Turkish Superior Court decision: can a website, in itself, constitute a permanent establishment?

Yusuf Gökhan Penezoğlu
Penezoğlu Law Firm, Istanbul
yusuf.penezoglu@penezoglu.com

Zeynep Kılavuz
Penezoğlu Law Firm, Istanbul
zeynep.kilavuz@penezoglu.com

Introduction

Taxation of the digital economy is one of the current trends for tax enforcers and a hot topic worldwide. Frankly, the reason why the digital economy is so attractive to tax authorities is that it is responsible for a very significant portion of global gross domestic product (GDP). Even though it is not possible to exactly determine its scale, due to the lack of an exact definition for it, it is considered that the digital economy constitutes approximately 16 per cent of global GDP. When this became the case, countries started imposing taxes on digital companies by enacting local regulations without waiting for international consensus. Turkey is one of the countries taking major steps in this direction and one of these avenues is the withholding tax applied to advertising services rendered on online platforms.

In spite of all of the discussions and legal objections, this imposition of tax, expressed as a digital advertisement withholding tax, was implemented in 2019 through the enactment of legal regulations.

This taxation aimed to impose a tax on digital platforms, such as Google, Facebook, Instagram and Twitter, through a tax withholding mechanism. The assumption was that this charge would be placed on the shoulders of the online advertisement platforms located abroad. However, in practice, the situation has varied for each company and while some online advertisement platforms have accepted this charge, some have refused to pay such charges, pointing out that such tax is not included in their service fees.

Court decisions

In practice, while the discussions on the financial burden created by the tax are ongoing, the companies, which are of the opinion that the tax is unlawful, have started to bring the issue before the courts. The decisions rendered by the first instance tax courts in the judicial proceedings initiated by such companies started being issued in late 2019. At this stage, the opinion of the courts was in favour of the companies initiating the lawsuits. Subsequently, with the affirmance by the Regional Administrative Court, which is the higher court next in line, of such decisions, the rate of initiation of lawsuits before the courts, in this regard, kept increasing.

In the thousands of lawsuits initiated, the courts continued to decide in favour of the taxpayers at a rate of almost 99.99 per cent until the end of 2022, on the grounds that:

• payments subject to tax withholding constitute commercial income of the online advertisement platforms residing abroad;

• for the taxation in Turkey of the companies residing abroad in terms of their commercial income, such companies must have a permanent establishment in Turkey and such income must be generated through a permanent establishment;

• permanent establishment is defined, under both the Avoidance of Double Taxation Agreements (the ‘DTTs’) entered into with the countries in which such companies reside and Turkish legislation, as a fixed place in relation to a business, such as a branch, office or warehouse, etc;

• however, such service providers, to which payments are made, do not provide such services in Turkey from such fixed places in relation to the business and the only presence in Turkey of such companies is their websites;

• taking into account that the DTTs and the local laws in effect refer, in relation to the permanent establishment, to a fixed place, it is not possible to say that websites constitute a permanent establishment; and

• in this regard, no tax can be imposed in Turkey on the commercial income made by online advertisement platforms without a permanent establishment in Turkey.

However, the Council of State, which is the highest court in the tax judicial system among ordinary appeals, issued its first ruling on the subject, which went against the taxpayer.

In this decision, which was a legally unexpected decision, the Council of State ruled that the websites constitute the permanent establishment, and that the income generated from Turkey by the companies, which provide online advertising services and are resident abroad, through their websites should be taxed in Turkey. Therefore, the tax, which was paid by way of withholding from the payments made to the aforementioned companies, is lawful based on the following reasons:

• in case of a discrepancy in the provisions on the same subject as international agreements duly enacted and relating to fundamental rights and freedoms and local laws, as per Article 90 of the Constitution of the Republic of Turkey, the provisions of the international agreement shall prevail and, in this context, the provisions of the DTTs executed by and between Turkey and the countries, in which such companies reside, shall apply to the dispute brought before the court;

• for the settlement of the dispute at hand, first an assessment must be made in terms of whether the websites on which the foreign companies provide advertisement services qualify as a ‘permanent establishment’ under Article 5 of the DTTs;

• the concept of ‘permanent establishment’ in paragraph 1, Article 5 of the DTT is defined as a fixed place through which the business of an enterprise is wholly or partly carried on and, in this context, for the places where the activities of taxpayers are carried out to qualify as a permanent establishment, such places ‘must be allocated to the performance of, or be used for, the activity’;

• in fact, the place which is identified as a permanent establishment, is a place that cannot be defined as conclusive and defined restrictively; on the contrary, it would be sufficient for it to be a place or environment that is suitable for carrying out the commercial, industrial, agricultural and professional activity;

• in this sense, a permanent establishment may exist in the case of a commercial activity that is being carried out online, and in such a scenario, the permanent establishment would be the place where the activity is being carried out, meaning the computer and the internet environment, which enable the communication; and

• in cases where the commercial activity is essentially carried out through a website (the internet) - considering the fact that due to the developments in internet technology it is possible for the servers or equivalents thereof to also provide services through satellites without requiring a physical location on earth, that the server can be placed in any country that is desired or can be relocated at regular intervals by being installed on portable computers and that by setting up ‘mirror sites’ on servers, which are located in several countries, it is possible to redirect the action carried out to the desired address, with the approach being that the permanent establishment would only be the physical location where the servers are located would not be correct from a tax law perspective.

However, when the following facts are taken into consideration, it is seen that the reasoning of the Council of State, summarised above, cannot be justified under the existing regulations:

• even though only the provisions of the DTT were taken directly into consideration in the decision rendered by the Council of State, due to the restrictive nature of the DTTs, it is not possible to impose a tax, as this is not allowed under the provisions of the local legislation and under the DTT;

• the provision in local legislation that regulates the permanent establishment is a provision created in 1961, and refers to a physical place of business;

• in that respect, there is no legal provision in the Turkish legislation that allows a website to be deemed the ‘permanent establishment’ and there is a legal gap concerning ‘digital permanent establishment’ in local legislation;

• where there is a legal gap, meaning that there is the lack of an explicit, clear, comprehensible legal provision that may constitute a basis for taxation, a tax cannot be imposed;

• otherwise, such taxation would be contrary to the legality of the tax principle, which the Constitution of the Republic of Turkey protects;

• where local legislation does not provide a legal ground for taxation, it is not logical to go to the DTTs and evaluate the cases within the framework of the DTTs’ provisions;

• however, even if for a moment, it is assumed that a website constitutes a permanent establishment under the local legislation and so the DTTs’ provisions can be evaluated in this regard, it is seen that the DTTs, as well, do not include any provision that may constitute a legal basis for a website to be considered as a permanent establishment;

• on the contrary, in the section in Article 5 of the Commentaries on the Articles of the Model Tax Convention, which constitutes the basis for the DTTs, it is indicated that ‘[…] an internet web site, which is a combination of software and electronic data, does not in itself constitute tangible property. It therefore does not have a location that can constitute a “place of business” as there is no “facility such as premises or, in certain instances, machinery or equipment” (as far as the software and data constituting that web site is concerned. On the other hand, the server on which the web site is stored and through which it is accessible is a piece of equipment having a physical location and such location may thus constitute a “fixed place of business” of the enterprise that operates that server.’

Conclusion

When the following facts are taken into consideration, it is seen that it is not possible to consider the place of business as being the computer and the internet environment, as stated in the decision of the Council of State and that the reasoning that ‘the approach concluding that the place of business would only be the physical location where the server is located would not be correct from the tax law perspective’ cannot be justified according to existing international regulations.

Along with the above, it is also debated whether the limits of the power, which is granted to the President in the legal provision concerning the mentioned withholding tax applied to payments to be made to companies residing abroad, are ambiguous and, therefore, whether the enforcement of such a provision would breach the principles of legal state, the non-transferability of legislative power and the legality of the tax.

For all these reasons, taxpayers have started to apply for decisions, which have been finalised against them, to the Constitutional Court. Even though the opinion of the Constitutional Court is curiously awaited, it is expected that given the existing legal and constitutional regulations, the Constitutional Court will rule that such a tax is against the constitution.

As the decision to be established by the Constitutional Court will include a final constitutional assessment in terms of whether the necessary legal regulations exist in relation to the qualification of a website as a place of business, it is expected to be a milestone decision with regard to Turkish tax practices.