Cablegate: Turkish Government Pulls Back Controversial Investor Tax

Published: Fri 23 Jun 2006 02:45 PM
DE RUEHAK #3717/01 1741445
R 231445Z JUN 06
E.O. 12958: N/A
SUBJECT: Turkish Government Pulls Back Controversial Investor Tax
Ref: A) Istanbul 392; B) 2005 Ankara 4494
1. (SBU) Summary: In a bid to calm bearish financial markets, the
Finance and Economy Ministers announced June 21 that the Government
was eliminating the controversial 15% withholding tax on foreign
investors' earnings from bonds and equities, while reducing the rate
on domestic investors from 15% to 10%. The withholding tax was
cited as one of the factors causing the global sell-off to hit
Turkey harder than other Emerging Markets. Although market analysts
praised the move, the Turkish press criticized the differentiation
between foreign and domestic investors. The measure failed to stop a
resumption in the lira's slide, leading to a Central Bank
intervention June 23. The Government's u-turn is also a success for
USG advocacy: the Ambassador had advocated on behalf of U.S.
companies whose offices in Turkey were losing business due to the
tax. End Summary.
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Finance and Economy Ministers Announce Surprise Pullback on
Withholding Tax...
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2. (U) On the morning of June 22, in a joint press conference,
Finance Minister Unakitan and Economy Minister Babacan announced
that the Government is submitting legislation to parliament to
eliminate the withholding tax levied on foreign investors' earnings
from equities and bonds. The 15% tax will remain for deposits and
repurchase agreements (repos). For domestic investors, withholding
on equities and bonds will be retained, but the rate will be reduced
from 15% to 10%. Unakitan vowed to pass the legislation before the
summer recess (due to start July 1) and the legislation passed
Parliament's Budget and Planning Commission on the day of the
.. in an attempt to Reassure Falling Markets
3. (SBU) Though Unakitan attempted to spin the move as conforming to
EU taxation norms, the Government was clearly concerned about
sliding markets. The withholding tax had long been controversial
with foreign investors and financial houses, which began complaining
to the Embassy a year ago, as the GOT prepared for the January 1,
2006 implementation of the withholding tax law. The law was
intended as a reform, equalizing taxation across all types of
financial instruments while it also, in theory, equalized treatment
between foreign and domestic investors. In practice, many market
contacts argued it was discriminatory to foreigners, who are not
subjected to these kinds of withholding taxes in other Emerging
Markets, and would have to institute cumbersome tracking and tax
filing procedures, whereas domestic investors were already filing
Turkish tax returns. In what the GOT hoped was a compromise that
would mollify foreign investors, the GOT watered down the original
measure by exempting derivatives when it implemented the tax at the
beginning of 2006.
4. (SBU) Although the markets seemed to shrug off the introduction
of the new tax in January, when Emerging Markets sold off in
mid-May, analysts cited the tax as one of the reasons Turkish
markets fell more than other markets. The GOT seems to have been
spooked on June 21, when the exchange rate fell even though global
markets were up. The IMF Deputy Resrep confirmed the Fund had been
consulted on the move, but only at the last minute. The Fund is
studying the revenue impact from the elimination of the tax but
doubts it will be significant, particularly in 2006. Adding to the
sense of GOT focus on markets was Babacan's presentation which
recapped the GOT's accomplishments, reminding investors that
approval of the third and fourth reviews under the IMF program was
imminent. In a sign of the urgency the Government has assigned to
rescinding the tax, the legislation has already cleared Parliament's
Budget and Planning Commission, and the head of the Tax
Administration announced that the implementing regulations will be
prepared such that the changes will be effective from the date they
are announced in the Official Gazette - a lightning speed
implementation compared to other measures.
Sell-off Continues
5. (SBU) Although markets briefly turned upwards following the
announcement, they soon resumed their descent, particularly the
beleaguered foreign exchange market. Having fallen from 1.6166 per
dollar to 1.6493 on June 21, the lira ended the day June 22 at
1.6687 and continued falling at the opening June 23 to 1.7036 at
mid-day. The continuing descent of the lira on June 23 brought the
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Central Bank back into the market with its second intervention since
Turkish markets started falling six weeks ago. Although the
reasons the for the severity of the sell-off in foreign exchange
markets remain somewhat mysterious, analysts believe the bearishness
reflects some combination of increased anxiety about domestic
politics, inflation worries, lack of confidence in the new Central
Bank team, concerns about the EU process, and, of course, a global
flight to quality. There are also new fears that some market
operators are speculating against the lira.
Praise from Analysts, Criticism from Press
6. (SBU) Market analysts generally praised the GOT move as a
positive market surprise that, over time is likely to render Turkish
equities and bonds more attractive to foreign inestors. In
particular, it may help Turkish Teasury to resume issuing some of
the longe-dated lira-denominated bonds, thereby helping to lengthen
the average maturity of treasury det. Though some analysts noted
the measure was unlikely to be powerful enough to turn around market
sentiment, it was still a market-friendly move. The head of Raymond
James/Istanbul told us the elimination of the withholding tax is
also likely to bring back brokerage business that had moved to
London. It is also likely to help the American Depositary Receipt
business which was threatened with extinction by the withholding
7. (SBU) The Turkish press, on the other hand, tended to be negative
in its coverage, focusing on the differential treatment between
foreign and domestic investors. The mainstream daily Sabah was
particularly harsh, comparing the decision to the reviled
Ottoman-era "capitulations" to western interests. The differential
treatment has raised concerns that President Sezer, or the courts,
could strike down the law. As one analyst noted, however, in that
case the GOT would simply eliminate the tax altogether, keeping the
regime investor-friendly.
A Success for USG Advocacy
8. (SBU) The USG played a role in encouraging the GOT's decision.
While we did not support a specific action or solution, we have been
consistently advocating on behalf of American business interests
that were negatively affected by the advent of the withholding tax.
The Ambassador raised the issue with the Minister of Finance in
April, and followed up with a letter June 16 passing on a
presentation that the U.S.-based brokerage Raymond James had made to
Turkish Ambassador to the U.S. Nabi Sensoy. The letter noted
Raymond James' arguments that the tax drove brokerage business
offshore, hurting companies that had made direct investments in
Turkey, and drove away needed portfolio investment. Raymond James'
U.S.-based executive responsible for the company's Turkish business,
thanked the Embassy for our role.
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