CORPORATE TAX SYSTEM IN TURKEY

1 Corporate Income Tax

The corporate income tax rate is decreased to 20% to be applicable for the year 2006 and onwards with the new Corporate Income Tax Law. Dividend withholding tax rate of 10 % is applicable to dividends distributed to individual and foreign corporate shareholders.

Note that the Council of Ministers is authorised to amend this rate. Please also note that dividend distributions to resident entities and branches of non-resident entities are not subject to withholding tax.

For non-resident entities operating in Turkey (i.e. branches, permanent establishments) withholding tax will only be applicable on the portion of the branch profit that is transferred to the headquarters.

Set out below is a table calculating the corporate income tax liability of a company in Turkey. Please note that the legal reserves that must be set aside under the Turkish Commercial Code are ignored for the sake of simplicity.

* Based on the assumption that 100% of the profit after corporation tax will be distributed to individual or foreign corporate shareholders.

For dividends distributed to residents of treaty countries the withholding tax rate that is in favour of the taxpayer will be applied.

In the event of dividend distribution by an international holding company in Turkey to its non-resident shareholders, the dividend withholding tax rate may be applied as 5%, upon certain conditions. Note that by virtue of this provision, an international holding company is defined as a joint stock company where 75% or more of total assets comprise of a participation of 10% or more of the capital of a limited or joint stock company

(except from those whose core business is financial leasing or security investment), or legal and business centre located abroad.

2 Advance Corporate Income Tax

Corporations are required to pay advance corporate income tax based on their quarterly profits at the rate of 20%. Advance corporate income taxes paid during the tax year are offset against the ultimate corporate income tax liability of the company, which is determined in the related year’s corporate income tax return.

3 Legal Reserves

Under the Turkish Commercial Code, Turkish companies are required to set aside first and second level legal reserves out of their profits. Please note that a branch is not subject to the legal reserve requirements.

First level legal reserves

Joint stock and limited companies are required to set aside 5% of their net profits each year as a first level legal reserve. The ceiling on the first level legal reserves is 20% of the paid-up capital. The reserve requirement ends when the 20% of paid-up capital level has been reached.

Second level legal reserves

The second level reserves correspond to 10% of profits actually distributed after the deduction of the first level legal reserves and the minimum obligatory dividend pay-out (5% of the paid-up capital). Second level legal reserves amount to approximately 1/11 of the profit to be distributed. There is no ceiling for second legal reserves and they are accumulated every year.

According to the Turkish Commercial Code, if the legal reserves exceed 50% of the paid-up capital, they shall be used to cover losses, maintain business activities in the case of bad business conditions, prevent unemployment or offset the negative effects of unemployment.

4 Calculation of Corporate Income Tax Base

Deductible expenses

In principle, general expenses incurred for the generation and maintenance of commercial income are allowed as deductions for corporate income tax purposes. Deductible expenses, inter alia, include the following:

• Expenses incurred for the issuance of share certificates or corporate bonds

• Start-up costs (these costs are to be either expensed or capitalised at the discretion of the taxpayer)

• Merger & liquidation expenses

• Previous years’ losses provided that they have not been carried forward for more than five years (on the condition that loss corresponding to each year is specified in the corporate income tax return)

• Donations made to governmental institutions or to associations and foundations that are granted tax exemption by the Council of Ministers, not exceeding 5% of the current year’s profit

• All of the donations made for construction of dormitories, nursery schools, rest homes and rehabilitation centres, subject to certain conditions

•

All of the cultural and artistic donations made to governmental institutions or to associations and foundations that are granted tax exemption by the Council of Ministers (such donations are cited in detail in the legislation)

• All of the sponsorship payments for amateur sport activities and 50% of the sponsorship payments for professional sport activities.

• Losses incurred in foreign jurisdictions (subject to certain conditions)

• Depreciation of fixed assets

• Depreciation and expenses of company cars provided to employees (Please note that company cars are not subject to income tax as they are classified as fringe benefits to

employees.)

• Meals provided on the premises of the company to the employees, without any limitations.

However, YTL 8.25 of luncheon vouchers per working day (subject to annual adjustment) granted to an employee for meals off the company premises is allowed as tax-deductible expenses

• Social security contributions

• Compensation paid or losses incurred in line with contracts or court rulings, provided that they are related to the business

• Travel and accommodation expenses related to and commensurate with the volume of business

• Technical reserves for insurance and reinsurance companies

• Research & development allowance, which is calculated as 40% of the research and development expenses of the corporations

• Profit shares paid to those who extend interest-free loans, as well as shares of profits paid against profit and loss participation certificates and against profit and loss participation accounts by private finance houses

• Real estate, stamp and municipality taxes, duties and fees that are relevant to the corporation

• Fees paid by the employers to the Labour Unions

• Contributions paid by the employers to the private pension system (subject to a ceiling)

• Cost value of the foodstuff donated to the food banks

Non-deductible expenses

In general, non-deductible items are limited to those types of expenditures that either cannot be properly documented or that are regarded as abuses in respect to “businessrelated” or “business-promoting” criteria (e.g., excessive entertainment, representation and travel

expenses). Needless to say, disallowable expenses increase the corporate income tax burden of companies since such expenses are not eligible for deduction from the corporate income tax base.

Disallowable expenses, inter alia, can be listed as follows:

. Interests, foreign exchange losses and other financial expenses on capital and on loans that are regarded as thin capital

. Fines and penalties and other indemnities arising from the wrongdoings of the taxpayer

. Legal reserves

. Donations to foundations (that are granted a tax exemption by the Council of Ministers) or to government institutions exceeding 5% of corporate profit.

. Expenses recorded through severance pay provisions (Severance pay shall be accepted as tax deductible only when actual payments are made to employees.)

. That portion of expenses incurred that is considered being in violation of transfer pricing regulations.

5 Depreciation Methods

The fixed assets, which are acquired after 01.01.2004, are subject to depreciation over rates to be determined by the Ministry of Finance, based on their useful life. Note that rates announced differ from 2 % to 33 %.

The fixed assets acquired before 01.01.2004 continue to be depreciated over the former application, in which the maximum rate applicable is 20% per year.

Depreciation may be calculated by applying either the straight-line or declining-balance method, at the discretion of the taxpayer. All tangibles, except for land, and intangible assets are depreciable over a minimum of five years. Under the previous application, buildings are an exception and are depreciated at a rate of between 2% and 10% per year, over a minimum of 10 or 50 years depending on the type of building.

Generally, assets are considered to be placed in service when they are capitalised and ready for use.

The applicable rate for declining-balance method is twice the rate of straight-line method. However, maximum applicable rate for declining-balance method is 50 %. On the other hand the declining balance method cannot be used for some items. For example, goodwill is depreciated within 5 years in equal instalments and leasehold improvements are depreciated over the rental period at a flat rate.

6 Controlled Foreign Corporation

The new law introduces the Controlled Foreign Corporations (CFC) provision to Turkish Tax Legislation. Corporations that are established abroad and are controlled directly or indirectly by tax resident companies and real persons by means of separate or joint participation in the capital or dividends or voting rights by at the rate of minimum 50% are considered as CFC provided that the below conditions are fulfilled:

. 25% or more of the gross revenue of the foreign subsidiary must be composed of passive income;

. The CFC must be subject to an effective income tax rate lower than 10% for its commercial profit in its home country; and,

. Gross revenue of the CFC must exceed the equivalent of YTL100,000 in a foreign currency in the related period.

CFC’s profit would be included in the corporate income tax base of the controlling resident corporation at the rate of the shares controlled, irrespective of whether it is distributed or not, in the fiscal period covering the month of closing of the according of CFC.

Control rate is considered as the highest rate owned in the related fiscal period.

The CFC’s profit that has already been taxed in Turkey as per this article will not besubject to additional tax in Turkey in the event of dividend distribution; whereas the portion of the profit distributed that has not been previously taxed in Turkey will be subject to taxation.

Taxes that the CFC pays over its profit in the related foreign country will be offset from the tax calculated for the same revenue in Turkey.

7 Transaction Taxes

VAT

Deliveries of goods and services are subject to VAT at rates varying from 1% to 18%. The general rate applied is 18%. VAT payable on local purchases and on imports is regarded as “input VAT” and VAT calculated and collected on sales is considered as “output VAT”. Input VAT is offset against output VAT in the VAT return filed at the related tax office by the 20th of the following month. If output VAT is in excess of input VAT, the excess amount is paid to the related tax office. On the contrary, if input VAT exceeds the output VAT, the balance is carried forward to the following months to be offset against future output VAT. With the exception of a few situations such as exportation and sales to an investment incentive holder there is no cash refund to recover excess input VAT.

There is also a so-called “reverse charge VAT mechanism”, which requires the calculation of VAT by resident companies on payments to abroad. Under this mechanism, VAT is calculated and paid to the related tax office by the Turkish company. The local company treats this VAT as input VAT and offsets it in the same month. This VAT does not create a tax burden for the Turkish and the non-resident company, except for its cash flow effect for the former, if there is no sufficient output VAT to offset there-from.

Special consumption tax

There are mainly 4 different product groups that are subject to special consumption tax at different tax rates:

. Petroleum products, natural gas, lubricating oil, solvents and derivatives of solvents . Automobiles and other vehicles, motorcycles, planes, helicopters, yachts

. Tobacco and tobacco products, alcoholic beverages

. Luxury products

Unlike VAT, which is applied on each delivery, special consumption tax is charged only once.

Banking and insurance transactions tax (BITT)

Banks and insurance companies are exempt from VAT but are subject to BITT at a rate of 5%, which is due on the gains of such companies from their transactions. The purchase of goods and services by banks and insurance companies are subject to VAT but is considered as an expense or cost for recovery purposes.

8 Property Taxes

Buildings and lands owned in Turkey are subject to real estate tax at the following rates:

. Residences 0.1%

. Other buildings 0.2%

. Vacant land* 0.3%

. Land 0.1%

* Allocated for construction purposes

The rates are applied twice for property located in the metropolitan municipality areas.

9 Stamp Tax

Stamp tax applies to a wide range of documents, including but not limited to agreements, financial statements and payrolls. Stamp tax is levied as a percentage of the monetary value stated on the agreements at rates ranging from 0.15% to 0.75%. Please note that salary payments are subject to stamp duty at the rate of 0.6% over the gross amounts paid, whereas a lump sum stamp tax is calculated for financial statements.

According to the stamp duty regulations, for the agreements signed in Turkey, taxable event occurs when the documents are signed. In the case of agreements signed abroad, it may be claimed that no stamp tax arises until the agreement is brought into Turkey to be submitted to the official departments or until the terms of the document are benefited from in Turkey. Please note that the definition of "benefiting from the terms of the agreement" is considered to be very broad under stamp tax regulations and if the agreement is exercised and the outcome is reflected in the legal books, the provisions of this agreement are deemed to be benefited from in Turkey. Likewise, the usage of this document to prove or support any rights, obligations or actions might be understood as being within the scope of "benefiting from the provisions of the agreement".

Stamp tax is payable by the parties who sign a document. Parties to a taxable document are jointly responsible for the payment of stamp tax. On the other hand, stamp tax arising from documents signed between official departments and real persons/legal entities are paid by the real persons/legal entities. Note that each and every signed copy of the agreement is separately subject to stamp tax.

The stamp tax per document shall not exceed YTL 878,400 (approximately US$570,000 at the prevailing foreign exchange rate).

10 Withholding Tax

Under the Turkish tax system, certain taxes are collected through withholding by the payers in order to secure the collection of taxes. These include income tax on salaries of employees, lease payments to individual landlords, independent professional service fee payments to resident individuals; and royalty, license and service fee payments to nonresidents.

Companies in Turkey are responsible to withhold such taxes on their payments and declare them through their withholding tax returns (please refer to Appendix I for the applicable withholding rates pursuant to the article 94 of the Income Tax Law and article 30 of the Corporate Income Tax Law.)

However, please note that local withholding tax rates may be reduced based on the available bilateral tax treaty provisions.

11 Resource Utilisation Support Fund (RUSF)

RUSF is applied on importation on credit basis and loans obtained locally or from abroad (except for foreign loans with an average maturity of more than one year). The rate of RUSF changes between 0-15%.This fund is not applicable where there is an incentive certificate or in the case of re-export credits.

12 Environmental tax

Municipalities are authorised to collect an environmental tax as a contribution toward the financing of certain services, such as garbage collection. This tax is levied at scheduled fixed amounts that vary according to the location of the office for which the environmental services are being provided. For houses the environmental tax is levied according to the water consumption of the domiciles. The taxpayer is considered to be the occupant of the premises, whether as owner or tenant.

13 Effects of Bilateral Tax Treaties

Turkey currently has a bilateral tax treaty network with 61 countries. Please refer to the Appendix II for a list of the countries with which Turkey has bilateral tax treaties. The withholding tax rates on dividends, interests and royalties may decline depending on the existence of a treaty if the treaty foresees a lower rate than the local legislation.

13.1 Calculation of treaty benefit on dividends

The local dividend withholding tax rate is determined as 15%. In order to apply the lower withholding tax rate stipulated by the treaty, the dividends should be distributed either actually or on an account basis. The benefit provided by the tax treaty will vary based on the ratio of the foreign shareholding, the maximum withholding tax rate specified by the treaty and the amount of dividend distributed.

13.2 Elimination of double taxation

Under the provisions of Turkey’s tax treaties, two methods are stipulated for the elimination of double taxation, namely the exemption method and the credit method. Fundamentally, the difference between the two methods is that the exemption method looks at income, while the credit method looks at the tax paid in the source country.

Under the principles of the exemption method, the country of residence does not tax the income, which according to a treaty may be taxed in the source country. In other words, income derived by a resident from a foreign country where it has already been subject to tax is exempted in the country of residence.

According to the principles of the credit method, credit is granted for the foreign taxes paid. However, the credit is generally limited to the amount of domestic tax that would be imposed on that foreign-source income if no credit for foreign tax were given.

In the absence of a tax treaty between the country of residence of the foreign shareholder and Turkey, the local law, which envisages a tax credit for foreign taxes paid in foreign countries under certain conditions, would apply. Please note that the new Corporate Income Tax Law also introduces new regulations with respect to taxes paid abroad. According to the new law, income taxes or corporate income taxes paid by the subsidiaries

whose at least 25% of shares are owned by resident joint stock companies abroad over their profit out of which dividends are distributed can be offset against the taxes payable in Turkey. The tax amount that may not be offset in the relevant year can be carried forward for three years, and the deduction can also be made in the advance corporate income tax periods.