Defense Offsets in the Turkish Aerospace & Defense Industry

The Guideline on Industrialization Period in the Defense Industry (“Guideline”) published by the Turkish Presidency of Defense Industries (“SSB”) aims to define the processes of regulating the procedures and principles regarding defense offset projects in aerospace & defense industry.

The “Project” within the scope of the Guideline is mainly defined as the projects carried out by the SSB for the supply of products and services needed for defense, aviation, and homeland security purposes. “Industrial Cooperation”, on the other hand, is defined as the activities such as production, venture capital, incorporation, technology transfer, joint marketing and export, joint production, investment, the conditions, and scope of which are defined before the signature of the Contract, which must be carried out by foreign obligors within the scope of the Offset Agreement.

The industrialization period includes the projects carried out within the framework of the Supplementary Principles of the Council of Ministers Decision No. 2018/11536. The procedures, principles, and processes defined in the Guideline are applied for Projects whose Request for Proposal (“RFP”) has been/shall be published as of 20/12/2019, and for Projects to be started before the RFP is published, if deemed appropriate by the SSB, for those whose Supply Contract has not been signed.

These processes are not applied in the projects to be realized with international consortium/cooperation to which Turkey is a party, in R&D and investment projects, including projects originating from TUBITAK, in supply projects through NATO agencies, feasibility studies, and consultancy services, emergency procurement projects, projects and procurements for construction works, in logistics support projects, innovative and original modernization projects that include trial and error and technology demonstration.

Within the scope of the industrialization period, only Local Content Liability, Technology and Product Acquisition (“TÜK”) Liability if deemed appropriate by the SSB, and Offset Liability can be defined for foreign subcontractors under a local obligor if deemed appropriate by the SSB. As such, Offset Liability can be defined as Export Type Offset and/or Technological Cooperation Type Offset and/or Industrial Cooperation. Local Content Liability consists of three separate liabilities of Turkish Added Value Liability, Product Library Liability, and Solution Partner Liability. No separate security deposit will be received for Local Content Liability. Accordingly, Local Content Liability is defined within the scope of the Supply Contract, as such, a separate Contract is not made. However, the rate of industrialization is 20% in rated procurements.

Turkish Added Value (“YİKD”) defines the amount remaining in the project in the country and its target rate is followed for information purposes. It is used for tracking the talent inventory and creating statistical data for the defense industry. The Sub-Industry/SME (“YS/KOBI”) Liability ratio, on the other hand, defines the part transferred by the obligor to the supplier industry and SMEs in the Project and is also defined as at least 21% of the Supply Contract price, excluding the Technology and Product Acquisition Fee, and this ratio must be met. If any, the obligation is completed by applying a penalty of at least 6% of the unrealized part at the end of the project for the unrealized part. Within the scope of SME, all local companies are included, except for the obligor who is not a SME, and, if any, the firm/institution/organizations defined specifically for the Project.

The YIKD amount and SME amount are within the invoice price of a product and/or service, all raw materials, materials, products, services, labor costs, related general management expenses, profits obtained by local companies during the production of that product, and/or service and the sum of the relevant taxes. Nevertheless, administrative costs are excluded from these expenses. However, the activities carried out within the scope of TÜK are not covered by the Local Content Liability. YİKD and SME realizations within the projects are followed up with the reports submitted on an annual basis. For every 12 months (“YİKD program year”) following the start of the Project implementation calendar of the Supply Contract, the obligor submits the YİKD report to the SSB in the format and scope specified in the Supply Contract, to be prepared regarding the realization of the YİKD’s within the relevant YİKD program year. SSB uses the information in the YİKD Report to track the talent inventory for the sector and to generate statistical data.

Within the scope of the Product Library (“ÜK”) Liability, to encourage product ownership, the ÜK Liability, which means the order guarantee, is applied with the obligatory addressing method of the ready-to-use local products within the scope of the Projects. In addition, a reference is made to the most up to date ÜK published by the SSB before the date of signing the Supply Contract. The obligor is obliged to procure the relevant item from the companies/institutions/organizations specified in the ÜK. However, if the item in question does not regress from the design/production locality specified in the ÜK and SSB approval is obtained, the relevant item can be obtained from another local company/institution/organization not included in the ÜK. The order of priority to be considered when assessing whether there is a regression is as follows: (1) Design and production are local; (2) Design is local, production is foreign; (3) Design is foreign, production is local. In this case, to create a new item number, the obligor shall ensure that the item is registered via SSB Talent Inventory Portal ("YETEN").

The ÜK is created using the YETEN. Firms/institutions/organizations register their products on YETEN together with technical specifications, product qualification, certification information, standards of production processes. Membership to YETEN is required for product registration. The ÜK is created by SSB using the information in question for YETEN and is updated at least quarterly. However, the products distributed are not included in the ÜK. If it is determined that the information declared for the products registered to YETEN is not correct/distributor, the relevant products are deleted from the new versions of the ÜK. If it is determined that the product deleted by the SSB has been re-registered to YETEN by the same institution/organization without being deemed appropriate by the SSB, the products of the relevant institution/organization in YETEN will not be included in the ÜK to be published for one year.

In the Project, it is obligatory to use the products in the ÜK that can be used in the design, development, and/or production of the items to be delivered. To ensure the matching and traceability of the products defined in the ÜK with the configuration breakdown of the product to be supplied in the Project, the Local Product Usage Traceability Matrix (“YÜKİM”) and the ÜK Liability are followed, which will be prepared at the stage when the obligor creates the configuration breakdown. The obligor may include items in other ÜK versions that are not included in the ÜK version referenced in the Supply Contract, as well as products not included in any currently published ÜK version but designed and/or produced by local institutions/organizations, to YÜKİM. The obligor shall add technical specifications, company/institution/organization name, environmental conditions, product standards, and design/production process standards information to YÜKİM for each product that is not included in the published ÜK's.

The contractor matches the products in YÜKİM with the configuration breakdown used/to be used in the design production within the scope of the Project and indicates whether the final output of the Project for each product matches the units in the whole configuration breakdown and if it does, whether the relevant product is used. The reasons for not using the product and the documents supporting this situation that must be submitted to the SSB are regulated. The obligor submits the first YÜKİM to be prepared, together with the critical/detailed design documents, for the approval of the SSB. In addition, every update to be made in YÜKİM will be subject to SSB approval. For the product(s) that are not used despite being in the ÜK, except for the defined excuses, the cost of the substitutes will be paid back to the SSB by the obligor. Within the scope of the Project, a Locality Incentive Budget, which is the budget to be paid to the obligor according to the success criteria defined in the contract, can also be defined for this obligation, if it does not exceed 3% of the Supply Contract price. In this case, a certain percentage of the total cost of the products used from the ÜK is paid to the obligor as an incentive at the end of the Project.

To use the capabilities of intermediate companies, sub-industry, and KOBI’s to the maximum extent, Solution Partner Liability is applied to carry out certain design, development, service, and production items by local companies within the scope of the Projects. The local subcontractor/subcontractor options determined for the system/subsystem/component/work and/or service items specified in the Solution Partner List in the annex to the draft Contract are used as the Solution Partner. The signatures of the subcontracting agreements for the Solution Partner List are defined as the prerequisite for the payments specified in the Solution Partner List. Obligors cannot change their Solution Partners without justification and SSB approval.

To carry out development projects in deficient areas and/or innovative technologies, to meet certification/qualification requirements, to establish production infrastructure, TÜK Liability is applied at least 2% of the Supply Contract price within the scope of the projects. Subjects of TÜK are determined by the Board established by the SSB. For the subject notified by the SSB and with the approval of the SSB, the obligor, as the TÜK Executive, signs a TÜK Contract with a local subcontractor. The performance bond is taken for TÜK Liability. Increases/decreases in the price of the Supply Contract are not reflected in the TÜK price. Payments within the scope of TÜK are paid by SSB to the obligor in defined stages to be transferred to the TÜK Executive. The advance payment can be made provided that the guarantee is received. Penalties can be defined to be applied to the TÜK Executive according to the scope of the Project.

In the projects to be carried out with foreign obligors, Offset is applied to ensure the import-export balance, to increase the cooperation opportunities between international companies and local companies, to transfer technology in deficient areas, and to support infrastructure investments. Offset processes are handled by the SSB under a separately signed Offset Agreement. Offset Liability may be executed for foreign subcontractors that will be under the local obligor. In this case, the Offset Agreement is signed with the foreign subcontractor related to the SSB. Within the scope of the Project, for the percentage of the export type and technological cooperation type Offset, Offset Liability will be at least 70% of the Supply Contract price if there is no Industrial Cooperation Liability under it. Export type and technological cooperation type are carried out by the Offset crediting method. Offset activity, which has received pre-approval from SSB, is credited with a coefficient determined by SSB when it is realized, and the liability is reduced. Within the scope of Offset, Industrial Cooperation is pre-defined export, infrastructure acquisition, technological cooperation, etc., and a crediting process is not operated. It is carried out with the special terms and conditions defined for this subject in the Offset Agreement. The Offset Agreement is included as an annex to the Supply Contract. Before signing a document for the realization of Offset activities, such as any contract, purchase order, a pre-approval application is made to the SSB in an official letter by the Offset obligor with the supporting information and documents specified in the Offset Agreement for each Offset activity. However, there is no need to obtain pre-approval for the projects defined in the Offset Agreement. Pre-approval applications are evaluated by the SSB in coordination with the relevant parties, according to the Coefficient Table in the annex to the Guideline, and the result is notified in writing to the Offset obligor. The pre-approval request that is not notified in writing to the Offset obligor within 60 days from the application date will be ignored.

Crediting request regarding Offset activities is made in an official letter according to the format in the Offset Agreement. The result of the crediting request is notified in writing to the Offset obligor by the SSB. Realizations are followed by the SSB according to the liability table defined in the Offset Agreement. Crediting of export type Offset activities are done based on YİKD. The real market value and/or equivalent value of the technology, investment, and/or other activities that can be evaluated within this scope are taken as a basis in the crediting transactions of the activities within the scope of technological cooperation. Details regarding the crediting are determined in the pre-approval given by the SSB. Temporary credit can be applied under the conditions detailed in the Offset Agreement, for activities that are anticipated to not be carried out within a specified period, if they remain within the Offset Liability Period. After the successful completion of the Offset activity subject to temporary crediting, the Offset obligor submits the crediting request with an official letter to the SSB, then the crediting process is applied. Excess credit performed by the obligor over an Offset Liability may be assessed at the end of each program period upon written request from the Offset obligor and appropriate consideration by the SSB. The transfer/use details of the excess credit can be determined in the Offset Agreement. The Offset obligor submits the transfer request in writing to the SSB. Moreover, the Offset obligor's transfer request is evaluated, and the result is notified in writing to the Offset obligor by the SSB. A pre-credit application can be made to SSB, provided that the pre-approval for Offset activities has been obtained by a firm that does not currently have an Offset Liability to SSB. In this context, a company that requests it can officially request the relevant application forms from the SSB before the pre-approval.

For Offset activities performed extra within the scope of Offset by an Offset obligor who already has an Offset Liability to SSB, pre-credit may be made by the SSB at the written request of the Offset obligor, to be counted towards the possible Offset obligor's future Offset Liabilities to the SSB. The request of the companies for the use of pre-credit is evaluated within the framework of the current Offset Liabilities of the relevant company. Pre-crediting related to Offset activities is valid for three years from the date of the pre-crediting letter. As such, pre-credit not used within this period becomes invalid. Usage details regarding pre-credit can be determined in the Offset Agreement. Offset guarantee letter is taken for Offset Liabilities. In addition, a penalty is applied according to the Offset Agreement for the liabilities defined within the scope of the Offset Agreement and which cannot be fulfilled in the relevant program period. If industrial cooperation is defined within the scope of the Offset Agreement, the industrial cooperation processes are carried out by the SSB according to the terms and conditions defined in the Offset Agreement.

In the Effective Cost Score, the weight of the industrialization score is specified as 20%. In the case of ÜK Liability in RFP, ÜK Liability takes place as an indispensable or mandatory criterion. If the ÜK Liability is not committed as specified in the RFP, 0 points are given from the entire industrialization score. In case there is a TÜK Liability in the RFP, the obligor candidates must make a TÜK commitment in their proposals. In case the TÜK Liability is not committed as specified in the RFP, 0 points are given from the entire industrialization score.

In the calculation of industrialization score in Projects that do not have an Offset Liability, the weight of the score given for the YS/KOBI ratio is calculated as 50%, and the weight given for the Solution Partner Liability is 50%. If there is an Offset Liability defined in the RFP for foreign subcontractors, the industrialization score calculation is made considering the said obligation, and the calculation method and criteria for this are also specified in the RFP.

If the obligor candidates submit bids below the minimum liability rates required to be submitted regarding industrialization in the RFP, 0 points are awarded for the relevant liability. To obligor candidates, to Solution Partner Liability in case of RFP, if the weighting is specified by the SSB, the score to be calculated according to the said weighting is given. In some cases, depending on the Project, the mentioned criterion may be written as mandatory. However, if any of the mandatory items are not committed, 0 points are given for the entire Solution Partner Liability. In the case of a YS/KOBI Undertaking in the RFP, the YS/KOBI ratio commitments of the obligor candidates are scored using the benchmarking method, so that 100 points will be given to the obligor candidate with the highest undertaking. If the YS/KOBI undertaking is lower than the minimum rate specified in the RFP, 0 points are given for this liability.

Finally, if the foreign obligor candidates have an Offset Liability in the RFP and cannot meet any of the minimum rates specified in the RFP for their Offset Liabilities, 0 points are given for the industrialization score. If industrial cooperation is defined within the scope of Offset in the RFP for foreign obligor candidates, the Industrial Cooperation Liability is a mandatory criterion, and if the obligor candidates have not committed as stated in the RFP, 0 points are given for the industrialization score. The minimum Offset Liability ratios defined in the RFP, and the export type and technological cooperation type Offset proposals submitted by the foreign obligor candidate who has undertaken the Industrial Cooperation Liability, if any, are scored by comparing them according to the proposed rates, the obligor candidate with the highest rate is given 100 points for the industrialization score.

Şafak Herdem, Esra Temur