Advance Dividend Distribution and Tax Advantages
Advance Dividend Distribution and Tax Advantages
Advance Dividend Distribution and Tax Advantages
Profitability is a crucial element for companies to sustain their assets and continue their commercial activities. However, how the earned profit is utilized is equally important.
When distributing profits, companies must adhere to certain rules and fulfill obligations according to the New Turkish Commercial Code and tax laws. A company may choose to distribute all of its profits or retain some of it as capital for investment financing.
In companies, profit distribution becomes clear at the end of the fiscal period. Advance dividend distribution, however, refers to the distribution of the interim net profit earned during the temporary tax periods, before the final profit at the end of the fiscal year. The procedure for advance dividend distribution for companies not subject to the Capital Markets Law (CML) was established by the regulation issued by the Ministry of Customs and Trade, published in the Official Gazette on August 9, 2012.
In our tax reviews of many companies, we have observed that shareholders often owe significant amounts to their companies. Shareholders meet their financial needs by borrowing from the company instead of taking loans. On the other hand, the company does not utilize its idle cash to generate income but lends it to the shareholders, thus forgoing certain revenues.
So, is borrowing from the company advantageous for shareholders? Providing loans to shareholders is considered a financing service. By borrowing interest-free from the company, shareholders avoid the interest burden they would face if they borrowed from a bank or other financial institution. However, since the shareholder is considered a related party by the Corporate Tax Law, such borrowing is deemed a hidden profit distribution through transfer pricing under Article 13 of the Corporate Tax Law No. 5520. The risk analysis centers of the tax administration, which gather data from various systems and use artificial intelligence, identify these situations through balance sheet reviews and forward the findings to the inspection units. During tax inspections, amounts detected through the transfer pricing analysis are subject to penal taxation, and Corporate Tax, VAT, and withholding tax are calculated.
These explanations show that borrowing from the company can lead to high tax costs for shareholders, making advance dividend distribution more advantageous.
Requirements for Advance Dividend Distribution:
The company must have made a profit in the 1st, 2nd, or 3rd temporary tax periods.
A decision to distribute advance dividends must be made by the General Assembly of the company.
Calculating the Advance Dividend:
The advance dividend is calculated by deducting any past years' losses, taxes, funds, financial provisions, and legal reserves required by laws and contracts from the interim profits. The amount of advance dividend to be paid cannot exceed half of the calculated amount. If profits are made in subsequent interim periods of the same fiscal year, the advance dividend amount is calculated by also deducting the previously paid advance dividends. Again, the amount paid cannot exceed half of the interim profit.
When is the Advance Dividend Recalled?
At the end of the relevant fiscal period, if the net profit does not cover the advance dividend paid throughout the year, the excess amount will be offset from the free reserves in the previous year's balance sheet, if available. If the free reserves are insufficient, the excess amount will be recalled from the shareholders at the request of the management.
Advance Dividend in Temporary Tax Periods:
The advance dividend is determined based on financial statements prepared for 3, 6, or 9 months. In this context, the March, June, and September periods are crucial. As of the end of September 2024, an advance dividend decision can be made based on the financial statements. The advance dividend must be paid within six weeks following the decision. There is no obligation to file a temporary tax return for advance dividend payments. It is sufficient to complete the period and determine the profit.
Tax Procedures for Advance Dividends:
Dividends fall under "Capital Income" as one of the seven income elements in Article 2 of the Income Tax Law. According to Articles 75/1-2 of the same law, dividends are subject to income tax, and under Articles 94/6b-i and ii, a 10% withholding tax applies. The withholding tax (withholding) must be declared in the withholding tax return for the month in which the advance dividend is paid. If the recipient of the advance dividend is a fully taxpayer institution, no withholding tax is applied.
Timing of the Advance Dividend Declaration:
For shareholders, the acquisition date of the distributed advance dividend is the fiscal period when the company's annual profit is finalized, and the dividend is distributed in cash or credited. The advance dividend will be considered acquired as of the date of legal and economic ownership. The advance dividend paid based on the 2nd temporary tax period of the 2024 fiscal year will be declared as income for 2025 and reported in 2026.
Example:
HARPUT LTD.ŞTİ decided to distribute an advance dividend based on the financial statements as of the end of September 2024. Advance dividend payments of 1,600,000 TL were made to the shareholders ZHR LTD.ŞTİ and Mr. BAHADIR, with 800,000 TL each (the required legal reserves under the Turkish Commercial Code were ignored for the sake of calculation).
For the corporate entity ZHR LTD.ŞTİ: The advance dividend payment of 800,000 TL will be distributed in gross, with no withholding tax. Once HARPUT LTD.ŞTİ's annual net profit is finalized, the dividend income acquired by ZHR LTD.ŞTİ will be exempt from tax under Article 5/1-A of the Corporate Tax Law, provided other conditions are met.
For the individual Mr. BAHADIR: Since the advance dividend payment of 800,000 TL is considered capital income, a 10% withholding tax will be deducted. Fifty percent of the dividend is exempt from income tax. If the remaining amount exceeds the income tax threshold, it must be declared. The advance dividend payment made to Mr. BAHADIR in 2024 will be declared as income for 2025, and if the dividend exceeds the second income tax bracket, it will be declared in 2026. If additional tax is due, it will be paid in two installments in March and July.
The second income tax bracket for 2024 is 230,000 TL. The following calculation assumes the 2025 income tax brackets will remain the same as in 2024.
Distributed dividend: 800,000 TL
Withholding tax deducted: 80,000 TL
Exempt dividend: 400,000 TL
Dividend to be declared: 400,000 TL
Amount exceeding the second tax bracket (230,000 TL): 170,000 TL
Tax to be paid: (400,000 - 230,000) * 0.27 + 40,500 = 86,400 TL
Withholding tax deducted: 80,000 TL
Tax to be paid: 6,400 TL
Conclusion:
Given the high inflation environment and rising commercial loan interest rates, which have exceeded 60%, the importance of early advance dividend distribution has increased. As demonstrated in the examples, the tax cost of the advance dividend is relatively low for individual shareholders compared to commercial loan interest rates. Companies with profitable operations can significantly benefit their shareholders by taking advantage of this mechanism.