Recent Constitutional Court ruling creates a tax loophole
Diyadin Yakut*Traditionally, income taxation in Turkey is based on a dual system: Namely, the taxation of individuals’ personal income and taxation of corporations’ corporate income, regulated in two distinct laws.
The tax treatment of corporate income of legal entities is dealt with in the Corporate Income Tax Law, No. 5520.
According to relevant provisions of that law, only legal entities (mostly stock companies) that meet certain criteria are held responsible as taxpayers of corporate taxation.
Since the legal tax liability rests solely with an entity, not a real person, in corporate taxation, the problem of designating a responsible person to pay the accrued taxes and other public receivables and the ultimate collection of those public receivables arises when the legal personality of the liable corporation is financially unable to pay.
That is why, the Turkish taxation system is devised in such a way to provide an all-out tax-collection mechanism that charges the legal representatives, managers and partners of liable corporations with that ultimate responsibility, should the relevant corporations lack sufficient financial resources to pay accrued public receivables.
Both the Tax Procedural Law, No. 213, and the Law on the Procedures of the Collection of Public Receivables, No. 6183 (a law that encompasses the principles and procedures of collecting virtually all public receivables including taxes), have very effective provisions to deter managers, partners and other legal representatives of corporations from abusing the system and not paying accrued public receivables by transferring their responsibilities and liabilities to irrelevant third parties.
One such article that had a tremendous significance in stemming the attempts by individuals operating as founders, partners, managers and legal representatives of corporations (as legal entities with corporate tax liability) to abuse their influence on organizations by carrying out business transactions in an evasive tax way, without being held responsible to ultimately pay taxes was the repetitive article 35 of Law No. 6183 in its reinforced form after incorporation of a 5th and 6th clause in 2008.
Before their annulment through the recent ruling of the Constitutional Court, it was stated in the 5th and 6th clauses of repetitive article 35 that former legal representatives and managers who ran a corporation in multiple periods of time would be held jointly responsible for the payment of the public receivables accrued, even after the administration of the corporation is transferred to a third party.
Joint responsibility in Turkish tax laws means that the fiscal authority has the right and mandate to seek public receivables simultaneously from the personal wealth of any one of the responsible parties, which in turn enables the collector to secure accrued public receivables including corporate taxes even in the case of bankrupt corporations.
Loophole arose after annulment of joint responsibility mechanism
Upon a lawsuit filed by a former manager in the Council of State on grounds that his property was under legal seizure by law enforcement authorities under the pretext of unpaid taxes of a corporation during his tenure in office but accrued after his departure, the High Court decided to take the case to the Constitutional Court for annulment, claiming that the relevant provisions that jointly held the plaintiff, together with the current manager, responsible for the payment of public receivables even though he didn’t have any legal, administrative and financial affiliations with the corporation, breached the constitution’s basic pillars of justice and fault-based liability.
Ensuing the examination of the case in the general and disputed provisions, specifically regarding their constitutionality, the Constitutional Court proceeded, with a majority vote, to issue a ruling dated March 19, 2015, annulling the 5th and 6th clauses of the repetitive article 35 of law No. 6183 due to their violation of one of the most basic tenets of the constitution by jointly holding individuals responsible for fiscal liabilities created by the actions of others.
Although the supremacy of the Constitutional Court vis- à -vis the rest of judicial and public authorities including the legislative body is indispensable to the establishment and maintenance of the “separation of powers” principle and a functioning “rule of law” to which every individual and entity, without any exemption, should adhere, it is evident that we, as a country, will remain short of having a coherent collection system that is able to seek and ultimately collect the public receivables from ill-intended former legal representatives of bankrupt corporations.
With that ruling, a detrimental loophole, in the broadest sense of the term, which has the potential to deprive the collection system of its capabilities to track down abusive acts carried out by managers and legal representatives, such as the selling corporations in order to transfer their liabilities to third parties with no financial resources like homeless people or fictional personalities, has emerged.
In the absence of a provision that strictly prohibits the malicious sale of corporations by their legal representatives to avoid taxes and other public receivables, it is highly likely that cases of fictitious alienations of companies with a substantial amount of debt will skyrocket.
*Diyadin Yakut is tax inspector at the Finance Ministry