1 European Union Indirect Tax Requirements and Implications for the Harmonization of Turkey’s Tax System Jorge Martinez-Vazquez Conference on Tax Options in the Wake of EU Accession for Turkey, Ankara, January12-13, 2009

2 Indirect Taxation Regime in the EU  The indirect taxation acquis  harmonized legislation in VAT and excise taxes as in the Sixth Directive (of 1977 and codified in 2006 for VAT) and Council Directive 92/12 for excises  VAT  non-cumulative general proportional tax on consumption prices, on all stages on production and distribution, providing equal treatment for domestic and import transactions  Excise taxes  duties to be charged, with minimum rates, on domestic and import transactions for energy products, tobacco products, and alcoholic beverages.

3 Customs Duties  Customs tariffs  The tariff is common to all EU members, although the rates of duty differ from one kind of import to another.  The Customs tariff will not be discussed any further in this presentation

4 Degree of Alignment for the Value Added Tax (1) Degree of Alignment for the Value Added Tax (1)  Overall, Turkey is largely aligned with the EU in the field of VAT  But some issues remain: On tax rates -- Turkey applies one standard rate (18%) and two reduced rates (8% and 1%). By EU standards, the standard rate may not be less that 15% and the one or two reduced rates can not less than 5% -- So, usage of the 1% rate is not in line with the EU acquis and part of the base for the 8% rate as applied to supplies of textile products prior to the retail stage is not in compliance either

5 Value Added Tax

6 Degree of Alignment for the Value Added Tax (2)  Other issues: -- Differences remain in the usage of some deductions, exemptions (for small enterprises), etc. -- Streamlining definitions for “taxpayer,” “economic activity” and using the acquis “place of supply” as opposed to “place of delivery” (this latter is also an issue for excise duties)

7 Degree of Alignment for Excise Duties  Important issues stand with regard to the taxation of “alcoholic beverages” and “tobacco products”  Some less difficult issues remain in the alignment for the taxation of “energy products”

8 Issues with the taxation of “alcoholic beverages”(1)  Main issue is that Turkey’s current structure results in higher taxation on those alcoholic beverages that are “mainly imported” and on lower taxation on “mainly domestic” products, which represents a breach of the Customs Union

9 Specific Rate Ad Valorem RateTotal Excise TaxVAT EU (minimum)4 euros /liter 15% EU (average6.2 euros /liter 19.4% Turkey Raki35,848 YTL275.6% max[35,848 or 275.6%]18% Whiskey70,926 YTL275.6% max[70,926 or 275.6%]18% Comparison of EU and Turkey: Taxation of Typical Alcohol Products

10 Issues with the taxation of “alcoholic beverages”(2)  Other less difficult issues: -- The EU only applies specific duties while Turkey applies an ad valorem duty replaced by a specific duty only when the ad valorem duty yields a lower tax -- For certain alcoholic beverages Turkey’s duties are based on “type of product” as opposed to the EU’s “ alcoholic content” -- In Turkey, all alcoholic beverages are subject to tax regardless of alcohol content… not so in the EU (de minimis strength of 0.5% for beer and 1.2% for other beverages -- Turkey does not tax pure ethyl alcohol; the acquis provides no basis for this exemption but for some isolated cases (denatured alcohol, etc)

11 Issues with the taxation of “tobacco products”(1)  Main issue is that Turkey’s currently applies a specific duty on imported tobacco and cigarettes to finance the “Tobacco Fund. The application of the specific duty only to imported products represents a breach of the Customs Union

12 Different Taxation of Imported Tobacco Products and Domestically Produced Tobacco Retail Price/ Pack Specific Excise Tax Ad Valore m Excise Tax Total Excise Tax/ Pack Total Excise as % of Retail Price VAT Tobac co Fund Total Tax as % of Retail Price EU Criteria 5-55%NA 57% of Retail Price 57% 15% (min.) NA EU Average 3,13 Euro 30%61% 59% 0,5Euro * * 75% Turkey 1,4YTL/pa ck 58% Max[1,4YTL, 58%] 18% 0,12Y TL NA Samsun 2,17Y TL1,40YTL 1,26Y TL 1,40YTL64,5%0,33YTL 80% Marlboro 4,68Y TL1,40YTL 2,71Y TL 73%0,71YTL 0,12Y TL 76%

13 Issues with the taxation of “tobacco products”(2)  Other less difficult issues: -- Turkey defines the cigarettes on the basis of the CN code (Combined Nomenclature of Customs) which is not in line with the acquis -- The minimum excise levels for cigarettes in Turkey are not established with reference to the “Most Popular Price Category” which is not in line with the acquis -- To be in compliance, Turkey needs to levy a specific duty (between 5% and 55%) in addition to the current ad valorem rate so the levy is at least 57% of the retail selling price and come to a total of minimum levy of 64 Euros (VAT inclusive) per 1,000 cigarettes

14 Issues with the taxation of “energy products”  Turkey still applies excise duty on fewer products( e.g., coal and coke are excluded.) Current legislation will need to be enlarged in the coverage of energy products  Turkey’s Council of Ministers is authorized to either increase the highest duty rate on gas and diesel by 50% or decrease down to 0%. This latter may imply that the EU required minimum rate is not applied  There are several definitional issues: -- Need to distinguish taxation on the basis of final use (e,g, heating, motor vehicle final use versus as an input of production, etc), although this is done in Turkey for electricity -- Currently some energy products still defined in an “unclear manner,” (‘petroleum products,’ ‘solvents,’ etc) not in line with the acquis

15 EU Minimum Excise Duties for Energy Products

16 Summary: Main Issues for Harmonization Reform  Address the different taxation treatment of imported tobacco products and domestically produced tobacco  Address the differential treatment of Raki relative to other alcoholic beverages of similar alcohol content

17 Recommendations for Tobacco (1)  Tobacco Fund has to be eliminated  However, there are possibilities for:  A graduated phase-in approach to eliminate the Tobacco Fund.  Control impact on relative prices facing domestic consumers by introducing differential excise rates for tobacco products by type of blend.

18 Elimination of the Tobacco Fund = -260 million YTL. Change in Excise Tax Due to Increase in Imports of Tobacco Products= 101 million YTL. Change in VAT Due to Increase in Imports of Tobacco Products= 2.2 million YTL, Change in Excise Tax Due to Decline in Consumption of Domestic Tobacco Products = -43 million YTL. Change in VAT Due to Decline in Consumption of Domestic Tobacco Products = -12 million YTL. Net Change in Tax Revenues = -212 million YTL. Revenue Impact (as of ) of Eliminating Tobacco Fund

19 Economic Impacts of Eliminating the Tobacco Fund  Production: Reduction in domestic production would be by 1.52% or 615 tons based on production levels in  Employment: A decline in 2,547 jobs based on number of farmers employed in  Income loss: 6.4 million YTL (2,500*2,547).

20 Recommendations for Tobacco (2)  Introduce a program for income maintenance and crop substitution that would soften the blow on the poor population in the East and the Southeast of Turkey. As part of the negotiations with the EU, ask for cost sharing in this income maintenance and crop substitution program up to 5 years or until accession of Turkey to the EU.  In the medium term for Turkey to reform the structure of its excise tax on tobacco by adopting a tax structure that includes both a specific in rem tax component and an ad valorem component according to EU rules.

21 Revenue Impact of Increasing Excise on Raki  Increase excise tax on Raki from YTL to YTL.  one hundred percent increase in the excise tax, would imply a 38% decrease in the consumption of Raki  Doubling the excise tax on Raki would approximately double its price.  The excise tax revenues would increase by 62% or by 404 million YTL.

22 Economic Impact of Raising Excise on Raki  Production of Raki would decline by million liters.  Decline in employment in Raki production would be 954 jobs.  The welfare impact would tend to be more on low income consumers (?).

23 Recommendation on Raki  Another feasible choice is to lower the taxes on similar (mostly imported) spirits at a revenue loss of about 20 million YTL.  However, the current tax structure is not similar to the EU and it would be necessary to adopt a structure similar to that in the EU.  There is the possibility of negotiating for a transition period.

24 Thank you