Withholding Tax Clauses in International Franchise and IT Contracts - Turkish Tax Considerations

I. Introduction

The withholding tax clauses in international franchise agreements and international license agreements are quite common and need to be reviewed by legal counsels since its interpretation and application are matter of local law and bilateral treaties. As franchise agreements and IT contracts have been prepared by franchisors, these clauses are mostly in favour of franchisors or service providers whereby franchisee or customers pays an additional tax to the relevant tax authorities which creates an additional cost in addition to royalty payments or license fees. Unaware of this situation franchisors and customers may risk themselves to incurring an extra cost. This issue should be addressed in the context of bilateral tax treaties and should be negotiated with the franchisors or customers in big transactions.

II. Turkish Tax Regulation and Bilateral Treaties

Under Turkish Tax system all kind of sale, transfer and assignment of any kind of intellectual property rights including royalty concession management and corporate name rights are subject to corporate tax rate. This rate has been determined as 20 % under the Decision of the Council of Minister dated 2009/14593 and dated 03 February 2009. Thus if no bilateral agreement has been concluded between the residency country of franchisee and franchisor the franchisee is required to withhold 20 % of any kind of payment to carry out to foreign incorporated franchisor.

Under Double Taxation Agreements between franchisor’s and franchisee’s country of origin, this matter is mostly addressed in a way that the use of information concerning commercial experience is classified as the use of information concerning commercial experience through which franchisee is deemed to withhold certain amount of the invoiced amount, mostly 10 %. The terms in the OECD Model Convention is wildly used in most bilateral tax treaties which determines the royalties as “payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.” [1] For instance, under the Article 12 of the UK/Turkey Double Taxation Agreement fees are all considered as “Royalties” since they are classified as “the use of information concerning commercial experience” and it is required to withhold 10% of the amount realized on the invoices. With the provision of Article 23/1(a) of this treaty these payments can be deducted as a Tax Credit in the United Kingdom by the party incorporated in the UK. With the provision of Article 23/1(a) of this treaty these payments can be deducted as a tax credit in the United Kingdom. Thus franchisors will have an advantage of an extra of 10% profit in this regard.

In addition to tax treaties, the application by the Turkish Tax Authorities is in the same direction whereby the franchisees are required to withhold 10% of the whole payment in return for franchisor deducting from its tax payment requirement where it is located. Indeed, Special Notice of Bursa Tax Authority is given upon the request of a hotel franchisee of an international franchise chain located in Bursa Turkey where it is stated that the Royalty term in the bilateral agreement includes other payments made by the franchisee under the name of a marketing fee, reservation fee and any online systems. It is also stipulated that the status of the payments whether they are invoiced as Royalty fee or not shall be classified as Royalty regardless of which term used for the invoice fees.

III. Clauses in Franchise Agreements and Negotiations

It is questionable who will bear the burden of the withholding tax in franchise agreements. However, the withholding tax clauses in franchise agreements prepared by the legal counsels of franchisors are as follows in most international franchise agreements: “The amounts payable to franchisor will not be reduced by any deduction or withholding for any present or future taxes. The amount paid to franchisor will be increased so that after the deduction or withholding the net amount actually received by franchisor will equal the full amount originally invoiced.”

As explained, the most bilateral treaties stipulate that the franchisors can use the withholding tax paid by franchisees as tax credit in their country of incorporations. Within this context, the withholding tax clauses should shift the burden from franchisees to franchisors since the the amount withhold will be used as tax credit. The above clause should be amended as follows: “The amounts payable to franchisor will be reduced and the franchisee will pay the reduced amount to franchisor while franchisor will use this as tax credit or any form.”

IV. Clauses in IT Contracts

Although most cross-border IT contracts are non-negotiable, it is of crucial importance to mention in this article on how the wording in IT contracts is drafted and affects the customers. In particular, in license agreements where a high license fees are involved, these clauses need to be negotiated by customers. In this regard, the withholding tax clause in Amazon Web Services customer contract published online can be given as an example. The article 5.2 of the Amazon Web Services Customer Contract is as follows: “All payments made by you to us under this Agreement will be made free and clear of any deduction or withholding, as may be required by law. If any such deduction or withholding (including but not limited to cross-border withholding taxes) is required on any payment, you will pay such additional amounts as are necessary so that the net amount received by us is equal to the amount then due and payable under this Agreement. “

The above clause shifts the burden of withholding tax from Amazon to its customers whereby customers withhold the tax as an additional expense changing between 10% to 20% depending on the bilateral tax treaties. In light of the above analysis, it is noted that these contracts should be revised by service providers such as Amazon and Oracle in order to protect their customers from incurring additional fees due to withholding taxes or the customers should negotiate. Indeed, most IT companies can get back the withholding tax paid by customers as tax credit in their country of incorporation if the customer pays the withholding tax in their home country.

V. Conclusion

The withholding tax clauses should be examined in a way that none of the party should incur any costs due to withholding tax deduction in its local country. These clauses should be addressed by i) local tax regulations and ii) bilateral treaties and should be negotiated with the franchisors.

[1] Article 12/2 of the OECD Model Convention.

(First published in Turkish Law Blog on 17 December 2020)