnership on the tax front.

1) Financial Restructuring Considerations 

The Provisional Article provides various tax reliefs and exemptions in relation to financial restructuring transactions.

The Omnibus Law’s general preamble states that the purposes of the amendments to the Banking Law are (i) resolving financial issues that have or may arise in the real sector due to the macroeconomic developments (ii) restoring solvency to debtors in financial trouble by facilitating the operation of reconciliation platforms that include financial restructuring programs; and (iii) establishing the legal infrastructure enabling debtors to comply with their obligations towards financial institutions.

With those broad purposes in mind, various tax exemptions were provided by the Provisional Article for financial restructuring transactions implemented under the Framework Agreements process.

  • These financial restructuring transactions are exempt from fees under the Law on Fees No. 492 (including judiciary fees), and the documents to be issued in connection with the restructuring (including framework agreements and financial restructuring agreements) are exempt from stamp tax under the Stamp Tax Law No: 488 (the “Stamp Tax Law“).
  • Amounts collected by creditor institutions are exempt from the banking and insurance transaction tax under the Expenditures Taxes Law No. 6802.
  • Loans granted and to be granted in connection with such restructurings are exempt from the resource utilization support fund deduction.

However, the tax exemptions would only apply to transfers between the transferor and the original creditor (and transfers between creditors) such that, for example, if the assets and collateral in question were restructured by a party that acquired it who then proceeded to transfer, that would result in above tax implications, which would only make restructurings more challenging. 

In addition:

  • Asset for debt swaps:
    • Real estate and shares: The corporate income tax exemption provided under Article 5/1-f of the Corporate Income Tax Law No. 5520 (the “Corporate Income Tax Law”) applies to debt/asset swaps made under the Framework Agreements umbrella, as well as to the income that credit institutions generate from the sale of these assets. Accordingly, if the debtors transfer real estate, shares, dividend right certificates and preferential rights to creditor institutions in a restructuring implemented under the Framework Agreements umbrella to be offset from their debts, the entire income corresponding to the portion used for closing the debt will be exempt from corporate income tax which the debtor would otherwise have to pay on the disposal. The creditor institutions are not required to initiate legal proceedings against debtors to benefit from this exemption. With regard to any onward disposal of those assets which might give rise to a tax liability in the hands of the credit institution, the income that credit institutions generate from the sale of these assets benefits from a 50% corporate income tax exemption for real estate transfers, and 75% corporate income tax exemption for other asset transfers.
    • VATable assets: The value added tax (“VAT“) exemption provided under Article 17/4-r of the Value Added Tax Law No. 3065 (the “VAT Law“) will apply to the transfer of otherwise VATable assets to creditor institutions effected under the umbrella of the Framework Agreements, as well as to the transfer of these assets by credit institutions who acquired these assets in this way. Accordingly, the transfer of real estates and participation shares by credit institutions and by debtors in the scope of financial restructuring will be exempt from VAT.
  • Treatment of write-offs: Loans written-down due to the inability to collect will be treated as “bad debts” for the creditors and as “waived loans” for the debtors under the Tax Procedural Law No: 213 (the “Tax Procedural Law“). As a result, creditor institutions will be able to treat receivables waived in a Financial Restructuring umbrella restructuring as deductible expenses when determining their corporate income tax without requiring a court decision or a similar document. However, financial restructuring transactions with debtors in the banks’ risk group defined under Article 49 of the Banking Law cannot benefit from this opportunity. They will be treated as taxable gains but with the tax deferred in that the gains can be recorded in special provision accounts in their books and offset against any losses arising within three years from the end of the year when the receivables were waived. Any amounts that cannot be depreciated against losses in that way are required to be transferred to the profit accounts and will be taxable as such.

However, if the debts of a debtor who has gone through financial restructuring become subject to financial restructuring again within two years, these tax exemptions will not apply. That said, these exemptions and incentives will be applicable without being subject to the two-year time limit and they will not need to be returned even if the restructuring is a failure.

There is no doubt that the aforementioned tax exemptions and incentives will have a positive impact on the financial restructuring of debts owed to creditor institutions by those who are in financial trouble. However, there are aspects of the new exemptions that create doubt as to whether they will serve their purpose. These more questionable features are as follows:

  • The exemptions of fees, stamp taxes and banking and insurance transactions taxes in relation to financial restructuring transactions do not apply to the disposition of assets and collateral acquired by credit institutions, except as regards transfers between creditors and the transferor itself.

Action recommended: Tax exemptions applicable only to the transfer of assets acquired within the scope of Framework Agreements umbrella between creditor institutions and/or to the transferor should apply to all transfers regardless of the process used to implement the restructuring. This would incentivize creditor institutions to be involved in financial restructuring.

  • The corporate income tax exemption is 100% for income derived from the transfer of the debtor’s assets to creditor institutions within the scope of financial restructuring (provided that the entire income is used for the debt collection), whereas the corporate income tax exemption is 50% for real estate and 75% for other assets in any onward disposal of those real estate and other assets by creditor institutions. In addition, since the corporate income tax exemption is applied within the scope of, the transfer of real estate, shares, dividend right certificates and preferential rights can only benefit from the corporate income tax exemption. Moreover, although it is contrary to the purpose of The Provisional Article incentivizing financial restructuring, it seems that (i) asset transfers by corporate parties other than debtors and guarantors cannot benefit from the corporate income tax exemption, and (ii) asset transfers by individuals under the financial restructuring framework cannot benefit from income tax exemption (save for the specific exemptions stated in the Income Tax Code), since The Provisional Article refers directly to the Article 5/1-f of the Corporate Income Tax Law which is applicable for only corporate debtors and guarantors.

Action recommended: The corporate income tax exemption for corporations and the income tax exemption for individuals within the scope of financial restructuring should be regulated through a separate exemption (instead of referring to Article 5/1-f of the Corporate Income Tax Law) providing that (i) the corporate income tax exemption applies to all assets transferred within the scope of financial restructuring, (ii) the corporate income tax exemption applies to all corporations other than corporate debtors and guarantors, (iii) the income tax exemption applies to individuals transferring their assets to the creditors under the financial restructuring framework,  and (iv) a full corporate income tax exemption also applies to assets acquired by creditor institutions through financial restructuring.

  • As the Provisional Article refers to Article 17/4-r of the VAT Law regarding the VAT exemption provided for financial restructurings, the VAT exemption will only be applicable for the transfers of real estate and shares. Furthermore, although it is contrary to the purpose of The Provisional Article incentivizing financial restructuring, it seems that (i) asset transfers of by corporations other than corporate debtors and guarantors, and (ii) asset transfers by individuals under the Financial Restructuring Framework cannot benefit from VAT exemption, since The Provisional Article refers directly to the Article 17/4-r of the VAT Law which is applicable for only corporate debtors and guarantors.

Action recommended: Tax exemptions applicable only to the transfer of assets acquired within the scope of Framework Agreements umbrella between creditor institutions and/or to the transferor should apply to all transfers regardless of the process used to implement the restructuring. This would incentivize creditor institutions to be involved in financial restructuring.

  • The corporate income tax exemption is 100% for income derived from the transfer of the debtor’s assets to creditor institutions within the scope of financial restructuring (provided that the entire income is used for the debt collection), whereas the corporate income tax exemption is 50% for real estate and 75% for other assets in any onward disposal of those real estate and other assets by creditor institutions. In addition, since the corporate income tax exemption is applied within the scope of, the transfer of real estate, shares, dividend right certificates and preferential rights can only benefit from the corporate income tax exemption. Moreover, although it is contrary to the purpose of The Provisional Article incentivizing financial restructuring, it seems that (i) asset transfers by corporate parties other than debtors and guarantors cannot benefit from the corporate income tax exemption, and (ii) asset transfers by individuals under the financial restructuring framework cannot benefit from income tax exemption (save for the specific exemptions stated in the Income Tax Code), since The Provisional Article refers directly to the Article 5/1-f of the Corporate Income Tax Law which is applicable for only corporate debtors and guarantors.

Action recommended: The corporate income tax exemption for corporations and the income tax exemption for individuals within the scope of financial restructuring should be regulated through a separate exemption (instead of referring to Article 5/1-f of the Corporate Income Tax Law) providing that (i) the corporate income tax exemption applies to all assets transferred within the scope of financial restructuring, (ii) the corporate income tax exemption applies to all corporations other than corporate debtors and guarantors, (iii) the income tax exemption applies to individuals transferring their assets to the creditors under the financial restructuring framework, and (iv) a full corporate income tax exemption also applies to assets acquired by creditor institutions through financial restructuring.

  • As the Provisional Article refers to Article 17/4-r of the VAT Law regarding the VAT exemption provided for financial restructurings, the VAT exemption will only be applicable for the transfers of real estate and shares. Furthermore, although it is contrary to the purpose of The Provisional Article incentivizing financial restructuring, it seems that (i) asset transfers of by corporations other than corporate debtors and guarantors, and (ii) asset transfers by individuals under the Financial Restructuring Framework cannot benefit from VAT exemption, since The Provisional Article refers directly to the Article 17/4-r of the VAT Law which is applicable for only corporate debtors and guarantors.

Action recommended: The VAT exemption within the scope of financial restructuring should be regulated through a separate exemption article (instead of referring to Article 17/4-r of the VAT Law) providing that (i) the VAT exemption applies to all assets transferred within the scope of financial restructuring, (ii) the VAT exemption applies to asset transfers of all parties including debtors, guarantors and third parties, and (iii) the VAT exemption applies to asset transfers of individuals to the creditors under the Financial Restructuring Framework .

Action recommended: To incentivize financial restructuring transactions more broadly, we recommend the revised tax exemptions applied under the Framework Agreements umbrella be provided for all financial restructuring agreements (regardless of whether those agreements are signed under the Framework Agreements umbrella) without any restrictions such as any period, the parties of the financial restructuring agreements, type of assets transferred under the financial restructuring. Considering the current financial issues and macroeconomic developments in Turkey, we believe resolving financial troubles that debtors have is much more crucial than the taxes that the government will waive to collect as a result of above-mentioned exemptions.

2) NPL Considerations

In Turkey, there are certain tax exemptions which apply to transfers of NPLs to Turkish asset management companies:

  • The delivery of assets and rights securing receivables transferred by banks, private financial institutions and other financial institutions to asset management companies for the collection of these receivables (including sale through auction) is exempt from VAT.
  • Transactions carried out by asset management companies and documents issued relating to the operations of asset management companies (including their establishment), are exempt from (i) stamp tax; (ii) fees under the Law on Fees No. 492; (iii) banking and insurance transactions taxes under the Expenditures Taxes Law No. 6802; and (iv) resource utilization support fund deduction for a five-year period starting from the year following its foundation.

The abovementioned exemptions are only available for asset management companies established in Turkey that are licensed and supervised by the BRSA. This fact restricts banks’ transfers of NPLs to buyers that are not resident asset management companies. In addition, the five-year time limit for the exemptions from stamp tax, fees, banking and insurance transactions tax and resource utilization support fund deduction has a negative impact on these transactions since these taxes will be applicable after the five-year period.

Action recommended: The exemptions available only to asset management companies established in Turkey must also be extended to all corporations that acquire banks’ and financial institutions’ NPLs. We also believe that the time limit on the stamp tax, fees, banking and insurance transactions tax and resource utilization support fund deduction should be removed.

As discussed above, according to views expressed by the BRSA, a Turkish entity cannot sell receivables owed to it by a Turkish debtor to a non-Turkish party. Even if this were possible, unless interest is paid to a “foreign credit institutions” (i.e. institutions which are authorized in their home jurisdictions to grant loans regularly and which grant loans not only to related persons but also to all individuals and legal entities.by the) the payment will be subject to corporate withholding tax under Article 30 of the Corporate Income Tax Law. This greatly reduces the appeal of Turkish NPLs to foreign purchasers. And only to add to that, Turkish legislation provides no clear definition of “foreign credit institution “.

On the other hand, banks’ transfers of receivables abroad may be subject to resource utilization support fund deduction for the interest amount for TRY loans, and for the principal amount for FX loans, depending on the average maturity of the loan.

In addition, if the transferee of the receivable is not a bank or foreign credit institution, the interest paid by the debtor in Turkey to the creditor will be subject to 18% reverse-charge VAT (noting though that this VAT can be offset from the VAT calculated over the debtor’s deliveries of goods and services).

According to the Turkish Stamp Tax Law, documents related to loans granted by banks, foreign credit institutions and international institutions, the collateral in relation to such loans and documents related to their repayment, and the transfer and assignment of receivables owed in respect of such loans, and annotations on such documents are exempt from stamp tax. Although this stamp tax exemption clearly covers banks, foreign credit institutions and international institutions, there are uncertainties in the practical application of this exemption, as the legislation is not clear on the definitions of “foreign credit institution abroad” and “international institution”.  The amendment removed this requirement by adding “international institutions” to the article, and accordingly the scope of the exemption was broadened; within this scope, international holding institutions comprising group companies should also be considered international institutions for stamp tax exemption purposes. The inapplicability of the stamp tax exemption for institutions abroad that are not banks, credit institutions or international institutions would adversely impact the transfer of NPLs especially whilst the legislation is unclear as to what kinds of entity would be so classified.

Action recommended: In order to encourage the sale of NPLs: (i) the corporate income tax on interest payments must be removed not only for foreign credit institutions, but also for other third parties, including investors resident abroad; (ii) the sale of NPLs must be exempt from resource utilization support fund deduction; (iii) interest payments must be exempt from VAT; and (iv) any agreements effecting such dealings must be exempt from stamp tax. In addition, the definitions of “foreign credit institution” and “international institution” should be clarified to eliminate uncertainties on the application of corporate withholding tax and stamp tax.

According to the Provisional Article, loans written off due to the debtor’s inability to pay and that are therefore considered bad debts within the scope of Article 322 of the Tax Procedural Law after setting a provision, can be treated as expenses and deducted from the corporate income tax base without requiring a court decision or similar document.

Although this amendment must promote write-offs of NPLs by banks, the impact may be less than hoped for since the relaxation is unavailable to asset management companies.

Action recommended: The receivables that asset management companies write off due to the debtor’s inability to pay, after setting aside a provision, must be considered bad debts within the scope of Article 322 of the Tax Procedural Law to facilitate write-offs of NPLs by asset management companies.

C) Conclusion

Following Turkey’s currency crisis in the beginning of 2018, companies have faced extensive liquidity problems because of the limited further credit available from Turkish financial institutions which only worsens their solvency position. Since then, a number of legislative steps have been taken in order to promote financial restructuring and, thereby, provide relief to the debtors, and also deleverage bank balance sheets to ensure that banks maintain their ability to disburse loans. While these steps must be regarded as moves in the right direction, there are still significant issues that need to be addressed by the relevant authorities to make the financial restructuring process more efficient.

It is of prime importance that financial restructurings have universal effect vis-a-vis creditors and debtors and creditors are armed with real restructuring tools such as cram down and debt-to-equity swaps, similar to other international restructuring processes. The new tax exemptions for financial restructurings are a very good start but need to be expanded to incentivize creditor institutions to implement financial restructurings as regards their debtors, and to incentivize foreign investors to enter the Turkish NPL market.

Further, given the latest BRSA press release revealing that existing loans on bank balance sheets amounting to TRY 46 billion must be classified as NPLs, the most important issue is to ensure that the banks will be able to withstand the regulatory capital pressure that will result from the increasing proportion of NPLs in their balance sheets. To relieve that burden, regulatory and tax reforms aimed at establishing a solid market for corporate NPLS and attracting international funds to acquire NPLs from Turkish banks would be very useful.

 

Author

Istanbul, Turkey