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Limitation on financial expenses deduction

Tax bulletin - 2021/5

In brief

Guidance released by the Turkish tax authorities on the application of the financial expense deduction limitation rule which became effective from 1 January 2021 by the Presidential Decision No.3490.


In detail

The Income Tax Law and Corporate Income Tax Law were amended in 2012 to introduce a new rule limiting the amount of financial expenses that could be deducted for tax purposes. As per the concerned rule:

  • The limitation on financial expenses applies only in situations where the amount of external financing of the taxpayer exceeds the taxpayer’s equity.
  • The non-deductible portion of the financial expenses is capped at 10%, and the Council of Ministers (later the president) is authorized to differentiate the rate by sector.
  • Credit institutions, financial institutions, financial leasing companies, factoring companies and financing companies are excluded from the application of financial expense restriction.

Although the new rule entered into force on 1 January 2013, it did not become effective as the Council of Ministers (and later the president) did not determine the rate of the limitation. With Decision No. 3490, published in the Official Gazette on 4 February 2021 the president set the rate of non-deductible financial expenses at 10% and hence put the limitation into effect. 

In a nutshell, the new rule means that income taxpayers and corporate income taxpayers whose external financing exceed equity are unable to deduct 10% of the excess financing costs (such as interest, commission, exchange rate differences, maturity diferences) from their taxable income. The concerned 10% portion will be treated as a non-deductible expense.

This rule – applicable from 1 January 2021 – has raised a certain number of practical questions. On 18 May 2021 the Turkish tax authorities released Corporate Income Tax Communiqué no.18 (“Communiqué”) that intends to provide guidance on the following items:

1.Definition of external financing

2.Definition of external financing costs

3.Interplay with other deductibility restrictions

4.Grandfathering rule

The purpose of our bulletin is to provide you with an overview of the key elements provided by the Communiqué when applying the financial expense limitation rule. 

Definition of external financing

The tax laws do not include a definition of external financing. The Communiqué provides a definition for the purposes of this new limitation in particular and indicates that external financing is the sum of short-term liabilities and long-term liabilities on the balance sheet. This constitutes one of the most debated issues of the new rule as the definition provided in the Communiqué is quite broad; it includes not only the financial borrowings but also other items such as provisions, accruals, advances that are not in the nature of a borrowing.    

Definition of external financing costs

The external financing costs include interest expense on all forms of debt and other costs economically equivalent to the interest (commission, maturity difference, foreign exchange rate differences), as well as certain expenses incurred in relation to financing.

Details on certain external financing costs

  • Foreign exchange gains and losses: The exchange gains and losses may be netted provided that they are related to the same liability. Linked to this, foreign exchange losses on external financing that are subject to the limitation cannot be reduced by foreign exchange gains arising from the valuation of assets, say from bank deposits.     
  • Maturity differences: With respect to suppliers account, maturity differences that are included in the sales price of a good/service are excluded from the definition of external financing cost, unless they are expressly stated on the sales invoice. 
  • Certain taxes and fees: With respect to loan arrangements, the Communiqué confirms that stamp duty incurred upon signing of a loan agreement as well as fees paid to banks for the transfer of funds should not be considered “external financing costs” under this restriction. Conversely, banking and insurance transaction tax (BSMV) due on the interest of the loan is included in the definition.
  • Loans used to fund group companies: Loans that are transferred to group companies on an one-to-one basis are excluded when computing the financial expense subject to deductibility restriction. These will be subject to deductibility restriction at the level of the ultimate borrower. 
  • Loans used to finance investments: Borrowing costs that are capitalized to the cost of investments are excluded from the deductibility restriction. The Communiqué clarifies that the meaning of “investments” should be understood as all fixed assets subject to depreciation. (irrespective of whether they are acquired under an investment incentive certificate or not).

Interplay with other deductibility rules

The Communiqué clarifies that only the tax-deductible financing costs of the taxpayer must be considered for the purpose of computing the “exceeding financial costs”. In other words, financing costs that would already not be deductible under the other rules (i.e. thin capitalization, transfer pricing, restriction on car expenses) should be excluded from the computation of the “exceeding financial costs”. This clarification is welcome as it prevents the double taxation of the same borrowing costs that could be considered non-deductible twice under different rules.  

Grandfathering rule

The financial expense deduction limitation does not apply to external financing obtained before 1 January 2013. (the date the rule entered into force.) 


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Ebru Türkçelik

Ebru Türkçelik

Tax Services, Director, PwC Turkey

Tel: +90 212 326 6454

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