Turkey: new tax audit wave focuses on nonresident digital companies

By Ramazan Biçer, Partner, Centrum, Istanbul

Turkey’s government has initiated a new wave of tax audits scrutinizing the taxation of nonresident taxpayers engaged in the digital economy.

Turkey’s Inspection Board of Ministry of Treasury and Finance has sent official audit letters to multiple taxpayers announcing the commencement of audits about revenues and earnings from digital activities in Turkey.

Both value added tax (VAT) and corporate income tax liabilities will be audited for the 2015–2018 period, the new Turkish tax audit letters say.

Turkey’s approach to the taxation of the digital economy

The taxation of companies operating in the digital economy is currently the subject of intense discussions in the international arena. No common approach has been introduced yet, but it is expected that an international consensus will be likely reached by 2020 with an OECD-led special project, so-called BEPS 2.0.

Since the UK first introduced its diverted profit tax in 2015, other countries, including developing countries, have enacted unilateral measures to tax digital activities.

Following this trend, the Turkish tax authorities have, in recent years, focused on the taxation of companies operating in the digital sphere, introducing several new laws.

Turkey has signed 90 bilateral tax treaties, most of which are based on the OECD Model Tax Convention. Although Turkey largely follows OECD’s approach in terms of taxation rights, there are certain deviations (e.g. taxation of professional services). Turkey has also reserved on 2017 OECD Model Tax Convention articles, including the Commentary to Article 5 of the OECD Model Tax Convention related to digital permanent establishment (PE).

Under this reservation, Turkey does not follow the OECD’s approach and accepts that a website creates a PE even if the server on which the website is stored is located outside of Turkey.

Under this reservation, Turkey does not follow the OECD’s approach and accepts that a website creates a PE even if the server on which the website is stored is located outside of Turkey.

This means that if a nonresident taxpayer conducts digital business activities and obtains Turkey-sourced income from a website, its activities are considered to create a PE in Turkey.

The Turkish tax authorities take this approach during tax audits of digital companies even though no law on digital PE is in force in Turkey.

In 2018, Turkey introduced a digital tax on cross-border online advertising services by Presidential Decree, which brought a withholding tax liability for payments made for non-resident online advertising companies.

With the introduction of the new digital tax, Turkey is actually trying to tax economic activities in the digital economy. It is clear that the new digital tax regulation aims to tax Turkey sourced advertising income of large multinationals, such as Google, Twitter, and Facebook.

New digital tax is legally arguable for non-resident taxpayers that do not have a fixed place of business or a permanent representative in Turkey, especially those who reside in a country that Turkey signed a double tax treaty with.

The new digital tax forces such companies to establish a presence in Turkey and become a resident taxpayer. However, it seems that digital companies are still evaluating the current situation and new tax obligations and voluntarily registration for corporate income taxation by these companies is limited due to mainly expected international developments.

Article 9 of the Turkish VAT law on the party liable for tax was amended in 2017. The amendment stipulated that VAT arising from services provided electronically by those without a residence, workplace, headquarters, or business center in Turkey to individuals in Turkey who are not VAT taxpayers must be declared and paid by the non-resident e-service providers.

New audit letters

In the new audit letters, the Tax Inspection Board states that not having Turkish tax registration or Turkish tax identification number will not prevent the initiation of a tax audit if the company has commercial activities in Turkey.

If the non-resident taxpayer does not accept the tax audit invitation or assign a representative, the audit will begin and continue in the absence of a company representative, the letters state. In such case, the tax auditor will commence the audit under the signature of two authorized tax auditors and it will be assumed that the company gave up any rights of objection and defense.

The letters are technically a call for initiation of tax audit under the Turkish Tax Procedure Code, where tax auditors invite non-resident taxpayers or their dully authorized representative to sign the official audit documents.

This is a concerning situation for all non-resident taxpayers carrying out Turkey-related digital activities as tax auditors can retrospectively audit corporate income tax and VAT liabilities of such taxpayers in Turkey.

In my opinion, the Tax Inspection Board has the right and is authorized to carry out such tax audits by the Turkish tax legislation. Nevertheless, whether Turkey’s taxation right on the income of non-resident digital companies exists is highly controversial.

Evaluation and recommendations

At the moment, we do not know how tax auditors will conclude their tax inspections of the business activities of non-resident digital companies in Turkey.

However, based on the audit invitation letters, it is my opinion that tax auditors will likely inspect whether the digital activities of an audited company create a digital PE in Turkey. If the tax auditor concludes in the affirmative, he will likely make retrospective tax assessment for corporate income tax purposes which also requires VAT payment obligations for the fiscal periods before 2018.

If the tax auditor concludes in the affirmative, he will likely make retrospective tax assessment for corporate income tax purposes which also requires VAT payment obligations for the fiscal periods before 2018.

This outcome will be likely realized if the non-resident company does not accept tax audit call and has no objections and defense for the tax audit to be carried out.

Tax collection

Another relevant question is how Turkey will collect corporate income tax and VAT from non-resident digital companies for previous periods.

To collect such taxes, the Turkish tax authorities may apply the Convention on Mutual Administrative Assistance in Tax Matters, for which Turkey is a party.

That means that other countries may also become involved in this issue. Again, we do not know what the reaction of other states will be, but certainly, Turkey’s unilateral action against digital companies will result in new international tax controversies.

Also, under the current tax legislation, Turkish tax authorities are empowered to block payments made to non-resident digital companies and they may collect the tax debt through Turkish banks.

This indicates that Turkey has capacity to unilaterally collect tax receivables from non-resident digital companies without the assistance of other countries.

On the other hand, it is possible that a company may accept the call from the tax auditor and appoint a representative duly authorized to benefit from the rights of objections and defense provisions under Turkish Tax Law.

The first action, in this sense, could be a risk assessment of the tax audit and to organize a meeting with tax auditor to understand the legal background of the tax audit.

Under Turkey’s tax procedure code, taxpayers, including non-resident taxpayers, are not obliged to sign audit papers even if a meeting with tax auditor is organized but, as mentioned above, a tax auditor has the authorization to initiate a tax audit without the signature of company representative.

If a non-resident digital company decides to object to a tax audit, audit defense will be crucial as objections of the company could also be the basis for litigation and will be regarded and mentioned in the tax audit report.

Otherwise, tax auditor will likely conclude his inspection deciding against the non-resident digital company and could make a retroactive tax assessment for corporate income tax and consequently VAT.

For that reason, I recommend that non-resident digital companies that receive an audit invitation letter take necessary actions and defend themselves during the tax audit with the appropriate objections. I also believe that a potential tax assessment based on a tax audit is highly controversial and does not have a legal basis as neither Turkish tax laws nor current tax treaties define digital PE.

If the tax auditor concludes in his tax audit report that a tax assessment is required for business activities of a non-resident digital company, then litigation mechanisms (e.g. reconciliation, lawsuit) applicable under Turkish Law could be followed by the company, as well.

Non-resident digital companies may also be faced with serious sanctions (e.g. banning of business activities) if they do not defend themselves.

Accordingly, the best reaction to a tax audit invitation of the Turkish Tax Inspection Board would be to accept the invitation and form an audit defense strategy, taking advantage of legal remedies available in the Turkish legislation such as reconciliation and litigation appeals.