US-Turkey Tax Treaty: Key Rules and Implications Explained

The tax treaty between the United States and Turkey aims to prevent double taxation and reduce tax barriers for individuals and businesses operating in both countries. By outlining specific rules on income taxation, withholding obligations, and reporting requirements, the treaty clarifies how earnings are taxed across borders.

Determining Residency

Residency status determines how an individual or business is taxed under the U.S.-Turkey tax treaty. A person is generally considered a resident of the country where they are subject to taxation based on domicile, residence, or place of management. However, conflicts arise when both countries claim an individual as a tax resident.

To resolve these conflicts, the treaty provides tie-breaker rules. The first consideration is where the individual has a permanent home. If they have homes in both countries or neither, the next test is where their center of vital interests lies—the country with stronger personal and economic ties. If that remains unclear, habitual abode, or where they spend more time, is considered. If residency is still uncertain, nationality is used. In rare cases where nationality does not resolve the issue, tax authorities from both countries negotiate a resolution.

For businesses, residency is determined by the place of incorporation or where effective management occurs. A company incorporated in Turkey but managed from the U.S. may face dual residency issues, affecting corporate tax obligations and treaty benefits. The treaty helps mitigate double taxation by allowing businesses to claim relief through tax credits or exemptions.

Taxation of Employment Income

Income from employment is typically taxed in the country where the work is performed, but the treaty modifies this rule in certain cases. If a U.S. resident works in Turkey, Turkish tax authorities generally have the right to tax their wages. However, an exemption applies if three conditions are met:

1. The employee is in Turkey for no more than 183 days in a 12-month period.
2. Their salary is paid by an employer who is not a Turkish resident.
3. The wages are not borne by a Turkish permanent establishment of the employer.

If any of these conditions are not met, Turkey can tax the income.

For Turkish residents working in the U.S., a similar exemption applies. If they stay in the U.S. for 183 days or less and their salary is paid by a non-U.S. employer without a U.S. permanent establishment, their income remains taxable only in Turkey. If they exceed the 183-day threshold or work for a U.S. employer, U.S. federal and state taxes may apply.

The U.S. and Turkey have a Totalization Agreement to prevent workers from paying social security taxes in both countries. Employees on temporary assignments (less than five years) continue contributing to their home country’s system, while those on longer assignments may need to contribute to the host country’s program. This prevents duplicate contributions and ensures eligibility for benefits.

Specific Income Categories

The treaty outlines how different types of income are taxed to prevent double taxation and ensure fair treatment. Certain income categories, such as dividends, interest, and royalties, receive special treatment, often reducing tax rates or clarifying which country has primary taxing rights.

Dividends

Dividends, or payments made by a corporation to its shareholders from profits, are taxable in both the country of the paying company and the country of the recipient. Under the treaty, Turkey can tax dividends paid by a Turkish company to a U.S. resident, and the U.S. can tax dividends received by a U.S. resident from a Turkish company. However, the treaty limits the withholding tax rate to 15% in most cases and 5% if the recipient is a company owning at least 25% of the paying company’s shares.

For example, if a U.S. corporation owns 30% of a Turkish subsidiary and receives $100,000 in dividends, the maximum Turkish withholding tax would be $5,000 (5%). Without the treaty, Turkey’s domestic withholding tax rate on dividends is typically 10%, meaning the treaty provides a tax savings of $5,000. The U.S. also taxes foreign dividends, but a foreign tax credit may offset the Turkish tax paid.

Interest

Interest income, including payments on loans, bonds, and other debt instruments, is generally taxable in both the source country and the recipient’s country of residence. The treaty limits the withholding tax on interest to 10%, meaning if a Turkish company pays interest to a U.S. lender, Turkey cannot tax it at a rate higher than 10%. This is beneficial compared to Turkey’s standard withholding tax rate on interest, which can be as high as 18% for certain payments.

For instance, if a U.S. bank lends $1 million to a Turkish company at a 5% annual interest rate, the Turkish company would pay $50,000 in interest per year. Under the treaty, the maximum withholding tax would be $5,000 (10% of $50,000), whereas without the treaty, the tax could be as high as $9,000 (18%). The U.S. also taxes interest income, but foreign tax credits may offset the Turkish tax paid.

Certain types of interest, such as those paid to government institutions or central banks, may be exempt from withholding tax under the treaty.

Royalties

Royalties, or payments for the use of intellectual property such as patents, trademarks, copyrights, and technical services, are subject to special treatment. Without the treaty, Turkey imposes a 20% withholding tax on royalties paid to non-residents. However, the treaty reduces this rate to 10%.

For example, if a U.S. software company licenses its technology to a Turkish firm for an annual royalty of $200,000, the Turkish withholding tax under the treaty would be $20,000 (10%), whereas without the treaty, it would be $40,000 (20%). The U.S. also taxes foreign royalty income, but a foreign tax credit may offset the Turkish tax paid.

The treaty also clarifies that royalties are taxable only in the country where the recipient resides unless they are attributable to a permanent establishment in the other country.

Withholding Obligations

When income is sourced from one country but paid to a non-resident, tax authorities require the payer to withhold a portion of the payment to ensure compliance. Under the treaty, withholding tax applies primarily to passive income streams and certain business payments, with rates varying based on the income type and the recipient’s treaty eligibility.

To claim treaty benefits, the recipient must provide documentation, such as IRS Form W-8BEN for U.S. purposes or a Turkish tax residency certificate. Without this documentation, withholding agents may default to higher domestic tax rates. Additionally, payments to related parties must meet arm’s length standards under transfer pricing rules to prevent tax avoidance.

Reporting Requirements

Taxpayers benefiting from the U.S.-Turkey tax treaty must comply with reporting obligations in both countries. These requirements vary depending on the type of income, residency status, and whether the taxpayer is an individual or a business.

For U.S. residents earning income from Turkey, reporting obligations include filing a U.S. tax return and disclosing foreign income, even if it is taxed in Turkey. The IRS requires individuals to report foreign bank accounts through the Foreign Bank Account Report (FBAR) if the aggregate balance exceeds $10,000 at any point during the year. The Foreign Account Tax Compliance Act (FATCA) mandates disclosure of foreign financial assets exceeding $50,000 for single filers or $100,000 for joint filers. Failing to comply can result in fines of up to $10,000 per violation.

Turkish residents receiving income from the U.S. must report their earnings to Turkish tax authorities. Businesses operating in both countries need to maintain documentation to support transfer pricing arrangements, as tax authorities scrutinize cross-border transactions. Companies claiming treaty benefits must provide tax residency certificates and other supporting documents to justify reduced withholding rates. The Turkish Revenue Administration and the IRS conduct audits to verify compliance, and failure to meet reporting requirements can lead to tax reassessments, interest charges, and legal consequences.