In our previous article, we have dealt with general nature of accounting adjusted for inflation, in the context of corporation tax accruing to a dormant company. Let us recall the second scenario, which brings about even more striking argument.
“An inactive company with a unpayable shareholder debt to its controlling shareholder choses to convert the dept into capital. The shareholder is being advised that, the inflation adjustment differences” are considered as “funds” or “internal resources” under (TCC) so that he cannot convert the receivables to capital, unless first he converts the inflation adjustment differences fully or on a pro-rata basis.
In the view of many legal and tax experts , the wording of TCC 462/3 prohibits the companies from making cash capital increase solely, (especially converging a shareholder loan) where the financial tables have become positive, after the inflation adjustment. This situation arises due to increase in the “Capital” and "Previous Year's Profit Calculation” There is a tendency to regards the shareholder loan and this differences on an equal terms for the application of TCC 462/3 so that the differences have priority upon the shareholder loan in a capital increase.
I do not believe that this is a correct interpretation of the law. Here are the reasons;
Let us quote TCC 462/1-3
TCC 462/1 lists all internal resources that can be added to the capital as follows: “The capital may be increased from internal resources by; converting the reserves (*“yedek akçe”) allocated by the articles of association or the decision of the general assembly and not allocated for a specific purpose, and the freely usable parts of the legal reserves and the funds allowed by the legislation to be included in the balance sheet and added to the capital.
TCC 462/“3) In the event that there are funds in the balance sheet that are allowed by the legislation to be added to the capital, the capital cannot be increased by committing capital without converting these funds into capital. Capital can be increased both by converting these funds into capital and by committing capital at the same time and at the same rate. ..
The critical discussion here is that, whether the positive differences of inflation in the financial sheet, can be interpreted as “funds” within the meaning of Article 462.
First of all, I do not think that it is permissible to claim that while drafting Article 462 of TCC, the legislator has envisaged an item that would merely be created by the tax authority to be implemented due to inflation. We do not see such reasoning the preamble of the law. “Capital Inflation Positive Adjustment Differences" do not comply with the definition of "fund" in TCC, in my view, simply, on the grounds that it does not correspond to cash that it can be withdrawn from the company. Let us consider further points.
1. Definition of Fund has not been provided in TCC, nor in the TPL but we know what funds generally mean in commercial and accounting terms.
While paragraph 462/1 defines a broad internal resource, including "reserve funds (yedek akçe)" and "funds", the prohibition under paragraph 462/3 uses only the term "fund" and does not include reserve fund (yedek akçe). This terminological difference has led to uncertainty and debate as to whether only those that fall under the definition of 'fund' will be included, and not other internal resources in terms of 462/3. There are also strong arguments that the legislator deliberately did not include the "reserve funds" listed in 462/1, within the coverage of 462/3.
In our opinion, this debate is still irrelevant as it does not resolve the actual problem. Whether the prohibition covers the “funds” only or “both reserve funds and funds” we still need to ascertain by what is meant by definition of “fund” or “reserve fund” and whether the value created by accounting adjusted for inflation will fall within the definition.
Moreover, considering the different purposes (teleological interpretation) of the TPL and the TCC; as a matter of fact, this practice is a clear intervention of the tax authority to the balance sheet and the result of such intervention has never been defined as “Fund” or “Internal Resources” in any way and anywhere in the relevant legislation.
2. The process of inflation adjustment is defendable only on the grounds that it provides fair, reasonable and up to date picture of the financial statements, but since the inflation rate is constantly changing, it is not a reasonably conclusive construction of the financial affair of a company for determination the payable tax base.
If we consider a company as a living organism, rather than a legal entity on the paper, we can easily arrive to the conclusion that definition of “reserve” or “fund” must correspond to a real economic value, cash or easily convertible to cash at any given time. You reserve an economic value (preferably cash or equivalent) today for later spendings, therefore the real “profit” you have saved, must be linked to business activities and mostly cash proceeds. For a company, “cash” is like the “blood” in the body upon which lives of an organism is dependent, whereas tangible and intangible assets are the much longer-term variables. This is why in most cases; the real strength of a legal entity is measured by the cash flow and its sustainability.
Naturally there is nothing wrong in applying Inflation Adjustments and it is even fundamental so far as it is related to showing the company have a sufficient capital adequacy. This process involves (and in theory should involve) raising values of all items of the financial statement so that we have an up-to-date financial position.Therefore, it will not be wrong to claim that both the "Capital Inflation Positive Adjustment Differences" and the Previous Year's Profit account under inflation adjustment cannot be qualified as a "fund" within the scope of TCC 462/3.
3. Teleological Interpretation of the Concept of "Fund": Usable Internal Resources Corresponding to Real Monetary Value
In the face of uncertainties by the TCC and TPL, it is imperative to interpret the concept of "fund" in a purposeful manner. In terms of accounting principles, in accordance with the spirit of the TCC, the values meant by the concepts of "fund" or "reserve fund" are the monetary values obtained by the company as a result of its economic activities or created as a result of the actual payments of the shareholders.
In this respect, internal resources are generally divided into two, as "capital reserves" and "profit reserves".
Capital Reserves: Such as share issue premiums (emission premiums), it consists of actual payments made by the shareholders to the Company on their capital commitments.
Profit Reserves: Such as legal, statute or extraordinary reserves, it consists of the real profits obtained by the Company as a result of its commercial activities and which the Company does not distribute but keeps.
As can be seen, the concepts of "fund" or "reserve fund" in accordance with the spirit of the law should be understood as “values that correspond to a real monetary value”, “that are based on real economic transactions such as the operating profit of the company or the cash payments of the shareholders” and are usable and distributable (or which can be added to the capital)
"Inflation adjustment differences" which we have so far analyzed do not comply with the concept of "Fund" simply because The inflation difference is not an OPERATING PROFIT or a CASH INFLOW. The inflation difference is a DEMATERIALIZED and HYPOTHETICAL TPL regulation.
IN TERMS OF ACCOUNTING PRINCIPLES, A "FUND" IS BASED ON A REAL ECONOMIC VALUE (SUCH AS PROFIT OR EMISSION PREMIUM).
4. Purpose and Accounting of Inflation Adjustment within the Scope of the Tax Procedure Law (TPL)
The basis of the TCC 462/3 debate lies in the correct determination of the legal and economic nature of inflation adjustment differences. Let us make it clear that, this item is an accounting practice arising from the TPL, not even the TCC.
Inflation adjustment is a mechanism applied in accordance with Article 298/A of the TPL when financial statements lose their ability to express the real situation due to changes in the purchasing power of money. With this regulation, the tax authority aims to ensure that the financial statements "express the real situation".
In essence, this process consists of mathematically multiplying the "non-monetary assets" (such as land, buildings, machinery and equipment, inventories and equity items) in the balance sheet by certain "adjustment coefficients" (containing certain assumptions) in order to bring them to the purchasing power on the date of the financial statement.
The main purpose of this regulation is not to generate an operating income, to provide cash inflow to the company or to create a distributable fund, but to ESTABLISH A TAX SECURITY INSTITUTION THAT IS COMPLETELY RELATED TO THE DETERMINATION OF THE TAX BASE AND REPORTING RELIABILITY. This situation consists of a dematerialized intervention in the balance sheet upon the request of the tax authority.
5. Nature of "Capital Inflation Positive Adjustment Differences" and "Previous Year's Profit Calculation After Inflation Adjustment": “A Non-Monetary and Hypothetical Value”.
As a result of inflation adjustment, "positive differences" occur due to correction of equity items (especially the "capital" item). The nature of these differences is critical for the TCC 462/3 discussion, in this respect, these differences are,
Not Monetary Values: These differences are not cash entering the Company's vault, a transfer deposited in a bank account, or a receivable collectible from a third party. t is completely hypothetical, on paper and dematerialized.
Restatement of Capital Itself: The transaction that consists of showing the current value of the capital on the balance sheet according to inflation is the current capital of the company itself, it is nothing but a different nomenclature of it. This difference is the substitution of the molten value of existing capital in the face of inflation on paper; It is not an additional value.
Accounting Nature: TPL communiqués and practices stipulate that the profit/loss difference resulting from the correction of the balance sheet dated 31.12.2023 will be shown in the "Previous Years' Profits/Losses" account. It is stated that the profit generated in this account will not be subject to tax. From a legal point of view, the fact that this amount is not subject to taxation is the solid proof that they are not seen as “real profits” even by the tax authority.
Capital Add-On Status: The legislation states that it is possible for corporate taxpayers to "add to the capital" the inflation adjustment profit tracked in the "Previous Years' Profits" account and that this transaction "will not be considered as profit distribution". However, it is clear that this does not mean that there is a "usable, distributable, real FUND". Because neither the term FUND, (as we have seen above) is explicitly present in the legislation nor are these amounts recorded under the name of FUND in the Company's records. The transaction is the accounting transfer of an item (Previous Years' Profits) only in the equity block to another item (Capital) in the equity block. In reality, it does not create any change in the Company's assets or liabilities.
Last but not the least, TPL states that this account will be subject to tax, in that period in case it is "transferred to another account or withdrawn from the business in any way" This also reveals that the transaction is conditional in terms of taxation, in other words, THIS ITEM IS NOT A REAL AND FREELY USABLE FUND, and it is a sensitive and dematerialized tax item.
Conclusion:
Our view is that inflation differences cannot be considered as a "fund" within the scope of TCC 462/3.