Attracting attention: Recommendations for improving the investment climate

Countries around the world have been making significant attempts to further direct foreign capital investment. In a globalised economy, the degree of foreign investment that a country attracts can have a significant multiplier effect, contributing to technological advances, employment opportunities and the ability to invest more in welfare.

Keeping the state’s taxation system up to date as economies become more integrated on the global stage is especially important for emerging markets such as Turkey in their quest to attract direct foreign capital investments into the country.

Direct foreign capital investments have grown rapidly in size on the international level since the 1980s. The relatively cautious view of foreign capital that emerged at the end of the Second World War was replaced by an embrace of a globalised economy from the 1980s onwards. In the aftermath of the war economic discussion was dominated by the concern of how best to limit and control foreign capital flows and nurture a national economy. In recent decades, however, the question at the forefront of policy-making has been how to attract foreign capital. Therefore, the globalisation of capital has driven countries to employ various instruments to attract external investment. One of the most important tools in this regard is tax incentives.

Tax Incentives Policies

The success of any incentives policy will ultimately be determined by its effectiveness as it is implemented in practice. In terms of taxation, we can define effectiveness as the system having the sufficient power to channel investments into targeted fields and sectors. Moreover, this should be done at rates that are desirable and feasible.

However, evaluations of tax incentives implemented in Turkey have suggested that economic changes since the 1980s have eroded the effectiveness of this policy. The government opted for investment allowance exemptions as the most effective tool with which to encourage investment, while the tax advantage afforded to corporations decreased by a third. Even in the case of an investment allowance of 100%, the maximum incentive, the investor was only able to get back 25% of the total investment amount, which can be attributed in part to the prevalence of rent-seeking, as well as the ever-expanding amount of government regulations with which businesses have to contend.

The incentives in the tax system have a dual structure. On the one hand, tax incentives have been implemented by way of changes made to provisions regarding exemptions and exceptions. On the other hand, there has been a concerted attempt to reduce the tax load of the rent-receiving segment, including interest, dividend and rent, by way of low rate and withholding at source taxation directed by Council of Ministers decrees.

Foreign Capital Investments

The importance of taxation policy and incentives in terms of direct foreign capital investments have both increased. For example, the impact of tax rates on investment decisions tends to be greater for multinational companies oriented towards exports.

Therefore, the executives of such firms pay close attention to the development of government policy on taxation, given its direct and significant impact on investment decisions.

Tax Rates

Taxation policy, while not necessarily determining the decision of whether or not to invest abroad, can exert a significant influence over the choice of one investment destination over another.

The taxation in the host country has a varied impact depending on whether the investment is oriented to the marketplace or funds. In a situation where all other conditions are equal, it may be an advantage to invest in countries with low tax rates.

So as to keep up with the frantic pace of global economic competition, countries are today increasingly engaged in simplifying their tax systems and reducing their tax rates to attract investors. The rate of corporation tax, which affects the profitability of multinationals and so is very pertinent to foreign investors, has been a particular focus.

In Turkey, corporation tax rates have decreased so that both local and also foreign capital could benefit in terms of tax. The corporation tax rate was set as 20% as of 2007 as per Act No. 5520. Considering the tax rates of Turkey’s potential rivals, this has helped the country attract foreign investors.

Indirect Taxation

An important factor influencing the decision of whether to invest in a foreign country is the impact of indirect taxes in the host country on input costs. Presently, for firms operating in the industrial segment, taxes on energy, which is the most basic input for firms, are at a high level compared to other countries.

The most expensive electricity in OECD member countries is found in in Italy, Japan and Turkey. Approximately one half of electricity consumed in Turkey is used in industry. The tax rate on electricity used in production is directly linked to production costs. Countries with the highest ratio of the tax calculated on the cost of electricity used in industry to its price are Italy, Norway and Turkey.

High Employment Taxes

The following calculation has been made for the present state of employment taxes in Turkey: in 2007, out of every 100 liras that was paid by an employer to employ a worker, only 71 could make their way to the pocket of a worker. In 2008 the amount going into the pocket of the average worker dropped further to 70 liras. However, by 2009, 79 liras out of each 100 lira paid by the employer could go to the pocket of the worker. This can be attributed to the implementation of a policy ensuring a minimum subsistence allowance.

According to OECD data, Turkey has the highest weight of employment taxes among the 30 OECD countries. An examination of OECD data shows that in top-ranking Turkey, 42.7% of the average labour cost is allocated to employment taxes. This rate is 26.6% across the OECD as a whole and as low as 16.4% in the US and 5.9% in Ireland.

Arbitrary Audits

Circumstances that cause continuing concern for investors in terms of legal compliance include the following:

  • The failure to handle tax laws under an overall government investment strategy;
  • The existence of certain superfluous restrictions on specific grounds and concerns;
  • The introduction of additional conditions by regulatory and explanatory texts sometimes going beyond the requirements laid down by the law;
  • The subsequent cancellation of such texts by judicial bodies;
  • The determination of judicial cases in an opposing way by different judicial bodies at the same level;
  • The issuing of contradictory opinions; and
  • The perception among auditors of tax audits as a system introduced for the purposes of collecting taxes, fines and interest.

Off-the-Books Economy

The continued existence and growth of the informal economy remains a fundamental problem for potential investors in Turkey. Businesses are unable to compete with a rival that does not pay taxes or insurance premiums because of off-the-books employment in the same industry, or that fails to pay value-added tax (VAT), corporation tax or income tax on off-the-books sales.

Foreign investors do not want to compete with a strong informal economy as there is no living space for formal foreign capital. Indeed, even local capital moves to countries with more favourable investment climates in these conditions.

Investment Allowance Exception

The investment allowance was introduced into the tax system to encourage private investment and to raise capital accumulation in the economy to further development. Investment allowances increase both the after-tax profitability of private enterprises and also their liquidity. However, the authorities revoked Section 19 of Income Tax Act No. 193 entitled “Investment Allowance Exception in Commercial and Agricultural Earnings”, terminating the investment allowance exception as of January 1, 2006.

The preamble of the act stated that the practice of this exception was abandoned because the investment allowance exception was starting to be used for tax planning and incentives for unproductive investments in contrast to its purpose of introduction. The revoking of the investment allowance led to criticism, as it was regarded by many as an increase on the tax load for potential foreign investors.

Exemption & Exceptions

Customs exemption is an incentives tool implemented by the state by abandoning Customs revenue. The investor is exempt from the duty payable upon the import of the machinery and equipment needed for the investment, leading to a decrease in the cost of investment. This incentives tool is an effective one especially for encouraging investments with high external input requirements to realise the investment.

Of the 4179 investment incentive certificates issued for foreign firms between 1980 and 2006, 2501 include the Customs exemption. The share among the total is 60% by quantity. As a result, the Customs exemption is one of the incentive tools utilised most frequently by foreign investors in Turkey.

VAT Support

Another important tax incentive in our country is the VAT support. It is implemented as a VAT exemption for imported and domestic machinery and equipment covered by the investment incentive certificate in recent periods.

The exemptions of VAT that exist for capital goods, machinery and equipment have made an important contribution to reducing the financing costs of firms in the phases of investment.

According to Section 13/d of the VAT Act, the deliveries of machinery and equipment to investment incentive certificate holders under the certificate are exempt from VAT. Therefore, it has also sought to encourage domestic machinery manufacturers. With this incentive, investments have been encouraged through the elimination of financial load corresponding to VAT on investment.

Tax, Duty & Fee Exception

The tax, duty and fee exception has been implemented since 1985. Tax, duty and fee exception is applied to project loans obtained for investment projects with export pledges and certain rates for five years following the completion of incentive certificate investments. The tax, duty and fee exception is not an incentive made available on their investments. In contrast to other incentives, the tax, duty and fee exception, also encourages a growth in exports.

Free Trade Zone Practices in Turkey

Turkey has introduced a range of regulations to attract a great degree of international capital, among which is those relating to the free trade zones providing advantages to foreign capital investments.

Zero taxes often apply in free trade zones, and in addition to financial advantages such as these, they also provide opportunities for enterprises to be set up using foreign capital as they eliminate the relations that exist between foreign capital and the tax authority, aiding the investment climate.


Based on these regulations, some conclusions can be drawn about the state of Turkey’s taxation system, as well as some further recommendations for its future evolution:

  • Under the present investment incentive system, there is no incentive with a scope that could be expected to affect the quantity, timing, region or sector of investments;
  • In Turkey, incentives and support provided by the state are commonly regarded as the raison d’être for a job, rather than as an auxiliary element that is able to support a job. This can lead to a fund transfer by excluding investments which can create additional value to the country’s economy;
  • In Turkey, in addition to main taxes, transition taxes are imposed in the form of funds, duties and fees that businesses encounter during the investment process. Given the absence of sound data regarding the amount of the same, no calculation can be made on their contribution to the incentive rates;
  • At a time when fierce competition for incentives has brought about increased costs for many countries, there remains insufficient data on investment amounts and incentives;
  • There are institutional conflicts, lack of coordination and ambiguity in incentives legislation. Tax administration and investment incentive system are conducted by several public authorities and organisations with most of the time overlapping and often conflicting pieces of legislation and authorities;
  • Government support must be selective when orienting investment projects by industry;
  • Retroactive tax regulations can create an insecure investment environment for foreign investors;
  • The informal economy can have an adverse effect on the decisions of investors in addition to the injustice in taxation it creates;
  • Ambiguous and frequently changing tax regulations, as well as delayed or unimplemented rebates, are the other most pressing problems relating to taxation concerning investors. These factors can create an unpredictable environment regarding business plans, especially for investors who are in the process of drawing up feasibility studies; and
  • Taxes on employment and indirect taxation can also hurt the investment environment; The following are some recommendations relating to the taxation system for bringing more direct foreign capital investments to Turkey.

They could have a positive effect on the investment environment:

  • Models of best practices and countries achieving serious success regarding foreign investments include enterprising investment strategies and the targeting approach of this strategy;
  • The country could better attract direct foreign investment if it adopted a more systematic and selective incentive policy that targeted a set of priorities and put industries, products, regions and firms at the centre of its focus;
  • When rearranging the incentives system, it must be ensured that the incentives like in EU countries are based on innovation, technology and employment. The burden on the employer that creates additional employment from the state must be reduced. Certain incentive mechanisms oriented to training manpower must be introduced;
  • Greater incentives must be provided for production in targeted industry, research and development, ICT. Long-term fiscal tax policies must be planned with strategic targets selected, and appropriate regulations implemented;
  • The tax holiday is the most popular tax incentive used by developing countries and transitional economies to attract direct foreign investments;
  • The concept of a “tax holiday” should be adopted and inserted into legal regulations;
  • The country’s economic rivals must be monitored closely;
  • The lifting of the investment allowance, commonly regarded as the most important tax incentive, has not been received favourably by a wide range of investors. It would be more beneficial to arrange this incentive under the same norms as EU incentives. This would help to raise the competitiveness of local investors and succeed in attracting more foreign investment to the country; and
  • The rates of direct and indirect taxes should be lowered to a level that can attract greater levels of investment. To that end, a comprehensive reform programme must be prepared, obtaining the agreement of all relevant parties.

The basic criteria considered by businesses as they select an investment location include the following factors, and should be considered by policymakers:

  • Overall economic performance;
  • Legal infrastructure;
  • Economic and political stability;
  • The level of transparency;
  • Market size;
  • Availability of a skilled workforce;
  • Conditions of competition;
  • The level of advancement in the stock market;
  • The trade and foreign currency regime;
  • Tax rates;
  • Physical infrastructure;
  • Raw material supply;
  • Strategic products; and
  • Investment costs; Indeed, the level of taxation and incentives, are just some of the elements determining the choice of investment destination, albeit significant ones. The taxation system must therefore continue to evolve.