Transfer Pricing Year End Adjusments due to High Inflation in Türkiye

Türkiye is struggling with high inflation which affects households and businesses seriously. Turkish Statistical Institute (TUIK) announced the annual inflation rate as 84.4 percent in November 2022. Although the inflation has been slowed from 85.5 percent in the previous month to 84.4 percent, it is obvious that the two-digit numbers will be continued.

As known, Türkiye has inflation accounting standard which is applicable to statutory financial statements when certain criteria are met. Briefly, inflation adjustment is required to be implemented if the increase of the inflation rate in the last three years (including the current year) is more than 100%, and the increase in the inflation rate in the current year is more than 10%. The conditions are already met and the financial statements will be restated. The inflation adjustments have been postponed to the end of FY 2023. Therefore the Companies did not apply inflation accounting as of FY 2022.

Since the Companies did not restate their financial statements; the inflation has resulted artificial high profits in many Turkish Companies. Once the non-monetary items will be restated, the profits of the Companies will be adjusted accordingly. On the other hand, since there is high inflation in FY 22 but the inflation accounting standard has not been implemented; the Companies are in a position to pay excess taxes over nominal values of their assets specially for those companies which also do not implement “Revaluation” which is a separate application other than inflation adjustment. Once the inflation adjustment will be performed; the Companies P&L results may turn back to its normal levels or even losses or low profits in future years. Therefore, the taxes paid may be offset by paying no or low taxes as a result of inflation accounting of course depending on the asset/liability intensive of Companies. 

So what is the issue? The issue is about transfer pricing (TP) applications of Multinational Enterprises (MNE) in Turkey. Imagine, a Turkish Company which imports all its products from its Group entities. The transfer pricing policy in place allows Turkish entity to earn a stable but routine profit margin with no extreme profits and no losses. For years which are “normal”, Turkish entity earns profit margin which is in the arm’s length range and it is not required to adjust the transfer prices. When coming to FY 22; due to high inflation in Türkiye, assume that Turkish entity has earned very high margins which are unreal but real in terms of financial statements. As a part of Transfer Pricing policy, the MNE will now perform year end transfer pricing adjustment to bring the excess profit of Turkish entity to arm’s length levels as a part of TP policy. The year-end adjustments will be in the form of a “debit note”. Generally, debit notes are not welcomed by not only Turkish Tax Authorities (TTA) but also by many of the other country’s Tax Authorities. However, under normal conditions, TTA may accept debit notes if there are sufficient economic arguments.  On the other hand, for FY 22, as stated above; one of the main reasons of debit notes may be high inflation prevailing in Türkiye. It is important to note that one can argue that high profit which is due to specific market conditions (i.e high inflation) of that market would be retained in this local market. In addition, some of the Companies may reevaluate their fixed assets for FY 22 which may lower their profitability. Therefore, year-end adjustments should be performed if still necessary after revaluation accounting.

In a nutshell; in order to support the deductibility of debit notes; it is very important to identify the actual reasons of high (excess) profit margins of Turkish entities which are deemed to be owned by Group entities as a result of transfer pricing adjustment; have a proper Benchmark Analysis with necessary adjustments specifically for FY 22 and transfer pricing documentation and intercompany agreements. Customs applications are also very important for debit notes especially if the Turkish entity is an importer. While the inflation accounting differences will be reflected in the P&L in FY 2024, Companies should start to monitor how the inflation differences will affect the profitability and whether the inflation adjustment differences to be included in the profitability calculation of Turkish Companies in line with TP models.  MNEs therefore may start to discuss how to treat Turkish subsidiaries differently than before in terms of transfer pricing applications.