Turkey: Transfer pricing of intra-group services with a special focus on recharacterisation as know-how

Canan Aladag

Establishing a transfer pricing policy over intra-group services may seem quite easy to accomplish, but it often requires a decision to be made about being precise and pragmatic, while there are non-TP impacts that should also be considered. Under Turkish transfer pricing rules, detailed documentation showing the calculation of the service charge, applying a mark up rate that is in line with the arm's-length principle and actual provision of the services by related parties, must be provided, which is pretty much in line with section 7.6 of the OECD guidelines (and BEPS draft section 7.7).

If the Turkish subsidiary fails to prove the benefit of the services, the outcome will usually manifest itself in the form of non-deductible services or recharacterisation of the payments from a corporate wihtholding perspective.

Under tax inspections during recent years, some of the intra-group service invoices received from overseas related parties in the form of service charges were treated as royalty payments by the Turkish tax authorities and subjected to withholding tax. Tax inspectors claim that the services concerned are an outcome of long term processes and experience that provide time and cost savings for the recipient company in Turkey, and therefore they should be reclassified as know-how which is a type of intangible property.

The outcome of these challenges was the payment of corporate withholding tax over the recharacterised payments according to the related articles of the OECD Model Tax Treaty.

It is quite unfortunate that the majority of these cases concluded with negative court decisions supporting the challenge made by the tax inspectors.

Even the multinationals' corporate management services are regarded as know-how instead of service activities and were treated as royalties.

Considering this background, it is vital to state whether the services received by the Turkish subsidiaries cover any know-how or intangible property aspect.

To analyse each service item separately proves to be the best approach for taking the right measures towards this challenge. Every payment that is made to the overseas related party should be reviewed from the corporate withholding tax treatment perspective with local and tax treaty-level focus as to whether they are independent professional services or intangible property, or both.

Additionally, the wording of service level agreements (SLAs) may also be checked as to whether they technically fall under the service definition from a Turkish and OECD Model Tax Treaty perspective.

It is extremely difficult to support the position that the payment is in return for independent professional services in the case that the Turkish entity has access to all intangible property in the group such as patents, know-how, and so on without paying any extra fees or royalties.

Lastly, taxpayers should check the calculation method of the services, that is, whether it is an allocation of costs plus an arm's-length mark-up or a percentage of sales of the Turkish subsidiary. If the calculation is as a percentange of sales, the tax authorities would more likely challenge the payment as a royalty type.

The challenges identified here will remain front and centre in taxpayers' minds until concrete guidance is provided by the Turkish tax authorities, unless there are more positive outcomes from the tax court decisions.

Canan Aladag (canan.aladag@tr.pwc.com)

PwC Turkey

Tel: + 90 212 326 6458

Website: www.pwc.com.tr