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Foreign Direct Investment” and “Foreign Direct Investor” Concepts

“Foreign Direct Invesment” and “Foreign Direct Investor” Concepts

Under Turkish Foreign Direct Investment Act

As is widely known, the 21st century’s global economic system is established on free trade and free movement of foreign capital. “Foreign Investor” and “Foreign Investment” are two concepts having critical importance to this capital flow. Having much more money in return is the first aim of both global investors and many emerging markets. The global investors usually transfer their capital from developed countries to emerging markets where economic activity is more dynamic. International capital flows are primarily performed in two ways: Foreign Direct Investment (FDI) and Foreign Indirect Investment (Portfolio Investment).

 In economic theory, foreign direct investments are defined as capital investments in a foreign country in which the owners of capital directly maintain ownership and operational influence on the investment. An international investor can use its funds either to start a business from scratch or to acquire already existing companies. In each possibility, the money holder leads the operations of funds and directly assumes the economic risks.

 Foreign Indirect Investments in which the investor purchases financial  instruments such as bonds or stocks or management of funds used by third parties. Issuers of bonds or stocks use the investor’s capital in their operations. The investor doesn’t assume any risk or directly manage the funds, in such cases, the investor only receives the dividend (stock) or the principal (bond) at the maturity of the financial instrument as return. One major characteristic of portfolio investment in comparison with FDI -- is liquidity.. The portfolio investor can sell its financial instrument(s) and leave the country in a considerably short period of time while the FDI investor cannot.

 Primary characteristics of foreign direct investments are:

  • Creation of new jobs and employment of the citizens of host company.
  • Know-how contribution from the investor’s country of origin.
  • Involvement in technology transfers beyond international borders.

 Principal reasons for attracting FDI’s are technology transfers and new employment possibilities (thus more aggregate income). The principal form of FDI is “merger and/or acquisition”. In this case, domestic companies of the host state are being bought by the subsidiaries of foreign companies (investors).

 Foreign direct investments in Turkey took off after the 90’s where the country initiated its global economic integration. However, FDI levels remained below global standards until 2001. After banking reforms led by the IMF at the beginning of 2000s,FDI saw a huge spike.  Enacted in 2003, the Foreign Direct Investment Act (FDIA) No:4875 (OG: 17.06.2003) secured the rights of international investor and allowed for their equal treatment.. Thus, dramatic increase after 2003 occured as expected.

 Foreign Investor and Foreign Investment in Turkish Foreign Direct Investment Act

Foreign investor and foreign direct investment are legally defined in Article 2 of Law no: 4875.

According to art. 2/a, a *foreign investor is: 1) Real persons who possess foreign nationality and Turkish nationals resident abroad, and 2) Foreign legal entities established under the laws of foreign countries and international institutions, who make foreign direct investment in Turkey.*

 The foreign investor can be both natural and juridical persons. In case of natural persons; the investor should either be of foreign nationality or aTurkish national residing abroad. Foreign nationality is determined by citizenship. In case of Turkish nationals residing abroad, Regulation for Implementation of Foreign Direct Investment Act (OG: 20.08.2003) art. 18 states that residency shall be documented by residence or working permit of a foreign country. Ownerships of such permits is adequate to be considered a “foreign investor”.

 For juridical persons, art. 2 rules that they should be established under the laws of foreign countries and international institutions.  Their place of establishment should be taken into account, and this place must be abroad to be considered a “foreign investor”. Their ownership, or nationalities of their shareholders are not taken into consideration for the assessment of this criterion.

 According to art. 2/b, *foreign direct investment is: i) Establishing a new company or branch of a foreign company by foreign investor, ii) Share acquisitions of a company established in Turkey (any percentage of shares acquired outside the stock exchange or 10 percent or more of the shares or voting power of a company acquired through the stock exchange) by means of, but not limited to the following economic assets:*

 1) Assets acquired from abroad by the foreign investor:

-  Capital in cash in the form of convertible currency bought and sold by the Central Bank of the Republic of Turkey,

-  Stocks and bonds of foreign companies (excluding government bonds),

-  Machinery and equipment,

-  Industrial and intellectual property rights.

2) Assets acquired from Turkey by foreign investor,

- Reinvested earnings, revenues, financial claims, or any other investment-related rights of financial value, or

- Commercial rights for the exploration and extraction of natural resources.

 Article 2 of Turkish FDIA is separated into two parts. The first part lists the potential types of investments that can be made with the available funds and the second part lists possible sources of funds. In the first part, potential investments are specified as either establishing a new company or branch or as acquiring pre-existing companies within the country.

 However, there is a restriction for acquisitions of pre-existing companies. The foreign investor should acquire the shares outside of the stock exchange, thus buying stocks with foreign funds (which is considered a portfolio investment) will not satisfy the condition and will not be subject to FDIA. The shares should be acquired through the contract where owners also assume the operational influence. However, there is an exception to the rule. If the total shares or voting rights acquired exceed 10%, the acquisitions will fall within the scope of FDIA even though it is acquired through the stock exchange. Because 10% or more shares or voting rights gives the investor a direct right to speak by having a strong influence on a company’s decisions -- and grants minority rights on the other hand. In that case the investor’s capital will share the same destiny as the company, thus considering it FDI is quite reasonable.

 The second part lists the sources of available funds, but they are not designated as numerus clausus, in other words, not limited to counted assets. Assets could either be transferred from abroad or obtained in Turkey. However, FDIA makes a distinction among assets regarding whether they are obtained from abroad or not. In case of funds from abroad, the assets might be currency, financial instruments like stocks and bonds, physical capital (machinery and equipment) or industrial or intellectual property rights. Any of the counted assets can be used to establish a new company or to acquire pre-existing companies. Conversely, the funds can be obtained within Turkey by the foreign investor. These could be reinvested earnings, revenues or investment-related rights that have financial value. A foreign investor that has already existing FDI’s in Turkey which generate revenue, can decide to spend the earnings in new investments within the country. Hence according to FDIA, it is also considered as an FDI. Additionally, art. 2 mentions commercial rights for management natural resources which means ownerships of such rights will also be adequate to be considered as FDI.

 Objectives of Turkish Foreign Direct Investment Act

The aim of Turkish FDIA is clearly designated in its art. 1. According to this article, *“The objective of this Law is to regulate the principles to encourage foreign direct investments; to protect the rights of foreign investors; to define investment and investor in line with international standards; to establish a notification-based system for foreign direct investments rather than screening and approval; and to increase foreign direct investments through established policies. This Law establishes the treatment to be applied to foreign direct investments.”*

The ultimate goal of the enactment of the Turkish FDIA is to encourage foreign direct investors. The law was enacted in 2003 in order to attract foreign investments to Turkey at the inception of its economic take-off. Lawmakers knew that it was only possible when potential foreign investors were assured certain rights. They would only invest in a comfortable environment where worry abouts unlawful treatment is eliminated. Thus, securing the rights of foreign investors is a primary objective of FDIA.

 Furthermore, art. 1 lists another objective as “to define investment and investor in line with international standards.” The legal definitions in the law, which are in accordance with international customs, are included to remove any confusion in the event of any dispute. Hence, FDI’s are facilitated when legal complications that can arise from differences in definitions between countries are eliminated.

 Additionally, Turkish FDIA establishes a notification-based system. Before the current law, FDI’s were permission-based. The foreign investor would have to apply to administrative authorities to explain the project and obtain a permission. However, this procedure had downsides. The system was slow and was not able to keep up with nature of commercial activity which is quite dynamic. Permission-based systems were lagging to respond. Thus, FDIA established a notification-based system which is much more in accordance with fast-moving global commercial activity. As a result, removal of bureaucratic obstacles emboldened and facilitated new FDI’s.

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