Mandatory Annual Transfer Pricing Report and Sanctions for Non-Compliance
Summary
Article 13 of Corporate Tax Law No. 5520 regulates disguised profit distribution through transfer pricing. The last paragraph of that article provides that the procedures relating to transfer pricing are determined by the President. Under this provision, Council of Ministers Decision No. 2007/12888 set out the transfer pricing procedures, and it was later amended by Presidential Decision No. 2151. The Council of Ministers Decision introduced an obligation for certain taxpayers to document their transactions with related parties in an "Annual Transfer Pricing Report". The communiqués explaining Article 13 of the Corporate Tax Law set out the same obligation. Although the obligation to prepare the report exists, the legislation provides no sanction for taxpayers who fail to comply with it. In practice, some taxpayers are unaware of the obligation and do not prepare the report.
Keywords: Transfer pricing, transfer pricing report, administrative sanction.
1. Introduction
The "entity concept" is set out in General Communiqué No. 1 on the Application of the Accounting System, issued under the authority granted to the Ministry of Finance by Articles 175 and repeated 257 of Tax Procedure Law No. 213. Under this concept, a business has a personality separate from its owners, managers, staff and other stakeholders. In line with this, Article 41 of Income Tax Law No. 193 and Article 13 of the Corporate Tax Law require taxpayers that buy or sell goods or services with related parties to set prices as if there were no relationship between them. Article 41(1)(4) of the Income Tax Law contains provisions parallel to the Corporate Tax Law and states that Article 13 of the Corporate Tax Law applies to matters not covered by it. Article 13 of the Corporate Tax Law sets out when earnings are deemed to be distributed, wholly or partly, in a disguised manner through transfer pricing; the concept of a related party; the arm's length principle; the methods for determining prices in related-party transactions; and the steps to be taken in case of disguised profit distribution. Its final paragraph provides that the procedures relating to transfer pricing are determined by the President.
The Council of Ministers set out the transfer pricing procedures in Decision No. 2007/12888 and required taxpayers to document their related-party transactions in an "Annual Transfer Pricing Report". The communiqués issued by the Ministry of Finance introduced the same obligation in line with the Decision.
The errors made by taxpayers regarding the obligation to prepare the Annual Transfer Pricing Report, and the way in which the obligation introduced by the Decision and the Communiqué is (or is not) backed by sanctions, prompted this article. We first discuss disguised profit distribution through transfer pricing, then the obligation to prepare the Annual Transfer Pricing Report and the sanctions for non-compliance, and finally make recommendations regarding sanctions.
2. Disguised Profit Distribution through Transfer Pricing under the Income and Corporate Tax Laws
In purchase and sale transactions with related parties, income and corporate taxpayers may, for various reasons, set prices that are far below or far above arm's length. For example, when goods are sold below the arm's length price, the seller forgoes profit equal to the discount, and the buyer gains income equal to that discount. Article 41(2)(5) of the Income Tax Law aims to prevent prices that deviate from arm's length in dealings with related parties. Under this provision, if a business owner applies a non-arm's-length price to a related party, the difference between the arm's length price and the actual price to the detriment of the business is deemed to have been withdrawn from the business. The article also defines related parties, the transactions treated as purchases or sales of goods or services and the cases in which taxation will be corrected, and states that Article 13 of the Corporate Tax Law applies to matters not covered.
Article 13 of the Corporate Tax Law is titled "Disguised profit distribution through transfer pricing". Under its first paragraph, if a corporation buys or sells goods or services with related parties at a price determined contrary to the arm's length principle, its earnings are deemed to be distributed, wholly or partly, in a disguised manner through transfer pricing. The second paragraph defines related parties and the third defines the arm's length principle: the price applied in related-party transactions must be consistent with the price that would apply between unrelated parties. Taxpayers must also keep the records, schedules and documents supporting their arm's length calculations as evidence. The fourth paragraph sets out the methods taxpayers must use to determine prices in related-party transactions. The fifth paragraph allows the method to be agreed with the Ministry of Finance at the taxpayer's request. The sixth provides that earnings distributed in a disguised manner are treated, for income and corporate tax purposes, as a dividend distributed (or, for limited taxpayers, as an amount transferred to the head office) on the last day of the accounting period in which the conditions are met. The seventh makes the acceptance of disguised distribution in certain cases conditional on a loss to the Treasury, and the final paragraph provides that transfer pricing procedures are determined by the President.
3. The Obligation to Prepare an Annual Transfer Pricing Report
Based on the final paragraph of Article 13 of the Corporate Tax Law (under which transfer pricing procedures are determined by the President; the words "Council of Ministers" were replaced by "President" by Article 173 of Decree-Law No. 700 of 2/7/2018), Council of Ministers Decision No. 2007/12888, published in the Official Gazette No. 26722 of 06.12.2007 and effective from 01.01.2007, set out the procedures for applying the article. The Decision requires certain taxpayers to carry out documentation showing that they take the arm's length principle into account at every stage of transfer pricing. The purpose of documentation is to make the transfer pricing process understandable and to show the details of the calculations. Under Article 19 of the Decision, titled "Documentation", certain taxpayers must prepare an "Annual Transfer Pricing Report" for this purpose.
Taking into account the amendments made by Presidential Decision No. 2151 of 24.02.2020, Article 19 of Decision No. 2007/12888 requires the following to prepare an Annual Transfer Pricing Report by the corporate tax return filing deadline, and to submit it to the tax administration or to tax inspectors on request after that deadline: taxpayers registered with the Large Taxpayers Office, for their domestic and cross-border transactions with related parties in an accounting period; other corporate taxpayers, for their cross-border transactions with related parties; corporate taxpayers operating in free zones, for their domestic transactions with related parties; and all corporate taxpayers, for their transactions with foreign branches and with related parties located in free zones.
In addition, General Communiqué No. 1 on Disguised Profit Distribution through Transfer Pricing, explaining Article 13 of the Corporate Tax Law and Article 41(5) of the Income Tax Law, was published in the Official Gazette No. 26704 of 18.11.2007. Section "7.3 – Annual Transfer Pricing Report" of the Communiqué contains provisions similar to Decision No. 2007/12888.
As shown above, under both Decision No. 2007/12888 and General Communiqué No. 1, the following must prepare an Annual Transfer Pricing Report:
taxpayers registered with the Large Taxpayers Office that have domestic and cross-border transactions with related parties;
corporate taxpayers with cross-border transactions with related parties, even if not registered with the Large Taxpayers Office;
corporate taxpayers operating in free zones that have domestic transactions with related parties;
all corporate taxpayers with transactions with foreign branches and with related parties in free zones (including their branches in free zones).
Accordingly, the following are not required to prepare an Annual Transfer Pricing Report:
taxpayers with no domestic or cross-border transactions with related parties;
income taxpayers;
corporate taxpayers with transactions only with domestic related parties, other than those registered with the Large Taxpayers Office and those operating in free zones;
corporate taxpayers operating in free zones that have no domestic transactions with related parties.
4. Sanctions for Taxpayers Who Do Not Comply with the Obligation
As noted above, Decision No. 2007/12888 requires certain taxpayers to prepare an Annual Transfer Pricing Report and to submit it to the administration or tax inspectors on request. However, it contains no provision on the sanctions that apply to taxpayers who fail to comply. General Communiqué No. 1 likewise sets out the obligation to prepare the report and submit it on request. Section "8 – Penalties" of the Communiqué states: "Penal action will be taken under the Tax Procedure Law against those who do not submit the reports, notifications and other information and documents required to be submitted to the Administration under this Communiqué within the periods specified, or who provide incomplete or misleading information." This provision, however, targets failure to submit the report, not failure to prepare it. As in the Decision, no sanction is provided for taxpayers who fail to prepare the report.
So although both the Decision and the Communiqué require the report to be prepared, neither sets sanctions for non-compliance. Only the Communiqué provides that the penalty provisions of the Tax Procedure Law apply to taxpayers who fail to submit the report on request. Failure to submit the requested report breaches Article 148 of the Tax Procedure Law on the duty to provide information, and the applicable penalty is the special irregularity penalty under repeated Article 355. For the penalty to apply, however, the second paragraph of that article requires the taxpayer to be notified in writing of the deadline for submitting the report and that the penalty provisions will be applied if it is not submitted on time.
Therefore, if the administration or a tax inspector finds that a taxpayer has not prepared an Annual Transfer Pricing Report, no sanction can be applied directly. The taxpayer is first sent a written request to submit the report, and only if it is not submitted is the special irregularity penalty imposed.
5. Recommendations on Sanctions
In practice, some taxpayers within the scope are unaware of the obligation to prepare an Annual Transfer Pricing Report and do not prepare it. Taxpayers explain that their related-party transactions were not large enough, or not of a nature, to require a report. Moreover, because non-compliance with the obligation introduced by Decision No. 2007/12888 and General Communiqué No. 1 carries no sanction, taxpayers do not take the matter seriously. Some even choose not to prepare the report, accepting the risk that it may be requested, since it is failure to submit, not failure to prepare, that is penalised.
The aims of administrative sanctions include establishing and protecting administrative order, deterring violations by penalising them and restoring public order. Administrative sanctions also serve to remind individuals of their duties and obligations (ERDİNÇ, op. cit., p. 260). Penalising failure to submit rather than failure to prepare the report leads taxpayers to underestimate the matter, to delay preparing the report until it is requested and to make errors; reports not prepared on time cause problems for both taxpayers and the administration. The Tax Procedure Law provides tax penalties for those who breach the tax laws for these same purposes. A new regulation on sanctions is needed to remind taxpayers of the obligation to prepare the Annual Transfer Pricing Report and to protect administrative order.
6. Conclusion
Article 13 of the Corporate Tax Law, titled "Disguised profit distribution through transfer pricing", provides that transfer pricing procedures are determined by the President, and Council of Ministers Decision No. 2007/12888 issued under this provision sets out those procedures. General Communiqué No. 1 on Disguised Profit Distribution through Transfer Pricing was also issued to explain Article 13 of the Corporate Tax Law and Article 41(5) of the Income Tax Law. Both the Decision and the Communiqué require certain taxpayers to prepare an Annual Transfer Pricing Report, but neither sets sanctions for those who fail to comply.
In practice, some taxpayers are unaware of the obligation. The absence of a sanction may also lead taxpayers not to prepare the report, accepting the risk that the administration or an inspector may request it.
A new regulation on sanctions for failing to prepare and submit the Annual Transfer Pricing Report is needed to remind taxpayers of the obligation, to help them avoid errors and penalties, and to protect administrative order.
Bibliography
Tax Procedure Law No. 213
Income Tax Law No. 193
Corporate Tax Law No. 5520
Council of Ministers Decision No. 2007/12888
Presidential Decision No. 2151
General Communiqué No. 1 on Disguised Profit Distribution through Transfer Pricing
ERDİNÇ, B., 2012, "İdari Yaptırımların Kavramsal Çerçevesi ve Cezai Yaptırımlarla Karşılaştırılması" (The Conceptual Framework of Administrative Sanctions and Their Comparison with Criminal Sanctions), Ankara Bar Review, Issue 2012/2, pp. 239–276, Ankara.
