CMS Expert Guide to cash pooling in Turkey

Cash pooling mechanisms (zero balancing agreement or notional cash pooling) are not specifically regulated under Turkish law. Therefore, the general principles of Turkish law shall apply regarding the liability issues that may arise in connection with setting up and operating a cash pool and any restrictions that may be applicable for the same.

Furthermore, it should be noted that Turkiye enacted a new commercial code (“TCC”) in 2012 and therefore precedents on various principles regulated under the TCC are yet to be established. Additionally, as cash pooling mechanisms are relatively unorthodox under Turkish legal practice and are not specifically regulated under any specific piece of Turkish legislation, it is unclear to what extent certain principles outlined under the TCC and other pieces of Turkish legislation would become applicable vis-à-vis a cash pooling mechanism.

On the other hand, from a general perspective, monies transferred as part of a cash pooling mechanism shall be considered as loans granted by the disbursing company to the borrower company that owns the cash pool account. In this regard, various legal and tax related implications would arise in connection with the establishment of such a cash pool mechanism, as further outlined herein below.

There are two commonly used types of legal entities under Turkish legal practice, namely joint stock companies (anonim şirket) (“JSC(s)”) and limited liability companies (limited şirket) (“LLC(s)”). In this regard, the explanations regarding the risks of implementing a cash pooling mechanism have been outlined below separately for JSCs and LLCs.

a) General Liability of Directors/Managers under Turkish Law

JSCs are, in principle, managed and bound by their Board of Directors (“BoDs”). The members of the BoD (“Director” or “Director(s)”) are required to act prudently (also referred to as the “business judgement rule”) in their duties undertaken for the relevant JSC. Furthermore, the Directors are under a liability based on negligence towards the JSC, the shareholders and the creditors of the JSC. This means that, where the JSC, its shareholders or its creditors suffer damage due to the negligent actions of a Director or Directors, such Director or Directors shall be required to compensate the relevant party for such damage.

In this regard, if the cash pooling arrangement results in any losses for the JSC, Director(s) who have authorised and signed off on that arrangement shall be liable for the compensation of such loss, to the extent that such Director or Directors have acted with negligence in that respect. On the other hand, Directors who oppose the implementation of such cash pooling system may be exempt from liability by virtue of the differentiated liability principle (farklılaştırılmış teselsül) introduced under the TCC, whereby directors shall only liable for the losses incurred due to their negligent actions, as compared to any general liability attributable solely to a director status.

For LLCs, the management and representation duties are undertaken by manager(s) (“Manager(s)”) (at least one of whom must be a shareholder). The principles of liability of the Managers towards the LLC, arising from the management duty of such LLC, are in principle the same as those of the Directors of a JSC. Thus, where the LLC, its shareholders or its creditors suffer damage due to the implementation of a cash pooling mechanism (and the Managers in question have acted with negligence in relation thereto), such Manager or Managers shall be required to compensate for the damage. The differentiated liability principle explained above shall also apply in the case of LLCs and therefore Manager(s) who oppose the implementation of a cash pooling system should be exempt from any liability arising due to any losses incurred in relation to such mechanism.

b) Liability Arising from Group Company Principles

Turkish law foresees a set of restrictions for JSCs where parent companies and their affiliated companies are restricted from entering into certain transactions. These differ, based, in principle, on whether the parent company wholly owns the affiliated company or only partially owns it.

Accordingly, where an affiliated company is not a wholly owned affiliate of a parent company, the parent company will not exercise control over the affiliate in a way that would lead such affiliate to incur any losses, unless:

1. Any loss arising due to such transactions is remedied within that financial year; or
2. A right of claim equivalent to the value of the loss incurred by the affiliate due to the transactions above is granted to the affiliate no later than by the end of the respective financial year, with a specific explanation of how and when this loss will be recovered.

Where an affiliate is a wholly owned affiliate of the parent company (whether directly or indirectly), the Directors of the parent company may give instructions and management orders to the affiliated company which could cause loss for the affiliated company only if such instructions and orders are within the pre-determined substantial policies of the group companies.
However, even when the parent company is the 100% owner of the affiliated company (directly or indirectly), the parent company must not give directions and orders, at any rate, to the affiliated company which clearly:

1. Exceed the financial means of the affiliate; or
2. Which will cause the affiliated company to lose significant assets belonging to such company.

Due to the fact that cash pooling arrangements are relatively rare in Turkiye and the restrictions outlined above have been enacted rather recently, it is currently unclear in Turkish legal practice as to whether the above restrictions would also apply to a cash pooling arrangement. However, due to the lack of clarity regarding this matter, it would be prudent to take into consideration the above restrictions while setting up a cash pool mechanism.

Failure to comply with the restrictions above would have the following consequences:

1. Where the Affiliated Company is not Wholly Owned by the Parent Company:
   1. The shareholders of the affiliated company may be entitled to ask for compensation of the losses from the parent company and the relevant Director(s) of the parent company;
   2. The lenders of the affiliated company may be entitled to request that the losses suffered by the affiliated company be compensated;
   3. The shareholders of the affiliated company may request that the parent company purchase the shares held by the said shareholders in the affiliated company; and
   4. The Directors (or other managers) of the affiliated company may request that the parent company assume all liabilities that may arise in detriment of the shareholders of the affiliated company to be assumed by the parent company under a contractual arrangement.
2. Where the Affiliated Company is Wholly Owned by the Parent Company:
   1. The creditors of the affiliated company may be entitled to ask for compensation of the losses suffered by the affiliate from the parent company and the relevant Directors of the parent company.

The restrictions explained above should only be applicable to JSCs under Turkish law (and not other forms of companies such as LLCs). However, since this is a recently introduced restriction, there is no market practice or jurisprudence as to how this would apply.

c) Liability Arising from Loans Granted to Shareholders

As the parties (JSCs and LLCs) to a cash pooling mechanism shall generally be considered as granting loans to each other, Turkish legislation regarding loans granted to shareholders should also be taken into consideration in setting up a cash pooling mechanism.

Pursuant to Turkish law, a shareholder (i.e. parent company) must not take out a loan from an affiliated company unless that shareholder has:

1. Already paid its due share capital; and
2. The profit of the affiliated company along with its freely usable capital reserves are sufficient to cover any losses incurred by the said company over the previous years.

In this regard, an affiliated company could face monetary fines if it sends monies to the cash pool accounts of its parent company where:

1. The direct shareholder of such affiliate has not yet deposited the respective share capital into the accounts of the affiliate; or
2. The capital reserves of the affiliated company are not sufficient to cover losses (if any) incurred in previous years.

In this regard, where a Turkish entity is party to a cash pooling system, such entity should observe the principles above.

d) Liability Arising from Capital Adequacy Principles

Pursuant to Turkish law, as part of the “protection of the share capital principle”, shareholders, in principle, cannot ask for a refund of the share capital they have deposited in a JSC or an LLC. In this regard, any resolution or transaction according to which such share capital is repaid to the shareholders (in an explicit or disguised manner) may be considered void or be challenged by, among others, the affiliated company, the creditors or the shareholders of the affiliated company.

Furthermore, the share capital of JSCs and LLCs must be maintained at all times. The loss of the share capital would require, among others, the general assembly of shareholders of the relevant company to convene and decide on the relevant remedies for such loss.

In this regard, a cash pooling mechanism effected by and between the affiliated companies and parent companies should not result in the repayment of the share capital deposited by the parent company or in the loss of the share capital of the affiliated company.

a) Corporate restrictions

A cash pooling arrangement may be prohibited (directly or indirectly) under the articles of association (“AoA”) of the relevant company (a JSC or an LLC) (the “Company”). Similarly, entering into such arrangement may be subject to certain corporate approvals of the Company’s statutory bodies (i.e. the BoD resolutions or general assembly of shareholders resolutions) according to the AoA or other contractual arrangements such as shareholders agreements (“SHA”) which may be binding on the Company and its shareholders. Furthermore, under Turkish law, the AoAs mandatorily regulate the distribution of profit, setting aside of legal reserves and the disposal of any other income derived by the companies in question. These issues are customarily regulated under other contractual arrangements as well (e.g. SHAs). In this regard, the Company could duly enter into a cash pooling arrangement only if such arrangement is not restricted under the statutory documents of, or other arrangements binding on, the Company.

b) Regulatory restrictions

In Turkish legal practice, only banks and certain financial institutions are allowed to lend money to third parties as part of their customary commercial activity. Thus, if entities party to a cash pooling arrangement are exclusively engaged in a lending activity and derive income (i.e. interest) solely from such activity, this may be considered a breach of the Turkish Banking Law (under which banks and certain financial institutions are granted exclusive rights to be engaged in lending activity).

It should be noted that, as cash pooling mechanisms are not common practice in Turkiye, it is not possible to determine whether a cash pooling arrangement qualifies as such extensive lending activity and constitutes a breach of the said law.

As discussed above, Turkish tax legislation, in principle, also views cash pooling arrangements as a loan granting mechanism. Thus, the tax law implications of a cash pooling mechanism arise from such assumption and differ on the basis of the residency of the entities (the “Lender” and the “Borrower”) party to that cash pool. Accordingly, further information regarding cash pooling mechanisms is provided below based on this distinction:

a) The Lender and the Borrower are both Turkish Companies

Where both the Lender and the Borrower are Turkish companies, the Lender must accrue interest at arm’s length on the amounts sent to the cash pool owned by the Borrower. The interest will be subject to value added tax (“VAT”) at the rate of 18%. The interest received will be considered as income for the Lender and be subject to corporate income tax. Further, if the borrowed amount exceeds three times the shareholders’ equity of the Borrower, the interest accrued on the excessive amount will be considered as thin capital and constitute a non-deductible expense for the Borrower.

b) The Lender is a Turkish Company and the Borrower is a Foreign Company

In this case, the Lender must accrue interest on the loan granted to the Borrower in line with the arm’s length principle. If the loan granted to the Borrower will be used in a foreign jurisdiction, the interest on the loan will not be subject to Turkish VAT, but will be considered as income for the Lender and accordingly be subject to corporate income tax.

c) The Lender is a Foreign Company and the Borrower is a Turkish Company

In this case, the interest paid to the Lender on the loan must comply with the arm’s length principle and will be subject to withholding tax at the rate of 10% as well as VAT at the rate of 18%. The VAT paid on the interest amount may be deducted from the entire VAT payable by the Borrower.

Any interest payment in excess of the arm’s length principle will constitute a non-deductible expense for the Borrower and be considered a dividend payment to the Lender. In that case, such excessive interest will be subject to Turkish withholding tax at the rate of 10%; however, a lower percentage may be applicable under the relevant double taxation treaty.

A written loan agreement (or other arrangement on the basis of which the amounts in question are transferred from the Lender to the Borrower) will be subject to stamp tax at the rate of 0.948% based on the highest monetary amount indicated under such agreement.

If the amount sent to the cash pool of the Borrower is in a foreign currency and the maturity of the loan is shorter than three years, a further deduction, namely, the Resource Utilisation Support Fund (more commonly referred to as the “RUSF”) will be applicable to such loan at a rate between 0.5% to 3% (depending on the average maturity). The RUSF is not applicable (i.e. is reduced to 0%) to foreign currency loans with a term of maturity equal to or longer than three years.

If the amount sent to the cash pool of the Borrower is in Turkish lira and the maturity of the loan is shorter than one year, the RUSF will be applicable to that loan at a rate of 1%. The RUSF is not applicable (i.e. is reduced to 0%) to Turkish lira loans with a term of maturity equal to or longer than one year.

Lastly, if the borrowed amount exceeds three times the shareholders equity of the Borrower, the interest accrued on that excessive amount will be considered as thin capital and will constitute a non-deductible expense for the Borrower. In that case, the excessive interest will be considered a dividend payment and be subject to Turkish withholding tax at the rate of 10%; however, a lower percentage may be applicable under the relevant double taxation treaty.