Hungary operates a system of selfassessment, with tight filing deadlines. The information that must accompany tax filings is limited. However, the tax authorities will periodically perform detailed audits. Significant interest and penalty costs may arise in respect of underdeclaration and late payments of tax. Hungarian taxes currently in force include corporate tax, personal income tax and value added tax (VAT). Customs and excise duties, social security contributions, transfer tax and local taxes levied at a municipal level may also give rise to significant cost.
Corporate tax system
A Hungarian resident company will be subject to corporate income tax on its world-wide income. A non-resident company will only be taxable on its Hungarian source income. The business year is normally the calendar year but as from 1 January 2001 subsidiaries of non- Hungarian entities may establish their business year according to the business year applied by the parent company if certain conditions are met. The base for corporate income tax is the pre-tax accounting profit adjusted by increasing and decreasing items set out in the law. Costs are generally tax deductible if they are incurred wholly and exclusively for business purposes. The general corporate income tax rate of 18% has been changed to 16 % with the effective date of 1 January 2004 As of January 1, 2004 outbound royalty and interest payments to non Hungarian companies as a general rule, not subject to Hungarian withholding tax. Foreign dividends received by Hungarian companies is exempt from Hungarian taxation, unless received from a CFC. There are certain changes regarding the carry forward loss regulations. If the taxpayer has negative tax base, the profit before taxation can be decreased with this amount in any of the tax years. After the fourth year, the carry forward loss can be deducted if certain conditions are met. For this transaction the permission of the Tax Authority is required, otherwise if there is no decision after 30 days then this should mean that the Tax Authority has accepted the process.
Transfer pricing
In general, transfer pricing rules continue to become more stringent. The Act on Corporate Income Tax and Dividend Tax and the Act on Value Added Tax incorporate the arm's length principle and the former specifies the available methods for setting transfer prices and, in general, refers to the OECD's 1995 Transfer Pricing Guidelines. In July 2003 a new Ministry of Finance decree was issued, setting out the documentation required for recording related party transactions. Missing the above administrative obligation should cause default penalty consequences of HUF 2,000,000 (approx. EUR 8,000) As from 1 January 2001, the portion of interest or royalty received from related parties, under a contract concluded or a security issued after 31 December 2000 which exceeds the fair market interest or royalty rate, qualifies as a dividend and is taxed accordingly. If interest paid to related parties exceeds the amount of interest received from related parties 50% of the difference will not be tax deductible. At the same time, if interest received from related parties exceeds the amount of interest paid to related parties 50% of the difference will be tax exempt. Only companies subject to Hungarian corporate income tax will be affected by this measure. A company is not obliged to apply these rules if it gives written notification of this to all its related companies (that pay or receive interest, including non-Hungarian companies) within 30 days of the end of the relevant tax year. Where notification is given none of the relevant companies will be entitled to apply the rules.
Thin capitalisation
As from 1 January 2001, if the debts of a company are in total greater than three times the equity then the interest charged on the excess amount will not be deductible for tax purposes. The level of debt applicable for this purpose is the daily average amount of debt arising from loans, private debt securities and bills of exchange received from anyone but financial institutions recorded in the statutory accounts for the year in which the relevant interest is paid. The equity is the daily average amount of equity recorded in the year for which the relevant interest is paid.
Dividends
As from 1 January 2001, the Act on Corporate Income Tax and Dividend Tax provides a precise and extensive definition of dividends. The Hungarian domestic rules applicable to dividend payments have been modified to bring them into line with the Parent/Subsidiary Directive of the EU; the new rules will be effective once Hungary joins the EU. Dividends paid by a company to its parent will be exempt from dividend tax if the parent company (i.e. a company with at least a 25% holding) has qualified as such for at least two years on the day of payment or an appropriate third party guarantee has been obtained.
Mergers
The provisions of the Merger Directive of the EU are incorporated into Hungarian domestic law for domestic transactions from 1 January 2003, and from the date that Hungary joins the EU for cross border transactions (1 May 2004). Basically, there is the right to opt for a deferral of taxation upon the actual realisation of a gain. The official commentary highlights that, regarding share mergers, the requirement of obtaining the 'majority of the voting rights' in the target company can be satisfied by considering more than one concurrent transactions (i.e. the shares or business quotas of several previous minority holders can be acquired, if in total they represent the majority of the voting rights).
Off-shore Company Regime
Under Hungary's off-shore regime, offshore companies ("HOCs") are only liable to corporate tax in Hungary at a rate of 4 % with the effective date of 1 January 2004. As from 1 January 2001, off-shore companies are obliged to pay tax in advance and must comply with the general top-up obligation. Due to Hungary's accession to the EU the HOC regime has been largely dismantled. As a consequence, HOCs may no longer be entered into the relevant registry of the Hungarian tax authority after 31 December 2002. If any person, who has not previously been a member or a related party of a HOC, obtains a majority interest (over 50% of the votes) in a HOC; or if the HOC is affected by a merger (ie. amalgamation or absorption) then the Hungarian tax authority will delete the HOC from its registry. Such related party exemption will fall away on 1 May 2004. All special rules applicable to HOCs (e.g. the 3% corporate income tax rate) will cease to have effect from 1 January 2006. Hungary has developed an extensive network of tax treaties with over fifty countries regarding withholding taxes. Most of Hungary's treaties closely follow the OECD model. A treaty will overrule Hungarian law to the extent that it provides for more beneficial tax treatment.
Personal income tax
Hungarian tax residents are subject to personal income tax on their world-wide income. They may, however, be exempted from taxation on foreign source income by tax treaties. Non-residents are only liable to tax on their Hungarian-source income. This includes income from employment performed in Hungary. The ranges of personal income tax payable on the consolidated tax base have changed. As from 1 January 2004, the portion of annual income below HUF 800,000 is subject to 18% personal income tax, between HUF 800,001 and HUF 1,500,000 the rate of personal income tax is 26% and above HUF 1,500,001 the rate is 38%. Capital gains arising from the sale of securities on the Hungarian stock exchange are now exempt from personal income tax, whereas previously they had been subject to a 20% capital gains tax. Once Hungary joins the EU, the same exemption will apply to capital gains arising from the sale of securities on any recognised stock exchange of a Member State. Interest income is exempt from tax in the hands of individuals. If an employee receives shares on advantageous terms because of the employment relationship, as a general rule with certain exceptions, such income is taxed as employment income at high progressive rates and is also subject to social security contributions. However, since 1 January 2003, the concept of "recognised share schemes" exists. The underlying principle of such schemes is that, if the employees or managers obtain securities under specified circumstances and hold them for a prescribed period, a tax liability in respect of such securities will only arise if the securities are later sold. Once the securities are sold in the market, the rules on capital gains will apply at the applicable rate (currently 20%). If the scheme fulfils all the prescribed requirements, the Hungarian Ministry of Finance will register the scheme and the beneficial tax treatment will be applicable. Shares subsequently sold on the Hungarian stock exchange under a recognised scheme will not benefit from the above described tax exemption. As of 1 January 2004 the rules regarding benefit in kind have been changed. Previously every kind of non cash benefits qualified as a benefit in kind, with exceptions listed in the relevant legislation as of 1 January 2004, now the personal income tax law contains a positive list of all the goods or services, which should be treated as benefits in kind.
Value Added Tax
Called the general turnover tax (ÁFA) in Hungarian, this is a conventional value added tax (VAT), based upon the framework of European Union directives. There are certain changes related to the VAT rates with the effective date of 1 January 2004. The standard rate of VAT remained 25%, but one of the reduced rate of 12% has been increased to 15%, which applies to certain goods and services (for example public utilities, books and newspapers, food, agricultural products). As an example, the VAT rate applicable to electricity, which was previously 12%, has now been increased to 25%. The VAT rate of goods and services which were zero rated has been increased to 5%. Imports are subject to VAT on a taxable base calculated as the sum of the customs value, plus customs duties, fees and consumption tax. Important change that the renting out and the leasing of property (including undeveloped construction sites) will be exempt from VAT. However, taxpayers will be allowed to choose, whether or not they require to pay VAT (with the exception of renting out flats and non-construction sites). Certain transactions which are carried out in Hungary are exempt from VAT (for example the sale, rental and leasing of land, the rental of an apartment, postal services, financial services and legal services). Businesses providing these exempt services will not be able to recover input VAT in full. Small businesses can elect to be VAT exempt under certain conditions. As from 1 January 2001, services provided free of consideration are also subject to VAT provided that the input VAT was deductible in full or in part. Hungarian VAT laws will be further harmonised due to Hungary's accession to the EU. Once Hungary joins the EU, the terms 'product import' and 'product export' will cease to exist with regard to transactions involving other Member States. Hungary will need to implement the socalled 'intra-Community acquisition' and 'intra-Community supply' principles of the EU's VAT Directive
Other Taxes on Individuals and Corporations
In addition to VAT, consumption tax is levied on certain goods. These goods include coffee, jewellery and passenger cars. Persons not subject to VAT cannot be liable for consumption tax. Consumption tax should be levied when goods are sold or imported for sale. From 1 January 1998, alcohol, tobacco and petrol products and from 1 August 2000 certain types of wine became subject to excise tax in place of the previous consumption tax. A local turnover tax can be levied by municipalities up to a maximum of 2% of net sales decreased by material costs and certain other costs. There is 10% transfer duty on real estate and certain other assets. As from 1 January 2003 a new form of tax, the so-called 'simplified business tax' was introduced. This allows small enterprises and private entrepreneurs to operate a simplified system of tax that replaces VAT, corporate and individual income tax. As of 1 February 2004 a new tax, the so-called registration fee is introduced. The purpose of this tax is to replace the consumption tax, which should be dismissed with the date of the EU accession regarding vehicles, bought in other EU Member States. The environmental load charge and the energy tax, as a new focus of tax were introduced with an effective date of 1 January 2004. The above taxes should be used by a small group of taxpayers. Other taxes include a building tax, a tax on undeveloped plots, communal charges and a tourism tax. Compared to the items discussed in detail above, these taxes are of minor importance.
Hungarian Tax Incentives: Keeping Hungary's Tax System Attractive For Multinational Group Investors Following EU Accession.
Traditionally, Hungarian tax rules undergo significant amendment at the beginning of a new year: loopholes exploited by taxpayers are closed and the budget is always in need of further income. The year 2004 brings changes on an even greater scale, as Hungary's accession to the European Union on 1 May 2004 requires domestic tax legislation to comply fully with EC law.
Abolition of the HOC-regime
Hungary's EU membership inevitably has some negative effects on tax rules. As of 1 January 2003 so-called Hungarian offshore companies ("HOCs") may no longer be entered into the relevant register of the Hungarian tax authority. Also, existing HOCs lose their tax advantageous status if the majority member (shareholder) of a HOC changes or if the HOC merges (an amalgamation or an absorption). Nevertheless, until 1 May 2004 the majority interest in a HOC could be transferred to a related party of the HOC without the loss of beneficial tax status. All special rules applicable to HOCs (e.g. the beneficial corporate tax rate of 4%) will cease to have effect from 1 January 2006.
Nevertheless, a number of steps have been taken to ensure that Hungary remains a preferred jurisdiction for multinational groups establishing their holding or financing companies in the EU and this has resulted in new benefits for investors.
Corporate tax rate
One such benefit is the highly competitive and recently reduced corporate income tax rate of 16% (for comparison, Slovakia has a rate of 20% and Austria 25%).
Dividends received
The beneficial taxation of inbound dividends should also be noted; dividends received by Hungarian tax resident companies are tax exempt, irrespective of the size of holding, unless the payer is a Controlled Foreign Company ("CFC").
A CFC in this context means a non-Hungarian tax resident that:
has its registered seat in a state where the effective rate of corporate income tax is less than 2/3 of 16% (i.e. approximately 10.67%); a Hungarian tax resident subject to Hungarian corporate income tax, or its related party, has a holding in; and has no active, genuine business in the state of its registered seat.
Interest & royalty income
Also of note is the so-called "50% Deduction Rule", which allows an additional tax deduction in respect of interest income received from related parties.
According to the "50% Deduction Rule", as set out in Act LXXXI of 1996 on Corporate Income Tax and Dividend Tax ("CIT Act"), a company may reduce its corporate income tax base by:
50% of the interest income received by (or due to) the company from its related parties; and accounted for and recorded by the company as interest income; which is in excess of the interest paid (or payable) by the company to its related parties; and accounted for as an expense by the company.
For example, a company receives interest income of 150 from a related party and pays interest of 100 to another related party: the company will be entitled to reduce its corporate tax base by (150 - 100) x 50% = 25
The "50% Deduction Rule" cannot be applied if the company qualifies as a small enterprise on the last day of the tax year and, under the CIT Act, the total amount of such deductions, together with certain other deductions, may not exceed 50% of the pre-tax profits of the company in question.
Similar rules apply to royalty income. Here, 50% of the royalty income received during the tax year is deductible from taxable profits, subject to certain limitations in the CIT Act.
Outbound interest & royalty payments
As of 1 January 2004, interest and royalties sourced in Hungary and paid to a non-Hungarian resident company are exempt from Hungarian withholding tax under Hungarian domestic legislation.
Tax treaty network, EC law
Hungary has an extensive treaty network (of more than 55 treaties), most of which are based on the OECD Model Convention and generally adhere to the more favourable exemption method. Furthermore, with Hungary's EU membership, EC law (e.g. the Parent/Subsidiary and Merger Directives, the Interest and Royalty Directive etc.) applies from 1 May 2004.
dr. Anna Bürchner
Tel: +361 483 4835
Fax: +361 483 4801
dr. Eszter Kálmán
Tel: +361 483 4842
Fax: +361 483 4801
To view Hungarian tax incentives click here.
