Transfer pricing is a system to evaluate whether the prices applied in the purchase and sale of goods or services within a group company are compatible with the prices used in transactions between independent enterprises. The international principle in this regard is the “arm’s length principle”. The principle requires that transactions between affiliates be priced under terms similar to those applied in dealings between independent entities.
Article 13 of Corporate Tax Law No. 5520 (“Law No. 5520”) states, “If a corporation buys or sells goods or services to related parties at prices that violate the arm’s length principle, its profit may be deemed, wholly or partially, distributed as a disguised profit through transfer pricing. Purchase, sale, manufacturing and construction transactions, leasing and renting transactions, borrowing and lending money, and transactions requiring bonuses, wages and similar payments are considered as the purchase or sale of goods or services in all cases and conditions.” Accordingly, disguised profit distribution through transfer pricing is regulated for corporations that buy or sell goods or services to related parties at prices violating the arm’s length principle and that transfer the profits to other parties, in whole or in part.
Corporate taxpayers may be accused of disguised profit distribution through transfer pricing if they are involved in transactions with related parties at prices that are contrary to the arm’s length pricing. In other words, these taxpayers transfer value or benefits to related parties without compensation, depriving themselves of the profit to be obtained as a result of pricing contrary to the arm’s length principle. (3rd Chamber of the Council of State, file no. 2023/10330, decision no. 2024/3235, 21.5.2024)
Accordingly, the following conditions must be met to establish the existence of a disguised profit transfer:
- A transaction takes place between related parties.
- The transaction involves pricing that is incompatible with market conditions, thus violating the arm’s length principle.
- The purpose is to provide tax advantages, and this is possible.
- Profits are pooled in another country or in a region with a lower tax rate to reduce the tax burden.
Companies may face various criminal sanctions if they are found to be involved in a disguised profit transfer through transfer pricing. In this case, a tax assessment will be performed first for the underpaid taxes, which may lead to the obligation to pay additional taxes, and a late fee will be imposed for the late payment of the tax.
In Türkiye, the penalties arising from Tax Procedure Law No. 213 (“Law No. 213”) are as follows:
- Tax Loss Penalty (Law No. 213, Article 341): When the arm’s length principle is violated due to disguised profit distribution through transfer pricing, an additional tax base is imposed on the taxpayer. Tax loss is identified through the tax assessment of the additional tax base, complementary or ex officio, depending on the situation. Pursuant to Article 341 of Law No. 213, tax loss refers to the situation where taxes are not accrued on time or incompletely accrued because the taxpayer or the liable party fails to make tax payments on time or makes them incompletely. A tax loss penalty will be imposed for tax losses arising from acting contrary to the arm’s length principle.
- Irregularity Offenses and Penalties (Law No. 213, Article 352): A 2nd degree irregularity penalty will be imposed in case of failure to comply with the provisions regarding the format, content and annexes specified in the law as well as other relevant regulations while filing tax returns, notifications and documents. Disguised profit distribution through transfer pricing is one of the forms in which the violation manifests itself. Corporate taxpayers are required to submit the “Form on Transfer Pricing, Controlled Foreign Entities and Disguised Capital” to their associated tax office. In this form, which will be attached to the annual tax return, the taxpayers should indicate their purchases and sales of goods and services with related parties during the year. If they violate this obligation, they will be deemed to have committed the 2nd degree irregularity offense.
- Special Irregularity Penalty (Law No. 213, Article 353): Pursuant to Article 353 of Law No. 213, if a taxpayer fails to issue or receive the mandatory invoices, expense receipts, producer receipts and self-employment receipts, including those required to be issued as electronic documents, or if they indicate amounts different from the actual amounts in these documents, they will incur a special irregularity penalty of 10% of the difference that should have been reported on these documents. In case of disguised profit distribution through transfer pricing, if no price is demanded in return for the goods or services sold, regardless of whether the price is set at arm’s length, and if documents such as invoices are issued or if the price is written incorrectly in the documents issued, a special irregularity penalty will be imposed. In addition, if documents such as invoices are issued at a price that is not at arm’s length, a special irregularity penalty must be imposed over the difference between the documents issued and the actual price, as stipulated in this article.
Conclusion
Transactions contrary to transfer pricing rules, including tax regulations, may result in serious financial and criminal sanctions. Leading to tax losses, disguised profit transfer through transfer pricing is under strict control by tax administrations. Therefore, taxpayers should follow the arm’s length principle in their transactions and fulfill the relevant documentation and recording requirements.
Transfer pricing requires diligence as transactions carried out in violation of the legislation may give rise to administrative fines, tax assessments and legal liabilities. When companies properly manage their transfer pricing processes, they can minimize both financial and legal risks.
Öykü Gülsen, Executive Associate
