PM Erdogan produced another of his now-customary yearly surprises on the economic policy front yesterday. In 2004, the surprise was a higher-than-budgeted hike to pension salaries, which created a gap to the tune of US$2.6 bn (or 0.8% of GNP) in the budget. PM made this announcement three weeks after the ratification of the 2004 budget in Parliament. In 2005, the surprise was the fertilizer and diesel subsidies granted to farmers, which inflated the expenditures by about US$1 bn. This year's surprise has been a drastic cut in the corporate tax rate from 30% to 20%. Ministers and top bureaucrats had been referring to a planned corporate tax rate cut; however, the suggested schemes were envisaging gradual cuts, unlike the announced sharp drop from 30% to 20%.
Although Finance Minister Unakitan claimed that the associated cost of TRY2.2 bn had been taken into account in the 2006 draft budget, we view this statement with scepticism. Corporate tax collections in 2005 will be around TRY9.5 bn; the 2006 target is set to be TRY10.55 bn, representing an increase of about 11%, which is in line with the nominal growth rate. Hence, we think these figures do not incorporate any declines in taxes, let alone a one-third drop in corporate taxes. In sum, our calculations point at a total cost of around TRY2.4 bn for the 2006 budget, which is not significantly different from Finance Minister Unakitan's estimate. However, we do not think that this has been reflected to the 2006 draft budget.
Thus, we expect the government to take some offsetting measures to maintain the 6.5% primary surplus target.
On the other hand, investment incentives are abolished starting from 2006. However, during the transition period, a company could choose between paying the 30% corporate tax, while using the investment incentive to reduce its tax base by 40% of the investment spending it makes that is directly related with its core business; or to pay the 20% corporate tax without benefiting from the tax incentive.
The other important change introduced is associated with the structure of the income tax. Currently, there are two income tax schemes: one for payrolls, from 15% up to 35%, and one for others (such as craftsman, small enterprises, etc.), from 20% to 40%. Starting from 2006, these two schemes will be merged, and the new tax scheme will start from 15%, proceed with 20% and 27%, and end with 35%. This implies that the tax burden on higher payrolls will increase while the tax burden on non-payrolls will decline. Companies are set to benefit from the corporate tax rate cut, despite the abolition of the investment incentives. According to our research department's preliminary analysis, the new tax scheme will increase the estimated 2006 aggregate net earnings by 12% and aggregate target valuations by 11% for our coverage universe. The banks stand to be the major beneficiaries of the tax cut, followed by debt free companies with no major investment plans (e.g. cement concerns) and/or substantial tax deductions.
On the other hand, benefits will be limited for companies with massive capex plans and/or substantial backlog of outstanding investment incentives, and/or high leverage. Moreover, companies operating in Turkey (i.e. subject to the Turkish tax code) are set to benefit more from those operating outside of Turkey (e.g. Enka Insaat, Anadolu Efes, Migros) while companies that report a net loss and/or have substantial accumulated losses from prior years will not be able to benefit from the new tax scheme, at least for the short run. Finally, an important point worth noting is that companies having net deferred tax liabilities, like Sisecam and Trakya Cam, will report significant deferred tax income in 2006, while those with huge net deferred tax assets will report significant deferred tax losses.
As a result of revision in our estimates, we upgrade our rating for Anadolu Cam, Bolu Cimento and Sisecam to MARKET OUTPERFORMER from Market Performer, as they offer the upside potentials of 30%, 32% and 21%, respectively. We also upgrade Cimsa and Trakya Cam to Market PERFORMER. |