Thin capitalisation and transfer pricing: basic rules for small companies
Rules on thin capitalisation and disguised profit distribution through transfer pricing in borrowing and purchases and sales between shareholders and group companies; the annual form and practical recommendations.
In small and medium-sized companies it is common for a shareholder to lend to the company, for the company to sell goods to its shareholder or to invoice a sister company for services. Tax legislation does not prohibit these transactions, but it asks two questions: is the loan really a loan, or is it capital? Is the price the one two unrelated parties would agree?
Thin capitalisation
If borrowings that the company obtains directly or indirectly from its shareholders or persons related to its shareholders exceed, at any time during the accounting period, three times the company's equity at the start of the accounting period, the excess counts as thin capital.
Consequences
- Interest, exchange differences and similar expenses paid or accrued on thin capital cannot be expensed in determining corporate income.
- These amounts are treated as a distributed dividend as at the last day of the accounting period; for individual shareholders, dividend withholding arises.
Example
| Amount | |
|---|---|
| Equity at the start of the period | TRY 2,000,000 |
| Limit (3 times) | TRY 6,000,000 |
| Loan from shareholder | TRY 8,000,000 |
| Thin capital | TRY 2,000,000 |
The share of interest paid to the shareholder attributable to the TRY 2,000,000 portion cannot be expensed.
Loans obtained from third parties (for example a bank) against collateral given by shareholders or related persons are, as a rule, also included in this calculation. The Law provides separate measures for some cases, such as loans from related banks; if you have such a loan, let us do the calculation together.
Disguised profit distribution through transfer pricing
If the company buys or sells goods or services with related persons at a price or consideration not at arm's length, the profit is treated as distributed in disguise. Related persons are a wide circle, such as shareholders, their relatives, and companies to which shareholders are linked through management or capital.
Typical risky transactions
- Selling a vehicle or real estate to a shareholder or their relative below the market price,
- Paying above-market interest on a loan from a shareholder; lending to a shareholder interest-free,
- Setting service fees between group companies without documents or off-market,
- The company paying a shareholder's personal expenses.
This is why calculating imputed interest on loans to shareholders matters: Shareholder current account and imputed interest · Imputed interest calculator
Documentation and the form
- Corporate taxpayers report their transactions with related persons on the form on transfer pricing, controlled foreign companies and thin capitalisation attached to the corporate tax return.
- Companies transacting with related persons abroad or in free zones, and companies registered with the Large Taxpayers Tax Office, also prepare an annual transfer pricing report.
- Arm's length is shown using the comparable price, cost plus, resale price and other methods. In small companies, market quotes, valuation reports and bank interest rates are often sufficient support.
Practical recommendations
- Put shareholder loans into a written agreement; set the term and interest rate.
- If there is a large shareholder loan relative to equity, consider a capital increase: Capital increase and reduction
- For sales to a shareholder or related company, document the price with a valuation or market research.
- For intra-group services, keep correspondence and reports showing that the service was actually provided.
- Finance expenses may also be subject to a restriction: Finance expense restriction
Our related service: Tax advisory
Legal basis: Corporate Tax Law No. 5520 arts. 12 and 13; General Communiqué Serial No. 1 on Disguised Profit Distribution through Transfer Pricing.