Taxation Advantages Related to Venture Capital Investment Funds

ABSTRACT

Venture Capital Investment Funds (“VCIF”) are investment instruments designed to provide financing for innovative projects and encourage qualified investors to participate in capital markets. Regulations introduced under Turkish tax legislation aim to increase interest in VCIFs by offering various exemptions, exclusions, and incentives. These tax advantages include several facilitations, such as deducting amounts allocated to VCIFs from the tax base, exempting investment gains from taxation, and exempting agreements related to ventures from stamp tax. These regulations promote the support of innovative ventures, thereby contributing to both economic growth and sustainable development. This study will comprehensively examine the legal framework of VCIFs, the criteria for qualified investors, and the tax regulations.

Keywords: Venture Capital, Venture Capital Investment Funds, Qualified Investor, Tax Advantages, Tax Deduction, Tax Exemption, Capital Markets Law, Tax Procedure Law, Corporate Tax Law, Income Tax Law, Stamp Tax Law.

1. INTRODUCTION

In the Turkish capital market, VCIFs stand out as a specialized investment instrument designed to provide financing for innovative projects and direct qualified investors towards capital markets. These funds are exclusively open to qualified investors and offer significant tax advantages for both investors and portfolio management companies. Within the scope of this study, we will present a detailed analysis of the legal nature and management of VCIFs, the legal regulations regarding the qualifications required to invest in VCIFs, and the tax advantages granted to these funds.

2. VENTURE CAPITAL INVESTMENT FUNDS AND LEGAL FRAMEWORK

VCIFs are assets without legal entity, established for a certain term by portfolio management companies authorized by the Capital Markets Board (“CMB”) with an operating permit. These funds operate based on a bylaw and are formed with money or shares collected from qualified investors in exchange participation shares. They manage a portfolio consisting of assets and instruments specified in the Communiqué on Principles Regarding Venture Capital Investment Funds (III-52.4)[1] (“VCIF Communiqué”) in accordance with the principles of fiduciary ownership on behalf of the shareholders.[2]

VCIFs do not have a legal entity. VCIFs possess legal entity strictly limited to trade registry procedures as outlined in Article 4, paragraph 5 of the VCIF Communiqué such as the establishment of the fund, trade registry procedures related to the fund (registration, amendments, cancellations, and corrections), as well as trade registry procedures of companies in which the VCIF will hold shares (establishment, capital increases, and share transfers). At this point, the ownership of the assets of VCIFs legally belongs to the portfolio management company, as the founder of the fund.[3] However, this ownership, as stipulated in Article 52 of the Capital Markets Law numbered 6362 (“CML”), is based on the principle of fiduciary ownership. Fiduciary ownership entails the transfer of the management authority of the fund to the portfolio management company within the framework of the bylaws, ensuring that the management of the fund remains with the portfolio management company. Accordingly, portfolio management companies are responsible for the professional management of the portfolios formed with the assets collected from investors and for minimizing investment risks.^[4]

3. INVESTOR ELIGIBILITY CRITERIA FOR VENTURE CAPITAL INVESTMENT FUNDS

Investors acquire participation shares, a capital market instrument that defines their rights and represents their contribution to the fund, in return for their investments in VCIFs. These participation shares not only signify the investors' contribution in the assets of the VCIF but also establish a sui generis, contract-based relationship between the investors and the portfolio management company.^[5]

Due to their high-risk, long-term, and low-liquidity nature, only qualified investors are eligible to hold participation shares in VCIFs.^[6] According to Article 3 of the VCIF Communiqué, the term "qualified investor" refers to individuals or entities defined in various regulations of the CMB regarding the sale of capital market instruments, as well as individuals holding an individual participation investor license. Accordingly, individuals licensed as individual participation investor, as defined in the Regulation on Individual Participation Capital[7] ("Individual Participation Capital Regulation"), are also classified as qualified investors.^[8] Pursuant to Article 3 of the Individual Participation Capital Regulation, an individual participation investor is defined as a real person[9] who transfers their personal assets and/or experience and knowledge to companies in the startup or growth stages. To obtain an individual investor license, at least one of the criteria specified under Article 11 of the Individual Participation Capital Regulation must be met.[10] Additionally, in the Communiqué on the Sale of Capital Market Instruments (II-5.2)[11], qualified investors are defined as professional clients and on-demand professional clients.^[12] The definition of a professional client is provided under Article 31 of the Communiqué on Principles Regarding the Establishment and Activities of Investment Firms (III-39.1)[13] (“Investment Firms Communiqué”). According to this regulation, a professional client refers to a client who has the experience, knowledge, and expertise necessary to make their own investment decisions and evaluate the risks they undertake.[14]  On-demand professional clients, on the other hand, are clients who meet at least two of the conditions listed in Article 32 of the Investment Firms Communiqué and submit a written request to be classified as a professional client.^[15] The verification of whether an investor qualifies as a qualified investor is conducted by the portfolio management company prior to establishing the investor’s ownership of participation shares.^[16]

In practice, following the determination that the investor meets the qualifications, an investor agreement is executed between the VCIF and the investor to formalize participation share ownership. According to the VCIF Communiqué, an investor agreement is defined as an optional agreement executed either individually or collectively, which regulates matters not covered in the bylaws, issue document, or fund issuance agreement.[17] Since the VCIF Communiqué does not contain specific provisions regarding the content of the investor agreement, the parties are free to determine its terms within the framework of contractual freedom.

4. TAX BENEFITS

The primary purpose of VCIFs is to attract investments and investors into high-risk, innovative ventures. This allows startup companies to achieve success and contribute to the economy of the country in which they operate. Through VCIFs, startup companies can access the capital they need, while investors have the opportunity to earn satisfactory returns on their investments due to the high growth potential of these companies. Many companies that are now industry leaders have grown through venture capital financing in today's competitive business environment.[18] Considering the economic contributions of companies of this scale, tax deductions, exemptions, and exclusions are applied in Türkiye, as in many other countries, to encourage venture capital investments and promote fund and partnership investments. These tax incentives are applied to both the earnings of VCIFs and the earnings of their investors, thereby fostering venture capital investments.  This study will examine the tax deductions, exemptions, and exclusions applied to VCIFs and their investors under the provisions of the Tax Procedure Law numbered 213[19] (“TPL”), the Corporate Tax Law numbered 5520[20] (“CTL”), the Income Tax Law numbered 193[21] (“ITL”), and the Stamp Tax Law numbered 488[22] (“Stamp Tax Law”).

4.1. Advantages Regulated Under the Tax Procedure Law

Article 325/A of TPL stipulates that a venture capital fund may be allocated from the relevant period's earnings or declared income for the purpose of contributing capital to venture capital investment partnerships established or to be established in Türkiye under the regulation and supervision of the CMB, or for purchasing VCIF shares. The article further states that the venture capital fund to be allocated cannot exceed 10% of corporate earnings or declared income and 20% of equity capital.[23]

The amounts allocated as venture capital funds for investment purposes can be temporarily held in a passive account. However, if no investment is made in VCIFs by the end of the year in which the fund amount was allocated, taxes not accrued on time will be collected along with interest for late payment.[24]

It is also important to emphasize that the relevant article stipulates that if the allocated fund amount is transferred to another account for purposes other than its intended use, withdrawn from the business, distributed to shareholders, transferred to the headquarters by limited taxpayers, or, in cases of business cessation, liquidation, transfer, or division, or if the VCIF participation shares are disposed of and the proceeds are not reinvested for the same purpose within six months, the relevant amount will become taxable in the period when such actions occur or when the six-month period expires.[25]

From the wording of the article, it is understood that the legislator aims to encourage investments in VCIFs that have not yet become operational. In line with this purpose, the article does not require the VCIFs in which the investment is made to be operational. This allows investors to allocate the relevant amounts for the funds even for funds that are yet to be established. Additionally, the opportunity provided by this regulation is available only to investors who keep books on the balance sheet basis. The allocation of the fund amount and its monitoring in a temporary account under liabilities is possible solely for taxpayers using the balance sheet accounting method.[26]

4.2. Advantages Regulated Under the Corporate Tax Law

4.2.1. Earnings of Venture Capital Investment Funds

Article 2 of the CTL recognizes funds subject to the regulation and supervision of the CMB as capital companies, stating that they are subject to corporate tax liability.[27] Accordingly, it would generally be expected that the earnings of venture capital investment partnerships are subject to corporate tax. However, sub-subparagraph (3) of subparagraph (d) of paragraph five of Article 5 of the CTL exempts the earnings of VCIFs or their partnerships established in Türkiye from corporate tax.[28] Since the term "earnings" in the text of the article is not limited in any way, all income derived by portfolio management companies, including those unrelated to portfolio management, is also exempt from corporate tax.[29]

4.2.2. Earnings of Investors

In addition to the exemptions and deductions granted to the earnings of VCIFs, sub-subparagraph (3) of subparagraph (a) of the first paragraph of Article 5 of the CTL stipulates that the profits arising from the participation shares of VCIFs, the income obtained from the refund of participation shares, and profit from the increase of value due to the appreciation of the participation shares are exempt from corporate tax.[30]

Furthermore, as mentioned in our explanations regarding the advantages regulated under the TPL, subparagraph (g) of the first paragraph of Article 10 of the CTL also allows the portion of the amounts allocated as a venture capital fund that does not exceed 10% of the declared income to be deducted from corporate earnings.[31]

4.3. Advantages Regulated Under the Income Tax Law

The dividends paid on participation shares of investment funds established in accordance with the CML are classified as income from securities capital in accordance with subparagraph (1) of the second paragraph of Article 75 of the ITL.[32] Income arising from participation certificates, which are considered capital market instruments under the CML and related legislation and are owned by individuals or legal entities, is subject to withholding tax under the first paragraph of the temporary Article 67 of the ITL.

The income arising from these participation shares can be categorized as follows:

- Income arising from the refund of participation shares to the fund (securities capital income),

- Income arising from the sale of participation shares to third parties (value increase gains), and

- Periodic income earned during the holding period of participation shares (securities capital income).[33]

In this context, the income derived by individuals from the refund of investment fund participation certificates or from the distribution of dividends by the fund, which are classified as capital market instruments under the CML and related legislation, is subject to withholding tax under the first paragraph of the temporary Article 67 of the ITL. Pursuant to the Council of Ministers’ Decision dated 23.07.2006 and numbered 26237[34], this income is taxed at a 10% withholding tax rate. However, for income derived from participation shares of VCIFs held for more than two years, the withholding tax rate is applied as 0%.[35]

If withholding tax is applied to the income derived by individuals from VCIF participation certificates, such withholding constitutes final taxation. Therefore, full taxpayer individuals are not required to submit an annual declaration for this income. If an annual declaration is submitted for other types of income, the income derived from VCIF participation certificates will not be included in annual declaration. Additionally, limited taxpayers are not required to submit a separate declaration for this income either.

Furthermore, as mentioned in our explanations regarding the advantages regulated under the TPL, pursuant to paragraph 12 of Article 89 of the ITL, the portion of amounts allocated as a venture capital fund that does not exceed 10% of declared income can be deducted from the declaration.[36]

4.4. Advantages Regulated Under the Stamp Tax Law

Contracts related to venture capital investments are exempt from stamp tax under Article 9 of the Stamp Tax Law. These exemptions are listed in Table (2) annexed to the Stamp Tax Law, which explicitly includes "contracts exclusively related to venture capital investments made by venture capital investment partnerships and venture capital investment funds, as well as other documents issued in connection with such contracts.". Accordingly, such contracts and related documents are exempt from stamp tax.[37]

5. CONCLUSION

VCIFs are a specialized investment model that enables qualified investors to manage their savings under professional management while providing innovative ventures with access to financing. The deductions, exemptions, and exclusions provided for VCIFs under various regulations, including the TPC, CTL, ITL, and STL, play a significant role in promoting these funds.

The primary purpose of these regulations is to facilitate the transfer of capital to venture companies, given their substantial potential to contribute to the economy of the country in which they operate. Additionally, the aim is to direct investors toward these areas and promote entrepreneurship, thereby encouraging economic growth and job creation. The tax incentives provided enhance the attractiveness of VCIFs for both investors and entrepreneurs, making it easier for ventures to access financing and contributing to the development of innovative economies.

REFERENCES

1. Erva Cavide Yurttadur, Girişim Sermayesi Yatırım Fonları, 2024

2. Tuğçe Aydoğan Çete, Girişim Finansmanında Girişim Sermayesi Yatırım Fonlarının Rolü ve Önemi, 2021

3. Mehmet Yüce, Bursa Bilanço, Issue 144, Vergi Mevzuatımız Açısından Girişim Sermayesi Fonu, 2013

4. Research Assistant Yaren Yitkin, Ticaret ve Fikri Mülkiyet Hukuku Dergisi, Vol. 10, Issue 2, Girişim Sermayesi Yatırımları Bakımından Kişi ve Kurumların Vergilendirilmesi, 2024

5. Republic of Türkiye Revenue Administration, Private Ruling dated 15.12.2020 and numbered 934609