Can Turkey make progress on transfer pricing audits?

National differences and approaches to transfer pricing are evident all over the world. In particular, tax jurisdictions in developed countries have now taken quite advanced steps in approaching complex transfer pricing situations from a technical debate perspective. Whereas in some countries, including Turkey, the concept of transfer pricing could be more advanced. Although Turkey has had local legislation reflecting the OECD perspective for more than ten years, experience indicates that these OECD transfer pricing principles are not applied consistently across the Turkish Tax Authority. This leaves taxpayers vulnerable and exposed to different approaches taken on transfer pricing audits.

An analysis of the general transfer pricing audit characteristics in Turkey can help provide an insight into where progress can be made.

Developing broader business and commercial knowledge

In reality, transfer pricing studies in Turkey are being held back by a lack of guiding case law to follow. In addition, tax authority representatives take different approaches to issues such as management fees. The OECD guidelines state that transfer pricing is not an exact science but requires tax authorities and taxpayers to exercise judgment. This judgment is directly related to understanding the taxpayer, the business and the industry. However, Turkey’s sectoral specialisation and industry dynamics often result in situations where the tax auditors have incomplete information about the wider sector and general supply chain structures and do not develop a commercial understanding. As a result, the tax authority often looks for a sector-specific profitability trend in related transaction types.

Use of secret comparables and different approaches to benchmark studies

Another issue in transfer pricing audits in Turkey is the use of group company data and secret comparables. While the tax administration’s use of secret comparables and its failure to disclose them to the taxpayer, especially during litigation, is unpopular, the tax authority continues to rely on its use.

In addition, tax administration officials take different approaches regarding the use of external benchmark studies provided by the taxpayer in transfer pricing audits. Although no commercial database exists in Turkey, tax auditors tend to request pure comparable domestic data. Secondly, while OECD Transfer Pricing Guidance (TPG) recommends the use of multiple years in the benchmarking process, it’s an approach not favoured by the Turkish tax authorities, who are more likely to request the use of current-year data. Last but not least, the tax administration collects information from other multinational taxpayers. This means tax auditors can expect to find the same or very similar ratios and prices used for a taxpayer under investigation, particularly regarding royalty rates. The tax administration will also typically overlook the use of external benchmarking studies.

Guidance on intra-group services

The OECD TPG does not provide complete guidance on the circumstances when intra-group services deliver commercial and economic benefits and how this should be fully documented. It’s an issue that causes both taxpayers and tax administrations to create norms and standards for themselves.

The point where the OECD TPG and the Turkish tax administration differ in approach is that the OECD TPG states that if the actual conduct differs from the contractual terms, actual conduct should always be taken into account. Although the principle of substance over form is covered in Turkish tax procedure law, the written contract always has a binding effect. For example, suppose a long-standing contract relating to the use of intangible property and the actual conduct of the related parties differs from the original terms. In that case, there is a high probability that the tax auditors would treat the payments as intangible payments in excess of the contractual terms as other than services. For this reason, it’s crucial that contracts between related party taxpayers should always reflect the actual conduct.

Consideration of transfer pricing reports

Tax audits in Turkey are categorised as either limited or full-scope audits. Limited-scope tax audits deal with a single type of tax. A full-scope tax audit means examining the taxpayer for more than one tax type and requires completion within a year. In full-scope audits, matters such as commercial and industry knowledge, correct interpretation of the function and taxpayer’s risk profile, and understanding and pricing of related transactions are not evaluated in detail by the auditor.

This lack of detail means the transfer pricing report could have a potentially significant influence on the audit. However, transfer pricing reports are rarely asked for in the batch of information requests. Instead, the questions are more general.

Allocating more resources

In conclusion, tax audits in Turkey have some way to go to catch up with the level of technical transfer pricing discussions around the world and the updated OECD TPG. While Turkey has fulfilled the OECD’s Base Erosion and Profits Shifting (BEPS) legislation updates on the documentation side, there is little or no clarification of the purpose of documentation. To truly embrace OECD standards, the Turkish tax administration must now allocate and invest more resources to ensure tax audits are performed at a higher technical level to progress.

If you need assistance with Turkish transfer pricing requirements, please get in touch.