Did You Submit an Understated Rent Contract to the Tax Office? The Penalties You May Face

Landlords sometimes draw up a second contract showing an amount lower than the actual rent and submit it to the tax office in order to pay less tax. While this practice may seem attractive in the short term, it carries serious risks both in tax terms and in criminal terms. In this article, we examine the legal nature of an understated rent contract, the tax penalties it can trigger, and even when it can turn into a criminal investigation, in light of court decisions and tax rulings (özelge).

Summary of the Situation

A landlord drew up a second rent contract with the tenant at an amount lower than the actual rent and submitted this understated contract to the tax office for declaration purposes. The aim was to reduce the amount of income tax (withholding) payable. However, when a dispute later arose between the parties (for example, damage caused by the tenant to the leased property or unpaid rent), the questions of which contract (the understated one or the one at the actual amount) would prevail, and the tax and criminal consequences of the situation, came to the fore.

The Legal Issue

Drawing up an understated rent contract is legally treated as collusion (muvazaa — a sham transaction). This gives rise to two separate problems: which contract will be deemed valid in the private-law dispute between the parties, and which sanctions will apply if the tax administration detects the situation?

What Do the Yargıtay (Court of Cassation) and the Danıştay (Council of State) Say?

The Contract Reflecting the Parties' True Intent Prevails

The 3rd Civil Chamber of the Yargıtay (Court of Cassation) (E. 2022/8389, K. 2023/388, decision of 2023) found that the understated contract drawn up for submission to the tax office had been prepared in order to pay less tax and was collusive. The court emphasized that priority must be given to the contract at the higher amount, which reflects the parties' true intent. This is of great importance in receivable or compensation disputes between tenant and landlord: even if one of the parties invokes the understated contract to reduce its liability, the court may base its decision on the actual rent.

Tax Loss Penalty: Up to Three Times the Tax

In its decision, the 9th Chamber of the Danıştay (Council of State) (E. 2019/5410, K. 2021/16, decision of 2021) held that where a sham rent contract is used before the tax office, imposing a tax loss penalty of three times the tax is lawful. In other words, tax is assessed on the difference between the actual rent and the declared amount, and a heavy penalty is added to that sum.

Special Irregularity Fine

Where rent payments are not documented through banks or financial institutions, or are under-declared, a special irregularity fine is imposed under repeated Article 355 of the Tax Procedure Law No. 213 (VUK) (Danıştay (Council of State), 3rd Chamber, E. 2019/7597, K. 2022/53, decision of 2022).

The Deemed (Comparable) Rent Rule: A Tax Safeguard Mechanism

Under Article 73 of the Income Tax Law, the declared rent cannot be lower than the deemed (comparable) rental value. As emphasized in a tax ruling, the deemed rent rule operates as a "tax safeguard mechanism" in cases where actual rental income is collusively under-declared. If there are indications that the declared rental income does not reflect the true situation, the tax administration may conduct an examination and proceed on the basis of the deemed rental value.

The Criminal Dimension: Risk of a Tax Evasion Offense

Drawing up an understated contract can produce not only financial but also criminal consequences:

• As stated in a Ministry of Finance tax ruling, the act of a taxpayer who causes the withholding tax to be under-assessed by drawing up a sham rent contract may constitute the offense of "tax evasion" (kaçakçılık) under Article 359 of the Tax Procedure Law (VUK). In that case, a criminal complaint must be filed with the Public Prosecutor's Office with the opinion of the relevant treasury directorate.
• However, the same ruling also states that if the person committing this act does not have "merchant status", no criminal complaint can be filed under VUK Articles 359 and 367; in other words, not every understated rent contract automatically turns into a criminal investigation.
• The Assembly of Civil Chambers of the Yargıtay (Court of Cassation) (E. 2005/491, K. 2005/471, decision of 2005) established that where a court finds a rent contract to be collusive, once the judgment becomes final it must order the case file to be forwarded to the relevant Treasury Directorate through the Chief Public Prosecutor's Office so that the necessary steps can be taken from a fiscal standpoint.
• The 11th Criminal Chamber of the Yargıtay (Court of Cassation) (E. 2003/11723, K. 2006/246, decision of 2006) emphasized that the purpose of a person drawing up a sham rent contract was to evade tax by understating the tax base and to obtain an unlawful benefit.

Points to Watch

• Weigh the risk of drawing up a second contract carefully. Paying less tax in the short term can end in a tax loss penalty of up to three times the tax in the long term.
• Make/receive rent payments through a bank. Cash payments and under-declarations increase the risk of a special irregularity fine.
• Remember that the actual rent may prevail in private-law disputes. If you end up in a receivable or compensation lawsuit with your tenant, relying on the understated contract may not protect you; the court will investigate the parties' true intent.
• A court finding of collusion can trigger a tax examination. If collusion is established as a result of a civil-court case, the file may be referred to the tax administration.
• Know the "merchant status" distinction. The scope of criminal liability may vary depending on the commercial capacity of the person drawing up the rent contract; each case must therefore be assessed on its own facts.

Conclusion: What Should You Do?

Although drawing up an understated rent contract may look like a short-term tax saving, it is a practice that carries both heavy tax penalties and, under certain conditions, the risk of a criminal investigation. If you have already drawn up such a contract and are currently facing a tax examination or a tenant dispute, it is very important first to gather all correspondence and payment records documenting your actual rental relationship, and then to consult a specialist in tax law and criminal law who can assess both the tax and the potential criminal risks together. In such situations, early intervention can be decisive in limiting both the financial burden and the criminal exposure.