1. The nominal interest rate is not the same thing as the true cost of financing
Measuring a firm’s cost of financing solely by the interest, profit share or coupon rate written in the loan contract is incomplete. What matters for the financial decision is a joint assessment of all the cash outflows the firm bears over the life of the financing in return for the funds it can actually use, and of the tax savings from which it can in fact benefit by reason of that financing.
After-tax economic cost of financing = [PV(Total financing cash outflows) − PV(Expected tax savings that will actually be realised)] / Net usable funds
The equation emphasises two points at once: First, the denominator of the cost calculation should not be the nominal amount of the loan but the net funds the firm can actually use. If, for example, a loan of 100 million lira is drawn but a commission of 1 million lira is deducted at the outset, the funds available to the firm are 99 million lira. Second, a tax advantage should be subtracted from cost only if it can actually be used. An amount that arises on paper but cannot be used because the firm is loss-making, the expense is non-deductible or the tax saving is delayed does not have the same economic value.
2. When is the classic kd × (1 − T) formula sufficient?
In the classic approach in the finance literature the after-tax cost of debt is shown as kd × (1 − T). That approach is consistent with Modigliani and Miller’s (1963) basic result explaining the corporate-tax advantage of debt. The formula yields a robust approximation only if three conditions hold together: interest expense is fully deductible, the firm has a sufficient tax base, and the tax saving can be used without delay. Graham’s (1996) study likewise shows that financing decisions should look not only at the statutory tax rate but at the marginal tax rate that reflects the firm’s actual capacity to pay tax.
The distinction is especially important in Türkiye. Restrictions on the deductibility of financing expenses, thin capitalisation, related-party transactions, loss carry-forwards and the domestic minimum corporate tax can reduce the portion of the theoretical tax shield that can actually be used, or defer it to later years.
3. Why does the tax rate change the cost of financing in Türkiye?
To the extent that interest on debt is deductible from the tax base, the value of the tax shield rises as the corporate tax rate rises, and the tax advantage of debt shrinks as the tax rate falls. A tax cut can therefore reduce the firm’s overall tax burden while at the same time weakening the tax advantage of debt relative to equity. The result looks contradictory at first sight, but it is fully consistent in financial terms.
This article takes a 24 percent rate for manufacturing income under the 2026 rules, and a 12.5 percent rate from 2027 onwards for manufacturing income that meets the relevant conditions. A long-term loan should therefore be modelled not only with today’s tax rate but with the tax rates that will apply over the life of the loan.
4. An applied example: Anadolu Makine A.Ş.
Suppose Anadolu Makine A.Ş. draws a bank loan of 100 million lira to finance a new production line. Let the annual interest expense on the loan be 40 million lira. To keep the illustration simple we set principal repayment aside at this stage and examine only the tax effect of the annual cost of financing.
| Assumption | Value |
|---|---|
| Nominal amount of the loan | 100 million lira |
| Annual interest expense | 40 million lira |
| 2026 tax rate on manufacturing income | 24% |
| 2027 tax rate on manufacturing income | 12.5% |
| Financing-expense restriction assumption | 50% of total foreign resources is attributable to the excess over equity |
| Restriction rate | 10% |
4.1. First stage: the theoretical tax shield if there is no restriction
If the whole of the interest is assumed to be tax-deductible, interest expense of 40 million lira in 2026 produces a tax saving of 9.6 million lira at a 24 percent tax rate. The after-tax economic effect of the 40 million lira interest burden therefore falls to 30.4 million lira.
| Calculation | Amount |
|---|---|
| 2026 tax shield | 40 × 24% = 9.60 million lira |
If the same financing is subject to a 12.5 percent tax rate in 2027, the tax shield is only 5 million lira. The after-tax interest burden then rises to 35 million lira. Although the firm pays a lower corporate tax, the tax advantage provided by debt has declined.
4.2. Second stage: adding the restriction on financing expenses
Now suppose that the firm’s foreign resources exceed its equity and that 50 percent of total foreign resources is attributable to the excess. In that case 20 million lira of the 40 million lira financing expense enters the restriction calculation. Ten percent of that amount, 2 million lira, becomes a non-deductible expense. Deductible financing expense falls to 38 million lira.
| Step | Result |
|---|---|
| Total interest expense | 40.00 million lira |
| Interest attributable to excess foreign resources | 40 × 50% = 20.00 million lira |
| Non-deductible portion | 20 × 10% = 2.00 million lira |
| Tax-deductible interest | 40 − 2 = 38.00 million lira |
The 2026 tax shield is then 38 × 24% = 9.12 million lira, and the after-tax interest burden rises to 30.88 million lira. In 2027 the shield is 38 × 12.5% = 4.75 million lira and the after-tax interest burden is 35.25 million lira.
| Period | Tax rate | Deductible interest | Tax shield | After-tax interest burden |
|---|---|---|---|---|
| 2026 | 24% | 38.00 | 9.12 | 30.88 |
| 2027 | 12.5% | 38.00 | 4.75 | 35.25 |
The example makes a basic financial result clear: the same loan with the same nominal interest rate produces a different after-tax cost when the tax rate and the deductibility of expenses change. The information “the loan rate is 40 percent” is therefore not, by itself, enough to take a financing decision.
5. Why does the true cost consist of more than interest?
In bank loans, commissions, tax and levy burdens, and the cost of collateral and guarantees must also be taken into account; in cross-border loans, withholding tax, the Resource Utilization Support Fund (KKDF), reverse-charge VAT, gross-up clauses and transaction costs; and in foreign-currency debt, the economic effect of hedge costs or unhedged exchange-rate risk.
If, for example, Anadolu Makine A.Ş. draws a loan of 100 million lira and the bank deducts an upfront commission of 1 million lira, the net funds the firm receives are 99 million lira. Interest may nevertheless be calculated on the nominal debt of 100 million lira. Looking only at the interest rate then understates the true cost. The correct approach is to compare, in the same cash-flow schedule, the 99 million lira the firm receives with all the cash payments and tax savings over the life of the loan.
| Item | Cash effect |
|---|---|
| Drawdown of the loan | +100.00 million lira |
| Upfront commission | −1.00 million lira |
| Net usable funds | 99.00 million lira |
| Annual interest | −40.00 million lira |
| 2026 tax saving (after the financing-expense restriction) | +9.12 million lira |
| 2026 net economic interest burden | −30.88 million lira |
Where the loan spans several years, these cash flows should be written year by year, the dates on which tax savings will be realised should be shown separately, and the after-tax true cost of financing should be calculated by the IRR method or, for irregularly dated cash flows, by XIRR. The time value of the tax saving is then taken into account as well as its amount.
6. Three further concepts if a cross-border loan is used
6.1. Reverse-charge VAT
Under the reverse-charge mechanism, for certain foreign services it is not the foreign service provider but the firm in Türkiye that receives the service which calculates and declares VAT as the party responsible. If, for example, the firm obtains consulting services of 1 million lira from abroad and the transaction is subject to 20 percent VAT, reverse-charge VAT of 200,000 lira may be computed. The deductibility of that amount and its cash timing can affect the firm’s true financing and working-capital burden.
6.2. Gross-up clauses
A gross-up clause is an arrangement by which the lender contractually guarantees a specified net interest amount. If, for example, the lender wishes to receive net interest of 10 million lira and a 10 percent withholding tax applies to the payment, the borrower’s gross payment is 10 / (1 − 10%) = 11.11 million lira. The difference of 1.11 million lira is additional financing cost borne by the borrower by reason of the contract.
6.3. Exchange-rate risk and hedge cost
A low nominal interest rate on foreign-currency debt can become expensive financing in reality because of an exchange-rate rise or the cost of hedging. The after-tax cost calculation for foreign-currency loans should therefore include, in addition to interest, the expected exchange difference, the hedge premium or the cost of a swap.
7. Why does borrowing from related parties call for particular care?
A loan from a shareholder or a group company may appear cheaper than a bank loan and yet not have a lower after-tax cost. Related-party debt that exceeds specified multiples of equity can give rise to thin capitalisation, and the deduction of some financing expenses attributable to that debt may be lost. Whether the interest rate, maturity, currency, collateral and the borrower’s credit risk are at arm’s length should also be assessed for transfer-pricing purposes.
8. Is equity finance really “costless”?
The absence of a contractual interest payment on equity does not mean that there is no cost. Shareholders incur an opportunity cost by tying capital to the firm. Dividends, moreover, are not deductible in determining corporate income. Arrangements such as the interest deduction on cash capital increases can, under specified conditions, reduce the tax disadvantage of equity. The comparison of debt and equity should therefore not be made in the form “there is interest / there is no interest”, but on the after-tax total economic cost of the two sources of finance.
The after-tax true cost of financing is the difference between the present value of all mandatory cash outflows the firm undertakes in return for the funds it can actually use and the present value of the tax savings that can in fact be used by reason of that financing. The approach is more informative than the classic kd × (1 − T) formula, especially in Türkiye, because of the restriction on financing expenses, thin capitalisation, the minimum corporate tax, changing tax rates and cross-border fiscal burdens. The financing instrument with the lowest nominal interest rate may not be the cheapest option once all of these adjustments have been made.
References (Limited)
- Modigliani, F. & Miller, M. H. (1963). “Corporate Income Taxes and the Cost of Capital: A Correction.” American Economic Review, 53(3), 433–443. Source
- Graham, J. R. (1996). “Debt and the Marginal Tax Rate.” Journal of Financial Economics, 41(1), 41–73. Source
- Graham, J. R. (2000). “How Big Are the Tax Benefits of Debt?” Journal of Finance, 55(5), 1901–1941. Source
- Revenue Administration of Türkiye (2026). Corporate Tax Filing Guide. Source
- Revenue Administration of Türkiye. Corporate Tax Law No. 5520 — current text (especially Arts. 10, 11, 12, 13, 32 and 32/C). Source
- Revenue Administration of Türkiye. Corporate Tax General Communiqué — explanations on the restriction of financing expenses. Source
- Revenue Administration of Türkiye (2026). Guide to the Domestic Minimum Corporate Tax. Source
- Revenue Administration of Türkiye (2026). Announcement on Law No. 7582. Source
- Revenue Administration of Türkiye. General Communiqué on Disguised Profit Distribution through Transfer Pricing (Serial No. 1). Source
- Revenue Administration of Türkiye. Sample private ruling on reverse-charge VAT in financing/services obtained from abroad. Source
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