Tax treaty between Switzerland and Turkey

Tax treaties help to maintain and expand reciprocal direct investment. 

After decades of negotiations on a double taxation agreement between Switzerland and Turkey, the “Agreement between the Swiss Confederation and the Republic of Turkey for the Avoidance of Double Taxation in the Field of Taxes on Income” (hereinafter: DTA CH-TR) was concluded on 18 June 2010. It entered into force on 8 February 2012 and, with the exception of two minor revisions in 2012 and 2013, has remained in force unchanged since then. The DTA CH-TR largely follows the model agreement drawn up by the Organisation for Economic Co-operation and Development (OECD) in both formal and material respects (hereinafter: OECD-MA), as well as Swiss treaty practice.

Furthermore, as of 1 January 2021, the Standard for Automatic Exchange of Financial Account Information in Tax Matters (hereinafter: AEOI) was also extended to Turkey. The first exchange will take place in 2022. The AEOI standard is an international standard with the aim of preventing tax evasion. So far, over 100 states have committed to adopting the standard, which regulates how participating states exchange information on financial accounts and securities custody accounts among themselves.
 

1.  Double Taxation Agreement

1.1       Scope of the Agreement
1.1.1   Persons covered

In personal terms, the DTA CH-TR is applicable to persons who are resident in one or both Contracting States. This personal scope of application also corresponds to the OECD-MA. The term “persons” includes natural persons, companies and all other associations of persons, whereby the term “companies” includes legal entities or legal entities that are treated as legal entities for taxation purposes.
 

1.1.2   Taxes covered

The material scope of application of DTA CH-TR extends to all taxes on income levied for the account of a Contracting State or its political subdivisions or local bodies. The taxation of wealth is not included because Turkey does not have such taxation.

Taxes on income are all ordinary and extraordinary taxes levied on the total income or on portions of income, including taxes on the profit from the sale of movable or immovable property, payroll taxes and taxes on capital gains.

In particular, the agreement applies in Switzerland to all taxes levied on income (total income, earned income, investment income, business income, capital gains and other income) at federal, cantonal and municipality levels (Swiss taxes). From Turkey’s perspective, the agreement applies in particular to income tax and corporate income tax (Turkish taxes). Taxes that are similar to the aforementioned taxes and are levied after the agreement enters into force also fall under the material scope of application of the DTA CH-TR. However, withholding taxes on betting, gaming and lottery winnings are explicitly excluded. 

1.2       Residence

The residence mentioned in Art. 1 of the DTA CH-TR is based on Art. 4 of the same agreement and thus corresponds to the OECD-MA. Residents are all persons who are liable to tax under the law of the Contracting State on the basis of their domicile, permanent residence, head office (registered office), place of management or another similar characteristic. If a natural person is resident in both Contracting States, the so-called tie-breaker rule according to Art. 4 para. 2 DTA CH-TR applies.

If a non-natural person is a resident of both Contracting States, he shall be deemed to be a resident only of the Contracting State in which his place of effective management is situated.
 

1.3       Permanent Establishment

A permanent establishment is assumed to exist if there is a fixed place of business through which the business of an enterprise is wholly or partly carried on. In particular, a factory, a branch or a mine etc. fall under this term, but not warehouses, mail-order houses or research facilities. 

In contrast to the OECD-MA, services in a Contracting State lasting more than six months within a year or construction and assembly work as well as related supervisory activities lasting longer than six months lead to the establishment of a permanent establishment. 

1.4       Income from Immovable Property

The provision on the taxation of income from immovable property is in line with the OECD-MA and follows the location principle. This means that income from immovable property, including income from agricultural and forestry operations, is taxed at the place where it is located. 

This rule applies to income derived from the direct use, letting, or use in any other form of immovable property and includes income from immovable property as part of a business or used for the exercise of a self-employed activity.

1.5       Business Profits

As a rule, business profits are taxed only in the Contracting State in which the company is resident. However, if the enterprise carries on business in the other Contracting State through a permanent establishment located there, the profit earned there, i.e. the profit attributable to the permanent establishment is taxed in that Contracting State. This regulation corresponds to the OECD-MA.

1.6       Dividends

Dividends distributed across borders by a company in one Contracting State to a person in the other Contracting State may be taxed in the Contracting State of the recipient of the dividend (so-called State of Residence). However, it is also possible to tax the dividends in the State of Residence of the company paying the dividends (so-called Source State), which is why the DTA CH-TR, just like the OECD-MA, provides for a shared right of taxation between the Source and the Residence State. Neither has an exclusive right of taxation on dividends. 

If Switzerland is the Source State, taxation may not exceed 5% of the gross amount of the dividends, provided that the beneficial owner is a company, but not a partnership, which directly holds at least 20% of the capital of the company paying the dividends (so-called qualified participation). In all other cases, the Swiss taxation right is limited to 15% of the gross amount of the dividends. In concrete terms, this means that, for example, a person resident in Turkey who receives a dividend from a non-qualified participation of a Swiss company is entitled to a refund of 20% of the Swiss withholding tax of 35%, as taxation in Switzerland may not exceed 15% on the basis of the DTA CH-TR.

If, on the other hand, Turkey is the Source State and there is a qualifying participation, Turkey may only tax 5% of the gross amount of the dividends if the beneficial owner is a company, but not a partnership, which directly holds at least 20% of the capital of the company paying the dividends. Relief from Swiss tax is granted for these dividends through a reduction in profit tax in the ratio of the net income from participations to the total net income or other equivalent relief. Thus, this reduction of the withholding tax to 5% is subject to the condition that the dividends in question are exempt from taxation in Switzerland. On the Swiss side, this exemption results from the participation deduction. In all other cases, the Turkish right of taxation is also limited to 15% of the gross amount of the dividends.

Section 2 of the Protocol to the DTA CH-TR states that the distributions of Turkish investment funds and trusts (“investment funds” without legal personality, “investment trusts” with legal personality) are deemed to be dividends within the meaning of Art. 10 DTA CH-TR, whereby these investment funds and trusts have no right to claim treaty benefits in their own name.
The Source State also has a right of taxation of 5% on branch profits. Here, too, the Turkish side has the reservation that this reduction to 5% is only granted if these profits are exempt from taxation in Switzerland. Otherwise, taxation in Turkey is 15%.

1.7       Interest

Similar to dividends, interest can be taxed in the Contracting State in which it is paid to the person or in the Contracting State from which the interest originates. Thus, interest is also subject to a standard OECD-MA shared right of taxation. However, the Source State’s right to tax interest is limited to 0% for interest paid to a contracting state or its central bank, to 5% for interest on loans granted, guaranteed or insured by an institution for the promotion of exports, to 10% for interest payments to a bank, and to 15% in other cases.

1.8       Royalties

In contrast to the OECD-MA, the DTA CH-TR provides for a shared right of taxation in the case of royalties, whereby the taxation of the Source State is capped at 10% of the gross amount of the royalty. Section 4 of the Protocol to the DTA CH-TR specifies that the provisions of Art. 13 DTA CH-TR apply to gains from the sale of rights within the meaning of Art. 12 para. 3 DTA CH-TR, unless it is proven that the payment does not constitute consideration for an actual sale of assets.

1.9       Capital gains
1.9.1   In general

In principle, the gain from the sale of property can only be taxed in the Contracting State in which the vendor is resident. However, capital gains originating in one Contracting State may be taxed in the other Contracting State, if the period between the acquisition and the disposal does not exceed one year. On the Swiss side, this restriction on the taxing power of the transferor’s State of residence is only recognised if the taxation of such gains in Turkey is proven.

Gains from the sale of immovable property situated in one Contracting State may be taxed in the other Contracting State. Further exceptions apply to gains from the sale of movable property that is business property of a permanent establishment and to ships and other vehicles in international traffic. 

1.9.2   Real estate companies, specific provisions

The sale of shares in real estate companies is treated as a disposal of movable assets under the DTA CH-TR. A real estate company in this sense is any legal entity whose main purpose is the acquisition, management and resale of real estate. Whether real estate company status is to be assumed is thus primarily determined by the statutory or actually perceived corporate purpose. For example, if the real estate merely forms the factual basis for a manufacturing, trading or other business operation, the company is not deemed a real estate company but an operating company.

1.10     Income from self-employed and employed activity

Income from self-employment may, with very few exceptions, be taxed only in the Contracting State in which the income was generated. Exceptions exist if a fixed establishment is usually available in the Contracting State other than the one in which the income was generated, or if the activity involves working in the other Contracting State for more than 183 days within a year. This provision no longer corresponds to the OECD-MA as this very regulation was deleted from the OECD-MA in 2000.

With regard to the taxation of income from employment, the DTA CH-TR still corresponds to the provisions of the OECD-MA. With the exception of remuneration for supervisory boards or boards of directors, remuneration for artists and sportsmen, pensions and remuneration in the public service, income from employment can only be taxed in the Contracting State in which the work is carried out. Further reservations result from Art. 15 para. 2 (so-called assembler clause) and 3 DTA CH-TR.

1.11      Methods for Elimination of Double Taxation
1.11.1  Switzerland

As usual, Switzerland applies the exemption method with a progression proviso. In principle, this method exempts all income that can be taxed in a state other than the Residence State. This means that income which Turkey is allowed to tax under the DTA CH-TR is segregated in Switzerland, but has an effect on the determination of the tax rate for income taxable in Switzerland. Switzerland grants lump-sum tax credit for dividends, interest and royalties.

1.11.2  Turkey

For persons resident in Turkey, double taxation is to be avoided through crediting. In concrete terms, this means that the taxes paid in Switzerland are credited against the taxes payable in Turkey. However, this only applies to the extent that the Turkish tax is not exceeded. Accordingly, double taxation cannot be completely ruled out in all cases despite the method article.

1.12      Exchange of information

The new Art. 25 DTA CH-TR largely corresponds to the wording of Art. 26 of the OECD-MA. Deviations exist with regard to the restriction of the exchange of information to taxes covered by the agreement; the exclusion of passing on the information received to supervisory authorities; the possibility of using the information for other purposes with the consent of both states; as well as the express authorization of the contracting states to take coercive measures to enforce information requests against banks, other financial institutions, agents and trustees, as well as to determine shareholding relationships.

Art. 25 para. 1 DTA CH-TR sets out the principle of the exchange of information. The information to be exchanged is that which is likely to be relevant for the implementation of the agreement or the application or enforcement of domestic law in the area of the taxes covered by the agreement. The idea is that by limiting the information to that which is likely to be significant, so-called “fishing expeditions” will be prevented. In addition, it is stipulated that the requesting Contracting State be required to exhaust its own investigation possibilities before submitting a request for information to the other Contracting State. It is not necessary for the exchange of information that the taxpayers concerned are resident in Switzerland or Turkey, provided there is an economic connection in one of the contracting states.

Art. 25 para. 2 DTA CH-TR includes confidentiality rules. This provision declares the confidentiality rules of the Contracting State that received the information to be applicable. However, it states that the information exchanged may only be made available to persons and authorities involved in the assessment, collection, enforcement, prosecution or adjudication of appeals in respect of the taxes covered by the agreement.

The provisions of Art. 25 DTA CH-TR are further specified in the Protocol to the same agreement (Section 6 of the Protocol). The Protocol upholds the principle of subsidiarity and expressly excludes “fishing expeditions” (Section 6 (a) & (c)). Accordingly, the Contracting States are required to submit a request for information only after they have exhausted all the usual means of obtaining information under their domestic law. So-called “fishing expeditions”, i.e. investigations carried out without a precise object of investigation in the hope of obtaining tax-relevant information, are expressly excluded. Furthermore, the Protocol sets out in detail the requirements for a request for information (Section 6(b)). In particular, a clear identification of the taxpayer concerned as well as the person (e.g. the bank) in whose possession the Requesting State assumes the requested information to be. The Requesting State must explain which information it requires for which tax periods and for which tax purposes. It follows that the exchange of information is limited to specific requests in individual cases.

2. Automatic exchange of information

The new global Standard for Automatic Exchange of Financial Account Information in Tax Matters (hereinafter: AEOI standard) provides for certain financial institutions, collective investment vehicles and insurance companies to collect financial information from their clients if they are tax resident abroad. This information includes all types of investment income and the account balances. The information is automatically transmitted, usually once a year, to the tax authority, which forwards the data to the tax authority abroad responsible for the client. The AEOI standard is intended to create transparency with regard to financial accounts in order to collect taxes correctly in the respective states and to prevent cross-border tax evasion. The states and their financial institutions provide each other with the information required to enforce the agreement.

At the end of 2019, consultation on the federal decree on the introduction of the automatic exchange of information with Turkey was put on hold, but resumed in February 2020. On 3 March 2020, the Council of States voted in favour of activating the corresponding exchange agreement. The State Secretariat for International Financial Matters (SIF) has confirmed that a first exchange will take place in 2022 in relation to the reporting period from 1 January to 31 December 2021.

Personal data such as account number, name, address, date of birth and the tax identification number are recorded. If the person has a tax residence abroad, the personal data as well as the financial data is transmitted to the respective state. All persons who have financial accounts in Turkey or Switzerland are affected by this agreement. The agreement thus applies to private persons as well as legal entities.

Data on real estate abroad is not recorded. However, it is possible that the tax authorities will discover other assets when they investigate the financial account data. For example, if you have a bank account abroad into which your tenants pay their rent, the tax authorities may find out that it is rental income.

3. Conclusion

How the above-mentioned tax treaties between Switzerland and Turkey may affect personal situations and business structures must be determined on an individual basis. 

Particularly with regard to the AEOI standard, consideration should be given to a voluntary declaration that exempts the taxpayer from prosecution. 

By Veysel Oruclar, Vischer, Switzerland, a Transatlantic Law International Affiliated Firm.

For further information or for any assistance please contact switzerland@transatlanticlaw.com

Disclaimer: Transatlantic Law International Limited is a UK registered limited liability company providing international business and legal solutions through its own resources and the expertise of over 105 affiliated independent law firms in over 95 countries worldwide. This article is for background information only and provided in the context of the applicable law when published and does not constitute legal advice and cannot be relied on as such for any matter. Legal advice may be provided subject to the retention of Transatlantic Law International Limited’s services and its governing terms and conditions of service. Transatlantic Law International Limited, based at 42 Brook Street, London W1K 5DB, United Kingdom, is registered with Companies House, Reg Nr. 361484, with its registered address at 83 Cambridge Street, London SW1V 4PS, United Kingdom.