Abandoning DIR

The presentation on the draft law on the new tax package prepared by the Ministry of Treasury and Finance was shared with the public to solicit the views of the sectors and relevant stakeholders. 

Undoubtedly, there are multiple topics in the presentation. In this article, we will only touch upon what is intended to be done regarding the Inward Processing Regime (DIR). 

In the Ministry's presentation, the following reasons are given under the heading "Abolition of the Inward Processing Regime in terms of VAT": 

"In the current regulation, VAT is calculated at customs for raw materials and auxiliary materials brought from abroad within the scope of DIR, but not paid. It is only tied to collateral.

- Meager amounts of collateral are obtained for VAT deferred at customs (66% provide collateral only at 1% of VAT).

- Imports of goods covered by the certificate become more attractive than domestic purchases, negatively affecting domestic production. (Imports without VAT, domestic purchases with VAT)

- Transactions under this regime increase the current account deficit (14% of total imports, 43% of total exports).

- The difficulty of tracking the production process of the goods imported in this way within Turkey and the diversity of regime practices within Turkey make it difficult to track the unpaid VAT and cause unfair refunds. (The tracking of duplicate goods is especially problematic; intermediary imports and exports cause unfair refunds)

Proposed regulation: This regulation would ensure that VAT is paid at customs for raw materials and auxiliary materials brought from abroad within the scope of DIR.

The legal regulation is envisaged to be valid for documents to be issued as of the date of entry into force or will enter into force to be effective as of 1.1.2027.

Impact Analysis: In 2023, the unpaid VAT due to the tax base of 328.4 billion TL is estimated to be approximately 65.7 billion TL."

Let us take a step back before expressing our views on the draft. In 1995, when Turkey was in the process of establishing a Customs Union with the EU, our industrial sector was complaining that "if customs duties are abolished, we will not be able to compete with the EU industry," the executives of the time said, "Don't worry, maybe we will abolish customs duties, but the EU will abolish the textile quotas imposed on Turkey, and you will also benefit from the opportunities such as DIR applied in the EU. Therefore, you will not face unfair competition". 

Indeed, by taking advantage of the facilities provided by DIR during the 28 years it was in effect, Turkey increased its exports from USD 27 billion in 1999 to USD 255.8 billion in 2023. Inputs unavailable in the domestic market or, even if available, could not be accessed at competitive prices were purchased from international markets at favorable prices and used in the structure of Turkish export products. As a result, Turkey's export products were able to gain a foothold in global markets at competitive prices. Until today, none of our industrialists, who can find the same inputs from the domestic market at the same prices, have unnecessarily incurred freight and other foreign trade costs and have not taken the pointless action of procuring these inputs from abroad.

So, are the assessments in the presentation of the said Ministry consistent? Based on the headings on the presentation page, we can list our views on this issue as follows:

- VAT is not paid but collateralized. A significant portion of this collateral is at the 1% level.

The related collateral is resolved when imported goods are subject to export after being used as an input in the domestic product. For this reason, there is no tax collection within the scope of DIR, which would be revenue for the treasury.

- Imported inputs become more attractive than domestic inputs due to imported inputs without VAT and domestic inputs with VAT

This determination is also based on an incorrect assessment. When products that use domestic inputs with VAT are exported, their VAT amounts are also deducted. In other words, in the final analysis, there is no revenue to the State Treasury for inputs supplied from the domestic market with VAT. It is not the VAT that makes imported inputs attractive; it is the fact that the unit sales price is very favorable compared to domestic inputs.

- Transactions under this regime increase the current account deficit

The current account deficit increases due to imports of final consumption goods and energy imports rather than industrial inputs imported under DIR. Since inputs under DIR are imported after being processed, imports and exports in this area have a neutral effect on calculating the current account deficit.

- Since the goods imported within the scope of DIR need to be more effectively monitored, VAT losses arise

In Turkey, a highly effective control mechanism has been created. It would not be misleading to say that the Turkish practice in this area is one of the best-monitored DIR practices in the world. On the other hand, this determination means that "one ministry of the state thinks that another ministry of the state does not fulfill its duties properly," and it is for the state to evaluate this rather than the sector members.

- Proposed regulation: Collecting VAT on goods within the scope of DIR, generating 65.7 billion TL revenue

In Turkey, a highly effective control mechanism has been created. It would not be misleading to say that the Turkish practice in this area is one of the best monitored DIR practices in the world. On the other hand, this determination means that "one ministry of the state is of the opinion that another ministry of the state does not fulfill its duties properly" and it is for the state to evaluate this rather than the sector members.

- Proposed regulation: Collecting VAT on goods within the scope of DIR, generating 65.7 billion TL revenue.

Within the scope of the DIR, the VAT of the imported goods is tied to a guarantee and the VAT guarantee is released during the export of the product after the inputs are included in the production within the product. As this is the practice, in the proposed regulation, the VAT of the imported goods will be collected, and the VAT amounts will be deducted or refunded when the inputs are used in the product and exports are realized. However, since this amount collected from the producer in TL will be eroded in the inflation environment, the producer will not have the same purchasing power on the return date. In this respect, the 65.7 billion TL mentioned in the presentation will not be a budget revenue, but a sum collected from the industrialists temporarily and returned again in 3-5 months. The additional loss of time and money that will be caused by the bureaucracy that both public officials and members of the sector will struggle with due to this operation does not seem to have been taken into account at all.

When VAT becomes a tax collected at the stage of temporary importation of goods and not bonded under DIR, only the taxes falling under the "customs duties" group will be bonded. In a sense, this will mean that DIR will be taken out of the use of the sectors.

Since the arithmetic average of the taxes grouped as "customs duties" in other countries of the world as well as in the EU and Turkey, which apply the same customs tariff, has fallen to around 5 percent, the biggest advantage of the DIR is that the VAT amounts, which are set at 15-20 percent, will be secured. In fact, since customs duties are not collected from a significant portion of imported products due to formations such as customs unions and free trade agreements, only VAT is secured in the temporary import of these products. In fact, an arrangement to collect VAT without collateralization would mean that "the advantage provided by DIR is withheld from Turkish entrepreneurs".

In this respect, even if the VAT to be refunded during the exportation of the goods transformed into products within the scope of DIR after being collected from the producer for a period of 3-5 months will create a short-term relief in the Treasury accounts, the time losses and costs that will be created by the return of these amounts and the bureaucracy of this return will result in a result where "the stone thrown is not worth the frog it scares".