Digital companies derive income from their access to online users. However, the debate starts when it comes to the tax perception of digital companies. Tax authorities and the general public feel that these companies are not paying their fair share of tax in proportion to their profits.
A survey covering the European Union (EU) indicates that 75 percent of Europeans expect urgent EU action in the fight against tax avoidance and evasion caused by digital companies. Participants think that companies that are dealing with activities based on digital business models may maintain their tax burden at low levels because of existing international tax laws and individual countries’ tax laws.
Digital business models allow digital companies to operate without a physical place of business. While the taxation rules based on physical place of business were applicable prior to the digitalization of the economy, they are not efficient to cover a digital company’s profits because the value chain in the digital economy has changed.
Many countries believe that digital companies derive large profits within markets and those companies should be taxed for that income as being the country of origin. In that context numerous countries, including Turkey, have been enacting or amending their tax regulations concerning the taxation of digital economy, under the categories of “reverse charge VAT,” “turnover” or “equalization tax.”
Is There a Global Solution for the Taxation of the Digital Economy?
Governments are closely monitoring the tax burdens of digital companies. The G-20 countries, including Turkey, took action on the taxation of digital companies. The Organization for Economic Co-operation and Development (“OECD”) published an interim report indicating the taxation challenges of the digital economy. However, the OECD was not able to develop a proposal since the member countries failed to reach a consensus.
A policy note on the “assessment of taxation challenges of the digital economy” was published by the OECD on January 23, 2019. Member countries agreed to examine different concepts, including significant economic presence, significant digital presence and “changes related to the threshold for place of business creation.”
Member countries also agreed to analyze the proposals objectively after holding debates on proposing “to grant more taxation right to the market or the user’s location” in the circumstance that “any value is created from a commercial activity formed with the participation of users” and which is focused on the sharing of taxation right including the matter of nexus.
The final OECD proposal is expected in 2020.
Turkish Digital Economy Taxation—Tax Protectionism?
The government has imposed a 15 percent withholding tax on internet advertising (published in the Official Gazette on December 19, 2018—presidential decree No 476 based on the authorization from the Law 6745 published in the Official Gazette dated September 7, 2016). The government has withheld 15 percent tax on digital advertising payments to services providers and intermediaries. The Presidential Decree is applicable to payments made as of January 1, 2019.
The introduction of taxing the digital economy through withholding taxation raised a debate on legality and contradiction to the constitution, since it was enacted by amending Article 11/7 of the Tax Procedure Law (“TPL”) determining taxpayers’ responsibility, but without any amendments to Article 156 of the TPL, providing the definition of a permanent establishment.
In this context, the taxation of online advertising services by the method of withholding as of January 1, 2019 does not comply with Turkey’s income and corporate tax laws and the double taxation agreements (“DTAs”) that Turkey has signed. The reason for this is the business nature of the profit due to the provision of advertising services in the “business activity” in the Turkish tax system.
If the revenue in the Turkish tax system is business profit, the earnings obtained should be acquired through a place of business and the income attributed to the place of business should be on a net basis. Business profits are not subject to withholding tax in both the Income Tax Law (“ITL”) and the Corporate Tax Law (“CTL”).
The withholding tax on multi-year construction projects is the exception to this implementation. However, the withholding tax for multi-year construction projects will be written off against the net corporate income tax liability and if the corporate income tax liability does not exist, the taxes withheld will be refunded to the taxpayers.
It is clear that the profit acquired in return for online advertising services delivered by resident or nonresident taxpayers to resident taxpayers in Turkey is business profit. In this case, profit acquired in return for advertising services is not subject to corporate tax in Turkey unless obtained through a permanent establishment or permanent representative in Turkey.
The opinion released by the Revenue administration on the withholding under the CTL related to the payment of advertisement services from abroad is as follows: “Within the scope of the DTT between Turkey and Ireland, in the circumstance that the Irish resident company does not own a place of business in Turkey as per the Article 5 of the concerning Treaty and does not provide the advertising service through this place of business, solely Ireland is entitled to tax the business profit to be acquired in return for the mentioned advertising service.”
Another issue concerns the regulations in relation to international taxation. DTAs signed by Turkey are mainly based on the OECD Model Tax Convention. Within the commentary on the OECD Model Tax Convention whether digital products will be treated as royalty instead of business profit is tied to the fundamental purpose of the payment. However, there is no such discussion on advertising services, because advertising services are considered as commercial income.
On the other hand, with regard to the hierarchy of norms, the double taxation treaties signed by Turkey are under the protection of the Turkish Constitution as a law and an international treaty since they are subject to and enacted by Parliamentary approval.
Within that context, Turkish treaties’ Article 5 contains clauses on cases for a place of business to occur in Turkey. Therefore, since withholding tax on the business profit will result in double taxation, it is contrary to international tax agreements and international tax rules; which will lead to disputes with the countries with which Turkey has signed a DTA. Therefore, it may be considered as a kind of tax protectionism.
At the beginning of these disputes, there would be applications for refunds of withholding amounts, because in the circumstance that a withholding tax is applied to the payments made to nonresident taxpayers in a situation that does not require withholding, as per the provisions of a DTA (in cases where business profit could not be attributed to place of business, since Turkey does not have tax rights), the nonresident taxpayers would apply for a refund of the taxes withheld.
Another problem is double taxation. It is well-known that the withholding tax amount applied on business profit will not be deductible in the country where the advertising service supplier is resident and the case would ultimately result in double taxation.
In addition to the challenges mentioned above, a significant problem arising in practice is the additional cost created for the Turkish tax residents who are making payment, because the nonresident taxpayer of the digital companies supplying the advertising services may exclude the taxes from the advertisement fee in the contract and reject any tax liability from the payment.
Therefore, the withholding taxation may result in the transfer of resources abroad if tax refunds arise for those receiving the advertising services. So, profit obtained through the collected taxes would be temporary for the treasury.
Taxes in Other Jurisdictions
Due to the challenges outlined above, other countries are introducing new types of taxes under different names such as “turnover tax,” with the purpose of taxing the nonresident taxpayer of digital companies.
As an example, the EU has proposed a short-term and a long-term solution to the digital economy taxation through a double stage draft.
As a short-term solution, applying a fixed 3 percent digital services tax on the turnovers of these companies as of January 1, 2020 is proposed. However, the EU cannot set a compromise even at a rate of 3 percent among member countries, since applying the proposed tax on the revenue turns it into an income tax. Since this tax is not a type of tax applied on the net income, its being applied on revenue will make it mandatory for companies to pay it even if they make a loss.
In addition, since the 3 percent tax will not be considered as a tax paid abroad, the nonresident taxpayer’s not being able to deduct it from its corporate tax liability in its country of residence is strictly criticized.
In summary, the principle of legality is the basis of taxation. Does adding tax regulations into the law texts gain them the qualification of legality? The fact that online advertising services are business profit does not comply with DTAs.
As indicated in the Constitutional Court’s Resolutions as well, the European Court of Human Rights stresses that the law has to be of a quality to a certain extent in terms of meeting the principle of legality. Therefore, it would be in the interests of Turkey to amend the definition of place of business in the TPL and perform the necessary arrangements in the income and corporate tax laws regarding the tax technique and quality of laws.
The matters subject to a long-term regulation are broad enough to be a topic for another article. However, in brief, a new model should be developed considering the digital companies’ significant digital presence as a basis for the EU proposal.
Turkey should closely monitor the 2020 report which will contain the OECD’s final proposal and if it introduces a solid structure for the taxation of profit acquired by nonresident digital companies in the Turkish market, this will remove the claims about “protectionism in taxation” as well.”
After the introduction of 15 percent withholding tax, digital companies should look at their existing structures, and more specifically:
- look at the contractual terms regarding who is liable to pay 15 percent withholding tax (advertising services supplier or service receiver in Turkey);
- evaluate the option of having subsidiary or PE in order not to lose any revenue from Turkey because 15 percent withholding tax imposition on advertising services will increase the cost in Turkey, which may lead to revenue loss; and
- collaborate with their Turkish business partner and decide whether or not to apply for a withholding tax refund, and agree how to share the burden, or refund.
Abdulkadir Kahraman is a Tax Partner at EY Turkey