| Mine BEYAZHANÇER Attorney-at-Law |
ABSTRACT
Companies can evaluate their past year profits by adding them to capital. Adding past year profits to capital can also provide advantages from a tax perspective. Within this scope, our article will examine the issue of adding past year profits to capital with its tax dimension.
Keywords: Capital Increase, Past Year Profits, Taxation, Capital Increase from Past Year Profits.
INTRODUCTION
Companies can add capital from outside the company either in kind or in cash, as well as they can increase capital from sources currently within the company. This type of capital increase is referred to as capital increase from internal sources. The past year profits account is the account where profits earned by companies in previous periods are recorded. It is possible to add the amounts in this account to capital instead of distributing them to shareholders as dividends.
Within this scope, our article will first include explanations regarding capital increase from past year profits, and subsequently evaluations regarding the taxation of capital increase from past year profits will be made.
I. CAPITAL INCREASE FROM PAST YEAR PROFITS
Capital increase aims to strengthen the financial structure of companies. Capital increase is among the special amendments to be made with the articles of association pursuant to the Turkish Commercial Code No. 6102 (“TCC”) and is subject to registration. It is also possible to make the capital increase by using the company’s internal sources. This matter is regulated in Article 462 of the TCC. In capital increase made from internal sources, unlike increase from external sources, there is no change in the assets of the partnership.¹ Therefore, capital increase from external sources is defined as effective capital increase, while capital increase from internal sources is defined as nominal capital increase.²
In the Communiqué on the Procedures and Principles Regarding the Application of the Provisional Article 13 of the TCC,³ past year profits are defined as amounts arising in previous activity periods and for which no decision has yet been made to transfer to other equity accounts.
It will be possible to add these profits to capital in order to meet the company’s investment capital need or to strengthen the company equity so that distribution of this amount to partners is not preferred.
In capital increase from past year profits, the transfer of this item, which is currently under equity, to the capital account is at issue. In this respect, the transaction made can be simplified as merely changing the location of an amount located in the company’s liabilities. No changes are made in the company’s assets. Article 457 of the TCC regulates that it must be guaranteed from which sources the capital increase made from internal sources is covered, and that these sources are real and exist within the company assets. In Article 462, it is regulated that the guarantee regarding the existence of these internal sources will be confirmed with an approved annual balance sheet and a clear and written statement to be given by the board of directors. In case more than six months have passed since the balance sheet date, it is foreseen that a new balance sheet must be prepared. In Article 73 of the Trade Registry Regulation, it is regulated that a sworn financial advisor or independent accountant financial advisor report or, in companies subject to audit, an auditor report regarding the existence of the capital increase amount covered from internal sources must be submitted.
II. TAX DIMENSION OF ADDING PAST YEAR PROFITS TO CAPITAL
In Article 94 of the Income Tax Law No. 193 (“ITL”), it is regulated that adding past year profits to capital will not be evaluated within the scope of profit distribution. Adding profit to capital is included in Articles 15/2 and 30/3 of the Corporate Tax Law No. 5520 (“CTL”).
While it is regulated that the tax withholding at the rate of 15% arranged for the institutions listed in Article 15 of the CTL will be made on dividends, it is emphasized that adding profit to capital will not be deemed as profit distribution.
In the same direction, in Article 30 of the CTL, tax withholding is regulated in narrow liability, and the issue that adding profit to capital will not be deemed as profit distribution is emphasized again.
In the evaluation made in terms of income tax, in the special communiqué of the Istanbul Tax Office Presidency Income Laws Income and Corporate Taxes Group Directorate dated 21.10.2022 and numbered E-62030549-125[6/2022]-1222362, titled “Whether tax withholding will be made on free share certificates to be given to partners after adding the company’s past year profits to capital”, the following explanations were made regarding the subject:
“In your special communiqué request forms recorded in interest (a) and interest (c): » It was decided to add … TL, which remains after legal reserves are separated pursuant to the Turkish Commercial Code No. 6102 (TCC), from the amount in your Company’s ‘570. Past Year Profits’ account, to capital, » It was stated that this transaction was made in accordance with the provisions of Article 462 of the TCC and free share certificates will be given to your real person partners according to paragraph (3) of the first paragraph of the same article, and our Presidency’s opinion was asked regarding whether the transaction of giving free share certificates to partners by adding past year profits to capital is subject to withholding based on profit distribution pursuant to Article 94/6-b-i of the Income Tax Law No. 193.
In Article 94 of the Income Tax Law No. 193, it is stipulated that trading companies, in their capacity as tax liable persons, must make withholding on behalf of the income taxes of the entitled persons when making the payments listed in the article paragraphs (including those paid as advances) in cash or by account, and in sub-paragraph (b/i) of paragraph (6) of the first paragraph of the same article, it is stipulated that tax withholding at the rate of 15% (valid as of 3/2/2009 with the Council of Ministers Decision No. 2009/14592) will be made on the profit shares written in paragraphs (1), (2) and (3) of the second paragraph of Article 75, distributed by fully liable institutions to fully liable real persons, to those who are not income and corporate tax liable persons and to those exempt from these taxes (adding profit to capital is not deemed as profit distribution.), and the tax withholding rate has been determined as 10% with the Presidential Decision No. 4936 dated 21/12/2021.
Accordingly, since the transaction of giving free share certificates to real person partners due to your company’s past year profits being added to capital will not be evaluated as profit distribution, no withholding will be made on these amounts added to capital within the scope of Article 94 of the Income Tax Law.”
As can be seen from this special communiqué, it is certain that no income tax withholding will be made on the share certificates given to partners based on the amount added to capital from past year profits.
With its decision dated 05.06.2023 and numbered E. 2023/180, K. 2023/3248, the 4th Chamber of the Council of State approved the decision given towards the cancellation of the penal taxation made upon the failure to fulfill the stopaj liability on the share certificates distributed to partners, where capital increase was made in return for the capital decreased in return for the assets transferred within the scope of partial division.
“…although penal income stopaj tax taxation was made on the subject of the lawsuit on the grounds that the plaintiff did not fulfill the stopaj liability pursuant to Articles 94/6-b-i and 6-b-ii of the Income Tax Law despite distributing the new company shares it received in return for the assets it transferred within the scope of partial division to its partners, since the devolved company share certificates were distributed to the partners by the plaintiff company in accordance with the provision that the shares of the transferee company acquired in return for the assets transferred in the partial division stated in the third paragraph of Article 19 of the Corporate Tax Law No. 5520 can remain in the transferor company or can be given directly to the partners of this company, and the devolved company share certificates given to the partners were distributed proportionally to the value corresponding to the partners’ shares in the divided company, and accordingly no increase occurred in the asset values of the company partners, and considering that the plaintiff company covered the decrease in its capital resulting from the partial division from past year profit, it is seen that there is a capital increase from past year profit and there is no profit transfer to the partners, and moreover it is clear that adding profit to capital should not be deemed as profit distribution according to Article 94 of the Income Tax Law, and it has been concluded that there is no compliance with the law in the penal taxation made on the grounds that it distributed the share certificates it received from the devolved company in return for the share certificates it gave to the devolved company resulting from the partial division to its partners, but did not fulfill the stopaj liability. For the stated reasons, it has been decided to accept the lawsuit.”
In the case where past year profits added to capital are distributed to partners by making capital reduction, tax withholding will be made based on profit distribution.
CONCLUSION
Companies can add their past year profits to capital instead of distributing them to partners. As a result of this transaction, although company partners indirectly benefit from the profit earned by the company by having the increased share certificates free of charge, this matter is not qualified as profit distribution within the scope of the ITL and is not subject to income tax withholding. Therefore, adding past year profits to capital is a practice that can be preferred from a tax perspective.
¹ Moroğlu, E. (2018). Sermaye Artırımı in Anonim Ortaklıklar. On İki Levha Yayıncılık, p.7
² Ibid. Moroğlu, E. (2018), p.195-196. ³ Official Gazette dated 17.05.2020 and numbered 31130
³ Official Gazette dated 17.05.2020 and numbered 31130