VAT Creativity in Forward Transactions!

Introduction

In our country, Türkiye, where production costs, especially raw materials and intermediate goods, are overwhelmingly indexed to exchange rates, fluctuations in exchange rates have created an environment of dollarization and then high interest rates in our economy.

Companies that want to avoid the risk of cost increase due to exchange rate fluctuations make forward transactions within the framework of the freedom of contract under the state of Article 48 of the Constitution in order to hedge such risks or to earn a profit.

In recent practice, we have observed that tax authorities initially apply an invitation to explanation procedure against the companies within the framework of Article 370 of the Tax Procedure Law, and subsequently issue tax penalties for non-payment of VAT due to the earnings arising from forward contracts, which are basically banking instruments.

However, in banking transactions, VAT is exempted; BITT is applied. On the other hand, while VAT can only accrue on the purchase of goods or services, companies that are customers of banks which make forward transactions from banks should not be considered as providing services to banks.

We have discussed the legal background of this issue under the following headings:

What is a Forward Transaction?

Forward contract is defined in the  General Communiqué on Corporate Tax Serial No. 1 as a type of contract that requires one party to purchase the financial instrument subject to the contract at a certain future date at the price specified in the contract and the other party to sell the financial instrument subject to the contract.

In forward transaction, two parties enter into a derivative contract to purchase or sell an instrument at a specified price on a certain date. Therefore, it has been translated into Turkish as “vadeli işlem sözleşmesi“.

After all, forward transactions are a financial instrument that has been provided by banks and intermediary organizations in Türkiye for many years in accordance with Article 4 of the Banking Law.

It is exemplified in our legislation exactly as follows:

Transaction Date                    : 4/1/2011

Maturity Date                                    : 4/4/2011

Contract Amount                   : USD 1.000.000

Contract Exchange                 : 1,4890

Spot Rate at Maturity             : 1,5268

Earnings Criteria                    : [(Value of the instrument of the contract based on the market price) – (Value of the instrument of the contract based on the transaction (utilization) price)]

Earnings                                : USD 1,000,000 x (1,5268-1,4890) = TRY 37,800

As a result, the earnings amount of TRY 37,800 – arising from this forward transaction in favor of (A) Institution was paid to (A) Institution by (F) Bank on the maturity date of the contract and this amount will be included in the corporate income of (A) Institution as of the mentioned date.

The Place of Forward Transactions in Turkish Banking Legislation

According to the Banking Law, one of the main fields of activity of banks is the purchase, sale and intermediary transactions of financial instruments based on economic and financial indicators, capital market instruments, commodities, precious metals and exchange; future contracts, option contracts, simple or complex financial instruments including more than one derivative instrument.

Specifically, forward transactions (option contracts) qualify as credit under Article 48 of the Banking Law.

In addition, according to the Regulation on Measurement and Assessment of Capital Adequacy of Banks, contracts based on exchange and gold have been included in Turkish legislation as derivative financial instruments.

Within the scope of these definitions, cash-settled forward purchase/sale contracts that qualify as derivative financial instruments should be assessed within the framework of the Banking Law No. 5411 and related Regulations.

Assessment of Forward Transactions in terms of VAT

The Value Added Tax Law is a type of tax that accrues only on matters that result in delivery or service. The taxpayer is the one who provides the goods or services.

Accordingly, the transaction must be carried out by the taxpayer (i) in Türkiye and (ii) a delivery or service must be made within the scope of commercial, industrial, agricultural or self-employment activity. Although forward transactions are carried out on a commercial basis, it is an incidental earning that is not within the continuity specified in the law.

As a matter of fact, according to the established decisions of the Council of State, VAT accrual from this transaction is against the procedure and the legislations.

However, in recent practice, we observe that Turkish Tax Administrations interpret the issue very differently.

Assessment of Forward Transactions within the Framework of Exemptions in Turkish Tax Legislation

Article 2 of the General Communiqué on Expense Taxes Serial No. 89 regulating the taxation of futures and options contracts clearly states that forward transactions are subject to BITT.

According to the Expense Taxes Law and Value Added Tax Law, it is clear that these contracts are exempt from mentioned taxes.

Procedure Followed in Practice

In practice, we observe that Turkish Tax Authorities initiate the procedure of invitation to explanation according to Article 370 of the Tax Procedure Law for companies that have earnings from forward transactions.

The process of invitation for explanation is an administrative process initiated before the taxpayer is subjected to tax inspection, referred to tax assessment commissions or notified by third parties. Essentially, if the Tax Authority is in doubt as to whether the taxpayer’s transaction is a taxable transaction or not, it invites the taxpayer to make an explanation/defense by using public power. The taxpayer is obliged to provide an explanation to the Tax Authority about the transaction. If the Tax Authority is satisfied with the taxpayer’s explanation, the taxpayer will not be subject to any sanctions or in certain cases, may be a remission applied for penalties.

This explanation/defense forms the basis of the defense in the annulment case to be filed in the future. Therefore, there is a legal interest in obtaining the consultancy of a attorney experienced in this field for the explanation letter.

However, in practice, we observe that serious VAT penalties are accrued after the invitation to clarify process.

Conclusion

In today’s economy, we are in a time when various creativity is important in terms of public revenues. One example of such creativity was the Presidential Decree dated September 24, 2018 increasing the SCT on vehicles with an engine displacement above 2000 cc. A more recent example, which directly affected the entire economy, was the Presidential Decree dated July 10, 2023 increasing VAT rates by 2% on many products.

It is possible to interpret the accrual of VAT to companies that purchase banking instruments from banks, despite the legal exemption, as an attempt to share in the earnings of transactions by using public power.

According to Article 73 of the Constitution, taxes can only be accrued by law. The legality of VAT arising from forward transactions is a matter of debate.

On the other hand, according to Article 2 of the Constitution, the Republic of Türkiye is not a police state; it is a state of law. A tax accrual which has debatable legality may give rise to various administrative and legal sanctions.

As a result, companies that have been subjected to an invitation to explanation procedure, tax inspection or tax penalty accrued due to forward transactions have serious interests in obtaining legal consultancy and opinion before the litigation as well as tax consultant.

If you have any questions about our article, we will be happy to help.