- Is there any legal ground for the corporate tax to arise under the inflation adjustment?
- Can the “inflation adjustment differences” be considered as “funds” or “internal resources” under Turkish Commercial Code (TCC) ?
- Do the inflation adjustment differences prevent a company to make cash capital increase under TCC 462/3?
These questions originate from the same root, the bane of accountants' existence, in other words, inflation-adjusted accounting. The obligation to adjust the financial statements by applying inflation rate has not been an issue since 2004, but unfortunately it has returned our lives in 2022 due to extreme inflation conditions in Turkiye. Since then, the issue has been a rather problematic one and widely criticized.
While at first glance, such an accounting practice seems to be innocent, the only justification for such intervention would be to re-assess the true and real capital adequacy of any given company. In any case we all know that there will always be artificial side to it, because one cannot determine the real value of an asset until (and to the extent) it is converted to pure cash in the accounts.
It is important to remember that under Tax Procedural Law (TPL, or Vergi Usul Kanunu “VUK”) for the corporate tax to arise, no presence of cash is required so that it will be sufficient to have the profit element properly registered in your books. Now imagine two scenarios which most companies often encounter:
A dormant company, -no business operations, no single cash proceeds- whose tangible fixed assets somehow gained value under the so-called inflation adjustment. The company ended up in having positive taxable base, so that now it must find cash to pay corporate tax.
A company with a serious shareholder debt, payable to its controlling shareholder who rather than sell the assets to collect his receivable, would like to convert his receivable into capital. He 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.
Question: Is there any legal ground for the corporate tax to arise under the inflation adjustment?
It is a tricky question. If you were an accountant, the answer would be simple “yes”, because that it is what the Tax Procedural Law (TPL) envisages. However, from a legal point of view under TCC the answer is more complicated.
In our opinion, the consequences of such adjustment would be against the basic of interpretation of Turkish Commercial Code. Can a dormant company be forced to pay corporate tax just because its fixed asset has gained value under the inflation adjustment?
It is apparent that the only way to pay this tax is either of the sale of fixed assets, borrowing a loan, or capital injection. Sale of fixed assets under legal coercion, will undoubtedly be done under unfavourable conditions. Another option would be to apply to Tax Court in order to cancel a payment order and may cause serious default interest risk. The issue would then be an “expert opinion” issue as the basis for a court ruling.
More importantly, how do we determine the value of a real estate without selling it? Even when the value is determined by a Capital Markets Board (CMB) licensed real estate valuation expert, "sale under difficult circumstances" or "due to urgency" must be taken into account, as well as comparable real sales and market dynamics in the same region, during the relevant period must be taken into account. There will be still unfairness in this whole process, because the real price is determined by not hypothetical, but a real purchaser at a given time.
Therefore, such an unjustifiable, arbitrary intervention to the property rights would be against the Constitution. First of all, inflation is not the fault of individual legal entities so why should they be punished for the errors made in management of economy, on the assumptions that there has been hypothetical increase in their tangible assets?
Over the years, in countries suffering from extremey high inflation, the capital and assets of the company loose value. From that point of view, it would not be wrong to claim that; what the inflation adjustment does is merely put the lost value back in the books. Thus, it would require more than “inflation adjustment”, for justification of the corporate tax. When this hypothetical exercise is completed, it is necessary to find the “real profit” or “gain” element in the books.
At this point, it is a striking issue that the TPL does not allow raising shareholder receivables in the same logic. While shareholder loan becomes bunch of papers, the assets keep their value. (* I do not use the “gain value” phrase because it is controversial and can only be used under specific conditions for each legal entity)
This favours the company while punishing the shareholder, who, in good faith have supported his company. This approach assumes that shareholder loans may be arbitrary and originate from the misuse of the controlling rights. Let this issue be the subject of another article but for the time being, sufficient to say that this practice is also, against the TCC and the constitutional property rights.
So far, we have been digging some ground with the hammer of TCC, which we know it relies upon UFRS, which is aimed to have a real financial position of the company from a creditor, shareholder and other interest groups point of view.
Whereas TPL's main concern is to establish a tax secure environment and is completely concentrated on the taxable base, as well as reporting reliability for the companies. However, if two legislation contradicts, I believe interpretation of TCC must prevail because its priority covers much wider interest groups.
In essence, it must be accepted that positive differences of inflation, even when reflected to the financial sheets, are merely dematerialized items and are not based on a real cash inflow. 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.
Despite being hypothetical, to some extent they may be considered reasonable interventions for the sake of of demonstrating the company's capital adequacy. But that does not change their true nature, meaning that, they are still mostly artificial and arbitrary values calculated in accordance with the provisions of the TPL, that they may lack certain financial rationality.
Last but not the least, we believe that especially for dormant companies, corporate tax should not be applied based on accounting adjusted for inflation, instead, it shall be postponed until the sale of fixed assets or liquidation of the company, with a proper evaluation of the economic losses of the legal entity due to high inflation.
To be continued; Part II (Can the “inflation adjustment differences” be considered as “funds” or “internal resources” under Turkish Commercial Code) ?