Commercial companies need capital to execute its business activities. Thus, paying the capital is regarded as the fundamental obligation of partners. In accordance with this, partners who do not pay their capital share on due date will be held liable accordingly to the private law in the context of TCC.
In addition to this, it is seen that this breach is sometimes interpreted as distribution of disguised profit through transfer pricing in the context of Corporate Tax Code (“CTC”).
Capital is one of the most important elements of a corporation and is essential for a company to carry on its activities and business operation. Turkish Commercial Code (“TCC”) regulates sanctions for partners in the event of failure to pay the capital that they had committed to in the Articles of Association (“AOA”) on the due date.
In this article, firstly the definition of the capital commitment of the partners will be examined, then the consequences of failure to pay the capital on the due date will be analysed in line with regulations and case law.
I. Definition of capital commitment
Capital can be allocated either in kind or in cash by partners to the company for the purpose of the continuity of the company and to provide the company with sufficient resources to attain the objectives agreed on in the AOA. This promise to pay the capital in cash or in kind by the partners is called ‘capital commitment’. The TCC Article 344, states that 25% of the capital must be paid before the establishment and the remaining 75% must be paid within 24 months of the establishment. Otherwise, in accordance with Articles 128, 129, 482 and 483 of the TCC, the optional rights that can be exercised by the company are stipulated by the legislator, aiming to protect the capital of the company. According to the articles herein mentioned, there is a private law debt relationship between the partner and the legal entity company where TCC law is applied. Payment of overdue debts arising from capital commitment comes to the fore in different situations, such as the prerequisite for borrowing to the company regulated in Article 358 of the TCC.
The mechanism/sanctions regulated under the TCC in case partners fail to pay the capital they committed are:
- paying compensation,
- interim injunction,
- default interest, and
In accordance with the TCC Article 128 Paragraph 7, a company can demand the payment of the capital commitment and file a lawsuit. This article also states that compensation can be requested from the partner who failed to make the payment. The TCC Article 129 further states that default interest can be demanded as long as the rights on compensation are protected. Although notification is not required to demand default interest, a notification to the said partner is deemed to be a prerequisite by law in order to make a claim for compensation for the loss. Furthermore, the TCC Article 482 states that the company is authorized to exclude the said partner, sell that partner’s shares, replace the partner by selling shares, and annul the shares given.
Annulment process is outlined in Article 483 of the TCC, and it is stipulated that a notice shall be issued through a notification to be published in the Registry Gazette and on the company's website through an announcement as mentioned by the AOA, and that this notice shall state that if the shareholder fails to pay the delayed amount within one month, they shall be deprived of their rights arising from the relevant shares and the contractual penalty shall be requested.
II. Tax-related consequences of failure to pay the capital in due date
It might be possible to consider the non-fulfilment of the capital commitment as a disguised profit distribution because capital is used free of charge. This argument will be evaluated below by taking the characteristics of the capital commitment into consideration.
Article 13 of the CTC states that if corporations purchase or sell goods or services with related people by breaching the arm’s length principle, the profit will be deemed to be distributed by the transfer pricing, wholly or partially. Additionally, “Distribution of Disguised Profit Through Transfer Pricing Communique No.1” (“Communique”) states three conditions that are required to define distribution of disguised profit through transfer pricing. Accordingly, it is stated that there will be no disguised profit distribution through transfer pricing if a good or service purchase or sale is made with a related person and the price or price determination conditions that are contrary to the arm's length principle are not met.
In this context, the following arguments have been made:
- In order the capital commitment to be evaluated within the scope of the CTC Article 13, there must be an advantage taken from this breach, but it is not possible to benefit from something that does not exist yet.
- Since default interest is not the only consequence that can arise from the regulation, it is not possible to consider failure to comply with the capital commitment in the context of distribution of disguised profit through transfer pricing.
In addition to these opinions, legal precedent also offers different views on whether distribution of disguised profit through transfer pricing does or does not occur in the event of failure to pay the capital agreed.
- As it cannot be accepted that the capital shown in the balance sheet, which could not be collected from the shareholders of the plaintiff company, is considered to be a lending transaction to the shareholders of the company, and that a disguised profit is obtained within the interest that is not applied, 4th Chamber of the Council of State decision dated 24.12.1998 and numbered E.1997/4274, K.1998/5542, upholds the decision of the First Instance Court for the abolition of the assessment.
- In the decision of the 4th Chamber of the Council of State dated 16.02.2022 and numbered E.2018/1135, K.2022/828, it was emphasized that the failure to calculate the default interest on behalf of the shareholder in debt by the company is not related to the purchase or sale of any goods or services, and that transactions such as capital, dividends, etc. regulated within the framework of partnership law are not considered within the scope of disguised profit according to the CTC Article 13 regarding disguised profit distribution even though it constitutes a violation of the provisions of the TCC. Therefore, it is decided that in case of default in capital commitment, there is no compliance with the Law in the penalty assessment made on the grounds that the company has given interest-free money to its shareholders from its own assets.
As seen in aforesaid Council of State decisions, there is a tendency to interpret that unpaid capital commitments cannot be evaluated in the context of disguised profits.
- The decision of the 4th Chamber of the Council of State dated 29.06.2021 and numbered E.2018/3677 K.2021/3633, states that in the tax inspection report issued about the plaintiff company, it was seen that the interest was not calculated on the capital share amount and that the shareholders failed to make payment even though they had committed themselves to do so. Thus, the Council accepted the appeal request since there was no contradiction to the Law in terms of penalizing the tax base difference found by calculating interest over the Central Bank rediscount interest rate to the capital not paid on due date by the shareholders.
On the other hand, the above-mentioned decision of the Council of State overturned the Regional Administrative Court Decision that states: “In order to be able to talk about disguised profit distribution through transfer pricing in case of unpaid capital commitment, the existence of the purchase or sale of goods and services, or one of the transactions that can be evaluated within this scope, is mandatory and the fact that no default interest has been charged by the company cannot constitute this profit transfer.
As explained above, the Council of State does not have consistent jurisprudence on whether or not the failure to pay the capital commitment constitutes disguised profit distribution through transfer pricing. In some of its decisions, the Council only rules for the payment of the default interest if the capital commitment is not paid within the legal period; it cannot be inferred from the provision that the shareholder, who fails to fulfil the capital commitment on due date, will be obliged to pay default interest without the need for a notice since that default interest is directed towards the interest benefited by the defaulting shareholder.
As a matter of fact, it is impossible to think that the shareholder, who did not pay the capital on due date, can benefit from an asset that does not exist in the company. However, as mentioned above, there are decisions of the Council of State to the contrary; it concludes that in case the capital contribution obligation is not paid on due date, a disguised profit transfer is made in accordance with the Article 12 of the CTC.
As we mentioned above, capital, provided by company shareholders, is one of the essential elements in terms of both the establishment and the continuity of companies. . In this context, if the capital commitment, a commercial debt between the partners and the company's legal entity, is not fulfilled in due time, certain mechanisms such as payment of compensation, application of an interim injunction, interest in default and application for annulment have been envisaged in line with the relevant articles of the TCC to protect the capital.
In line with the opinions stated in this article and a number of decisions made by the Council of State, it is argued that the CTC Article 13 should be applied, and it should be concluded that the distribution of disguised profit through transfer pricing occurs in the event of not fulfilling the capital commitment on due date. On the other hand, there are also some contrary opinions and decisions of the Council of State that argues that it is not possible to benefit from an asset that does not exist yet and the conditions stated in the Communique on the Distribution of Disguised Profit Through Transfer Pricing are not met. In our opinion, this topic being open to interpretation harms the legal certainty principle, and this inconsistency should be ceased by deciding that there is no distribution of disguised profit through transfer pricing from our standpoint. In that respect, the Council of State should clarify the issue and provide consistency regarding the consequences that may arise in cases where the capital commitment is not paid due date.
By Mine Beyazhancer, Lawyer and Ahmet Hakan Mirza, Legal Intern, Nazali Tax & Legal