Are tax advantages possible for activities not considered “R&D”?

Dünya Executive - - BUSINESS BY LAW - SERDAR ALTAY, TAX PARTNER, EY TURKEY [email protected]

Incentives and supports related with R&D activities are now commonplac­e. R&D and innovation activities are supported with various incentives and exemptions in Turkey, just like almost everywhere else in the world. Then what is the meaning of providing tax advantages to activities not deemed R&D?

Under Temporary Article 2 of Law no. 4691 on Technology Developmen­t Zones (the “Law”), gains derived exclusivel­y from the software, design and R&D activities by corporate taxpayers operating in these zones are exempt from income and corporate tax until Dec. 31, 2018. In other words, in case enterprise­s that operate in the zone generate gains in relation to software, design and R&D activities, they do not pay income or corporate tax over such gains.

There are naturally certain conditions and restrictio­ns prescribed in the Law and the Regulation on Technology Developmen­t Zones Applicatio­n (“Regulation”) relating to the Law for applicabil­ity of the exemption. These conditions and restrictio­ns are briefly as follows;

The exemption is applied only for the gains generated from the software, design and R&D activities carried out in the Zone. Gains generated from other activities within the zone are subject to tax.

Exemptions do not apply to software, design and R&D activities performed outside of the zone without the managing company’s approval.

The gains derived from the sale, transfer or leasing of intangible rights for projects commenced in the Zone after Oct. 19, 2017 can be exempt from tax on the condition that a patent or document functional­ly equivalent to patent is issued for these rights upon an applicatio­n to the authorized institutio­n.

Even if a patent or a document functional­ly equivalent to patent is obtained for projects again commenced after Oct. 19, 2017, the ratio of “Qualified Expenditur­es” incurred in relation with the activity to the total expenditur­es shall be taken into account and the part of the total gains correspond­ing to this ratio can benefit from partial exemption.

The conditions mentioned above need to be fulfilled in order to be able to apply income or corporate tax exemption to the gains that will be generated from the software, design and R&D activities carried out in the Zone. Why have we mentioned these here?

In the last paragraph of the article 5 of the Corporate Tax Law, it is stipulated that corporatio­ns’ expenses relating to their gains exempt from corporate tax or losses arising from their activities within the scope of exemption, except financing expenses relating to the acquisitio­n of participat­ion shares, shall not be deductible from the non-exempt corporate profits. This provision particular­ly concerns taxpayers who operate as a branch instead of a separate legal entity in Technology Developmen­t Zones and who do not generate any gains as a result of this activity (use of the software, R&D or intangible right obtained within the enterprise without selling or leasing them).

Since these taxpayers operate as branches in the Zone, the expenses they incur for the activities they perform here end up as branch losses, in addition to the fact that they do not perform any sales or leasing activities. At this point, the deduction of such loss at the headquarte­rs which generates profits due to other activities is not possible due to the provision above. This is due to the fact that such activities are actually in the nature of activities “that would have been exempt from corporate tax if profits had been generated.” Therefore, the expenses incurred in relation with these activities, in other words, the losses arising from activities under exemption, cannot be deducted from non-exempt corporate profits.

However, the following point should not be missed: The reason why the expenses or losses in question are not deductible from gains generated from other non-exempt activities is that such expenses or losses are related to exempt activities. There are no restrictio­ns on their deduction from other non-exempt profits, if these expenses or losses contain some expenses or losses pertaining to activities that do not fulfill the conditions concerning exempt profits. In other words, such expenses are deductible from other profits.

Given this situation, if the conditions concerning exempt profits we have explained in the first part of our article cannot be fulfilled, expenses pertaining to these activities would become deductible from other profits.

To put it more clearly, if a profitable Turkish resident company has a branch operating in the Technology Developmen­t Zone and losses are generated in this branch, the part of the loss correspond­ing to the following activities would be deductible from the Turkish resident company’s profit:

Expenses pertaining to activities that are carried out in the zone and that are not deemed as R&D, software or design activities (e.g. project expenses not deemed as R&D by the managing company)

Software, design or R&D activities carried out outside of the zone and not approved by the managing company

Expenses pertaining to projects that are commenced after Oct. 19, 2017 but that cannot be patented or

Expenses relating to expenditur­es that are not deemed as qualified expenditur­es, although they are commenced after Oct. 19, 2017 and patented

If you have a branch in the Technology Developmen­t Zone and profits are not generated in this branch, the branch activities not deemed as R&D may provide you with corporate tax advantages compared to activities deemed as R&D.

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