Legal Reserves of Companies in Turkey: A Detailed Guide for Foreign Investors
Introduction
Turkey’s strategic geographic location, large consumer market, and increasingly favorable investment environment have drawn the attention of foreign investors. However, before entering the Turkish market, it’s essential to understand the legal and financial obligations imposed on businesses by Turkish law. One of the most important financial requirements for companies operating in Turkey is maintaining legal reserves.
The concept of legal reserves in Turkey ensures that companies retain a portion of their profits to protect against future financial difficulties and guarantee solvency. For foreign investors, understanding the rules regarding legal reserves is critical for compliance and long-term financial planning.
In this article, we will break down what legal reserves in Turkey are, their purpose, the types of legal reserves, and the obligations for foreign investors looking to establish companies in the country.
What Are Legal Reserves?
Legal reserves refer to the portion of a company’s profit that must be set aside by law before distributing dividends to shareholders. These reserves are intended to protect the company from financial risk by ensuring that it retains a minimum amount of capital.
Under the Turkish Commercial Code (TCC), companies operating in Turkey are required to allocate a certain percentage of their annual profits to a legal reserve fund. This requirement applies to both joint-stock companies (A.Ş.) and limited liability companies (Ltd. Şti.). The amount set aside as a legal reserve varies depending on the company’s structure and the total annual profits.
Purpose of Legal Reserves in Turkey
The primary purpose of legal reserves is to safeguard the financial stability of companies. By mandating that companies set aside a portion of their profits, the law ensures that businesses maintain a financial buffer for emergencies or unexpected downturns. Legal reserves can be used in the following situations:
- Covering losses: If a company experiences losses, the legal reserves can be used to cover those deficits.
- Securing creditors: Legal reserves offer protection to creditors by providing an additional layer of security if the company faces financial difficulties.
- Safeguarding capital: By retaining a portion of profits, companies maintain their equity and capital base, ensuring long-term solvency.
Legal Framework for Legal Reserves in Turkey
The legal basis for legal reserves in Turkey is found in the Turkish Commercial Code (TCC). The TCC outlines the types of legal reserves, the conditions for setting them aside, and the percentages of profit that must be allocated annually. Legal reserves are categorized into primary reserves and secondary reserves:
1. Primary Legal Reserves
Primary legal reserves are the first category of reserves that companies must set aside. According to Article 519 of the TCC, 5% of the company’s net profit must be transferred to the legal reserve fund annually until it reaches 20% of the company’s paid-in share capital.
Key Points:
- The primary legal reserve fund is designed to ensure the protection of the company’s paid-in capital.
- Once the reserve fund reaches 20% of the paid-in capital, companies are no longer required to allocate further profits to the primary reserve unless the reserve falls below the required threshold.
2. Secondary Legal Reserves
Once a company has fully funded its primary legal reserves, it may be required to allocate additional profits to the secondary legal reserve. According to the TCC, 10% of the dividends distributed to shareholders exceeding 5% of the company’s paid-in share capital must be set aside as a secondary reserve. This reserve provides additional protection for creditors and shareholders in the event of financial difficulties.
Key Points:
- The secondary reserve is required once dividends surpass 5% of paid-in share capital.
- The secondary reserve is meant to offer additional financial protection, though it can only be used under specific conditions, such as covering losses or insolvency.
3. Optional Reserves
In addition to legal reserves, Turkish companies may also choose to create optional reserves based on their articles of association or a general assembly decision. These reserves offer companies more flexibility in managing profits and ensuring future financial stability.
Key Points:
- Optional reserves are not required by law but can be established for precautionary purposes.
- Companies may decide on the allocation and use of these reserves in accordance with internal policies and financial strategies.
When Do Companies in Turkey Use Legal Reserves?
Although legal reserves are accumulated for protective purposes, companies are restricted in how they can use these funds. According to the Turkish Commercial Code, legal reserves can only be used in the following situations:
- Covering net losses: In case the company incurs losses in a financial year, legal reserves may be used to cover these losses, ensuring that the company maintains financial stability.
- Maintaining share capital: Legal reserves can be used to preserve the company’s paid-in capital when it is at risk of falling below the required threshold.
- Emergency payments: If the company faces an urgent financial crisis, it may tap into legal reserves to meet necessary financial obligations.
Importantly, legal reserves cannot be used for dividend distribution, and their primary purpose is to maintain the company’s financial health.
How Legal Reserves Impact Dividend Distribution in Turkey
One of the most significant implications of legal reserves in Turkey is their effect on dividend distribution. Before dividends can be distributed to shareholders, companies must allocate the required percentages of their profits to legal reserves. This means that investors, including foreign shareholders, will not receive dividends until the company has fulfilled its reserve obligations.
Key Points for Foreign Investors:
- The amount allocated to legal reserves reduces the pool of profits available for distribution as dividends.
- Once the legal reserve reaches 20% of the company’s paid-in capital, dividend distribution can proceed without further reserve allocations (except for secondary reserves).
- Foreign investors should consider the legal reserve requirements when calculating potential returns on their investment.
Legal Reserve Requirements for Joint-Stock Companies (A.Ş.) and Limited Liability Companies (Ltd. Şti.)
Both joint-stock companies (A.Ş.) and limited liability companies (Ltd. Şti.) in Turkey are subject to the legal reserve requirements outlined in the TCC. However, there are some key differences between these two types of companies:
1. Joint-Stock Companies (A.Ş.)
- Minimum capital: 250,000 TRY
- Legal reserve requirements: As outlined in the TCC, joint-stock companies must set aside 5% of their annual profits to the primary legal reserve until it reaches 20% of the company’s paid-in capital. Secondary reserves must also be set aside once dividends exceed 5% of paid-in capital.
2. Limited Liability Companies (Ltd. Şti.)
- Minimum capital: 50,000 TRY
- Legal reserve requirements: Limited liability companies follow similar rules as joint-stock companies in terms of setting aside legal reserves. However, the process for dividend distribution and reserve allocation may vary slightly based on the company’s structure and internal agreements.
Legal Reserves and Taxation in Turkey
Another critical aspect of legal reserves for foreign investors is their impact on taxation. In Turkey, legal reserves are considered part of the company’s retained earnings and are therefore not subject to corporate income tax until they are distributed as dividends.
Key Points:
- Legal reserves are not taxable at the time they are set aside.
- If legal reserves are distributed as dividends, they become subject to dividend withholding tax, which varies depending on whether the shareholder is a resident or non-resident of Turkey.
- Double Taxation Treaties (DTTs) between Turkey and other countries may reduce the withholding tax rate on dividends for foreign investors.
How to Ensure Compliance with Legal Reserve Requirements in Turkey
For foreign investors looking to establish a company in Turkey, ensuring compliance with legal reserve requirements is essential for maintaining good standing with Turkish authorities. Here are a few key steps for ensuring compliance:
- Engage a Local Accountant or Financial Advisor Foreign investors should work with a qualified Turkish accountant or financial advisor who understands the legal reserve requirements and can assist with setting aside the appropriate amount each year.
- Include Legal Reserve Provisions in Articles of Association When incorporating a company in Turkey, it’s essential to include provisions regarding the allocation and use of legal reserves in the company’s Articles of Association. This ensures transparency and compliance with the TCC.
- Monitor Annual Profit Calculations Companies must calculate their annual profits accurately to determine how much must be allocated to legal reserves. Working with a qualified accounting firm can help ensure that profits are calculated correctly and legal reserve allocations are made in a timely manner.
- Report to the General Assembly The company’s general assembly of shareholders should be informed of the status of legal reserves annually. This ensures transparency and allows shareholders to understand the financial health of the company.
How We Can Help Foreign Investors
We specialize in helping foreign investors navigate the complexities of Turkish corporate law, including the requirements for legal reserves in Turkey. Our services include:
- Legal compliance guidance: Ensuring that your company complies with all legal reserve requirements.
- Financial planning: Helping you incorporate legal reserve obligations into your overall financial strategy.
- Tax advisory services: Offering advice on the tax implications of legal reserves and dividend distributions.
- Incorporation services: Assisting with company formation and the drafting of Articles of Association that comply with Turkish law.
By working with a professional advisor, foreign investors can ensure that their businesses remain compliant and financially secure while operating in the Turkish market.
Conclusion
Understanding the rules surrounding legal reserves in Turkey is crucial for foreign investors looking to establish and grow their businesses in the country. These reserves are a vital part of the financial framework that protects companies, creditors, and shareholders from financial instability.
By complying with the Turkish Commercial Code and setting aside the required portion of profits, companies can maintain financial health and build a solid foundation for long-term growth. Whether you’re considering establishing a joint-stock company or a limited liability company, working with a qualified advisor will ensure that you meet all legal obligations related to legal reserves and other financial requirements.
For more information on legal reserves or to discuss how we can assist you with your investment in Turkey, feel free to contact us for a consultation.
FAQ
1. What are legal reserves in Turkey?
Answer:
Legal reserves in Turkey are amounts that companies must set aside from their profits as a financial safeguard. Under Turkish Commercial Code, 5% of the annual net profit must be allocated to legal reserves until they reach 20% of the company’s paid-in capital. These reserves are intended to protect the company’s financial health.
2. How are legal reserves calculated in Turkey?
Answer:
Legal reserves in Turkey are calculated by allocating 5% of the company’s annual net profit. This process continues each year until the legal reserve reaches 20% of the company’s paid-in capital. The reserves are meant to provide financial stability and are used under specific circumstances, such as covering losses.
3. When can legal reserves be used by companies in Turkey?
Answer:
Legal reserves in Turkey can only be used under certain conditions, such as covering losses or paying debts during liquidation. They are not generally available for distribution to shareholders and are meant to provide a financial cushion for the company, ensuring long-term stability.
4. Are legal reserves mandatory for all companies in Turkey?
Answer:
Yes, setting aside legal reserves is mandatory for all joint stock companies (A.Ş.) and limited liability companies (LTD) in Turkey. This requirement ensures that businesses maintain a minimum level of capital to protect against potential financial difficulties.
5. How do legal reserves impact dividend distribution in Turkey?
Answer:
Before dividends can be distributed in Turkey, companies must first allocate the required portion of their annual net profit to legal reserves. Dividends can only be paid after the company has met its legal reserve obligations, ensuring that a portion of profits is retained for financial security.
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