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UNCLAS SECTION 01 OF 03 ISTANBUL 000392 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
TREASURY FOR CPLANTIER 
 
E.O. 12958: N/A 
TAGS: ECON EFIN TU
SUBJECT: NEW TURKISH WITHHOLDING TAX ROILS BROKERS AND 
BANKS BUT HAS MINIMAL MARKET IMPACT 
 
 
¶1. (SBU) Summary: Turkey's new 15 percent withholding tax on 
capital gains and interest from government securities has had 
little of the market impact that market players predicted 
last year.  A number of analysts profess surprise at how 
limited the impact has been, with some noting that the 
Treasury wisely reduced its rollover ratio at the same time 
that it introduced the tax, thereby minimizing its impact. 
Interest rates on government debt have risen slightly in 
recent weeks, most analysts ascribed the increase to the 
impact of increasing rates in the U.S. and other developed 
countries on flows to emerging markets.  The withholding 
tax's impact on stock prices has also been minimal, with many 
noting that the negative hit from the new tax has been more 
than counterbalanced by gains resulting from the reduction in 
Turkey's corporate tax rate from 30 to 20 percent.  Still, 
the tax has had an important impact in several derivative 
markets, most notably in that for American depository 
receipts (ADRs) for Turkish companies.  Local custodians note 
that because of uncertainty surrounding tax issues, new ADRs 
are not being issued, and while existing ones continue to be 
traded, they are not being cancelled or reissued.  Concerned 
depositary institutions, including notably the Bank of New 
York (BONY), which holds 70 percent of the local market, have 
lobbied without success for the exclusion of ADRs from the 
tax.  From a big picture policy perspective, the withholding 
tax has considerable merit as it is part of a broader, 
IMF-supported effort to tax all financial instruments 
equally.  End Summary. 
 
¶2. (SBU) A Controversial Measure: The new withholding tax 
sparked extensive concern and opposition last year, with 
leading local and international brokerages making the journey 
to Ankara to argue that the measure could bring a sharp spike 
in the interest rates Turkey pays on its government debt, as 
investors took on board a new cost that would significantly 
diminish the return they received on their investments.  In 
the event, however, the new tax made its debut not with a 
bang, but with a whimper, with an almost imperceptible impact 
on Turkey's broad market indices.  Local brokerages we 
surveyed (including Global, EFG Securities, EkspresInvest, 
and Finansinvest) admit to being surprised by the low-key 
reaction.  They attribute it to several factors, including a 
wait-and-see attitude adopted by many investors in the first 
months of the tax's implementation, and the fact that the 
measure does not apply to bonds purchased before the tax's 
entry into force on January 1.  Cem Akyurek at Global also 
noted that the Treasury's decision to reduce the rollover 
ratio on Turkish debt helped to minimize the impact.  Some 
analysts believe, however, that the tax's full effect will 
only be visible in 6-10 months, as more existing treasuries 
expire and investors must select another investment vehicle. 
Baturalp Candemir at EFG, notes that with the interest banks 
pay on deposits matching (and in many cases exceeding) the 
rates on treasury bills, more and more investors are opting 
to take their money out of government bonds when their 
existing holdings mature and put them in deposit accounts. 
He attributes the slight uptick in rates at the end of 
January and early February in part to this phenomenon, and 
predicts that this trend will intensify. 
 
¶3. (SBU) Localized Impact: Though the broad market impact of 
the new tax has been limited, certain of its provisions have 
severely roiled some market segments, including particularly 
the market for American Depository Receipts (ADRs) of Turkish 
companies.  That market has been frozen since the beginning 
of the year, as the way in which Turkish tax authorities 
apply the tax leaves the final purchaser of such an 
instrument liable for tax on the capital gain over its entire 
life when it is cancelled or reissued, potentially eclipsing 
any capital gain he or she earned from it.  The Bank of New 
York (BONY) has pursued this issue with the Turkish 
Government without success, and warns that if the rules are 
not reworked to permit the ADR market to function, BONY, 
which controls 70 percent of that market in Turkey, may be 
compelled to close its local office.  "We have lost our 
entire revenue base," BONY's Istanbul Representatiave 
Neslihan Tombul told us recently.  Tombul characterized her 
meetings with government officials in Ankara as unproductive, 
noting that officials there seem intent on maintaining an 
approach to taxing these instruments that is out-of-step with 
world practice.  Others who participated in the meetings note 
that while the Ministry now understands the problem, it is 
not inclined to correct it, as it believes it would be unfair 
provide special treatment to one type of instrument.  They 
note that local brokers have lined up on the other side of 
the issue out of fear that exempting ADRs will shift 
transaction volume out of the Istanbul Stock Exchange and 
 
ISTANBUL 00000392  002 OF 003 
 
 
overseas.  Tombul appealed for the Embassy to raise the issue 
with the GOT, given its impact on BONY's bottom line. 
 
¶4. (SBU) Swaps: Complicating the story is the fact that for 
the time being at least, authorities are not applying the 
withholding tax to swap contracts in countries such as the 
Netherlands or the U.S. which have double taxation treaties 
with Turkey.  Local brokers characterize this market as a 
"gray area," which is neither completely legal or illegal.  A 
number of them, however, have looked into the market and 
decided that the risks are too great, as the custodian in the 
Netherlands or other tax treaty country may be left with the 
tax liability if, for instance, the transactions are 
investigated and it is determined that the end beneficiary of 
the swap was not a resident of the Netherlands who was 
entitled to benefit from the tax treaty.  This specific issue 
has also been raised with the U.S. Mission by concerned 
investors, who note that Turkish authorities are considering 
a regulation whereby they will make this exclusion explicit. 
This, investors note, would prevent them from establishing 
special purpose vehicles (SPVs) in Holland to benefit from 
the treaty.  In seeking an explicit statement from Turkish 
tax authorities that existence of such a vehicle conforms to 
the requirements of the Dutch-Turkish tax treaty, Raymond 
James Securities made the argument to us that such a 
statement would level the playing field for all foreign 
investors, and asked rhetorically, "where is the fairness in 
permitting one group of international investors to invest in 
Turkey without paying the withholding tax while another group 
has to pay the tax?" 
 
¶5. (SBU) Local brokers are not swayed by the argument, 
however.  They prefer that all investments be taxed equally, 
arguing that otherwise foreigners (including "mustachioed 
foreigners"-- another term for Turkish capital held overseas) 
will shift their investment activity offshore.  In this 
regard, one analyst at a local brokerage told us, ADRs are a 
much greater risk than swaps, since many funds are either 
prohibited from engaging in the latter or have strict limits 
on them.  Exclusion of ADRs from the tax, he argued, would 
lead to a dramatic rise in their use, above and beyond the 40 
companies that currently issue them. 
 
¶6. (SBU) Treaty Violation?: Beyond these specialized issues, 
some tax analysts suggest to us that the withholding tax is 
in violation of the U.S.-Turkey bilateral tax treaty, full 
stop, though they note that investors have been reluctant to 
draw attention to themselves by pressing the point.  Umurcan 
Gago, tax division manager at Pricewaterhouse Coopers, notes 
that under the treaty American investors are subject to tax 
only in their home jurisdiction so long as the following 
three conditions apply: they held their assets for more than 
a year, they sold them to a non-Turkish resident, or they 
consisted of stocks or bonds that are quoted on a stock 
exchange in Turkey.  Historically, however, he notes, the 
Turkish Ministry of Finance has interpreted the conditions 
more stringently, arguing that a stock or bond must be 
registered, quoted and listed, and "actively traded" in order 
to benefit.  Investors have been unhappy with this 
stipulation since it was first introduced in the late 1990s. 
The provision has become much more problematic since January 
1, however, as investors no longer benefit from the tax 
exempt status they enjoyed on assets such as government 
securities.  In addition, the Finance Ministry has been 
insistent that treasury bonds are not technically "quoted" on 
an exchange, and hence cannot benefit from the "quotation 
release." 
 
¶7. (SBU) Though our financial market contacts are 
understandably focused on the considerable and sometimes 
unfavorable impact the new tax is having on their business, 
the tax itself is part of a broader IMF-supported reform to 
tax all financial instruments at the same rate.  In addition 
to withholding at source in an attempt to maximize 
compliance, the single rate was designed to get the 
government out of the business of favoring one instrument 
over another.  This change is particularly beneficial in 
lessening the "crowding out" by government securities, since 
until 2006 these securities were not taxed.  The change is 
also likely to encourage the badly-needed deepening of the 
banking sector, since bank deposits can now compete on a 
level playing field with government securities. 
 
¶8. (SBU) Comment: These exceedingly technical and arcane 
issues are likely to keep investment professionals occupied 
for quite some time to come.  While the macroeconomic impact 
of the new tax has been minimal, in the face of the global 
 
ISTANBUL 00000392  003 OF 003 
 
 
flood of liquidity that continues to wash over Turkey, the 
impact has been dramatic on some specific markets.  In 
response to BONY's requests for Embassy intercession with the 
GOT on the ADR issue, we have suggested that they first 
pursue their efforts to secure support from ADR issuers such 
as Turkcell, who also stand to be signficantly affected, as 
well as from the local brokerage community, whose resistance 
to ADRs appears to have stiffened the Ministry's back on the 
issue.  To date, however, they have not been successful on 
either front.  Local brokers remain staunchly opposed to 
exempting ADRs, while issuing companies do not see the issue 
in the same "life and death" terms as BONY, given that their 
other investment vehicles are flourishing in Turkey's buoyant 
markets.  End Comment. 
JONES