Traditionally, Hungarian tax rules undergo vast change at the beginning of a new year: the budget is always in need of further income and loopholes exploited by taxpayers are closed. In addition, changes are required to the domestic tax legislation in order to comply with EC law in preparation for Hungary’s entry into the EU.
Corporate Tax
The fact that Hungary is joining the EU also has its negative aspects. Unfortunately, so-called Hungarian off-shore companies ("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 per cent) in a HOC; or if the HOC is affected by a merger, then the Hungarian tax authority will delete the HOC from its registry. All special rules applicable to HOCs (e.g. the 3 per cent corporate income tax rate) will cease to have effect from 1 January 2006. The benefits available to enterprises established in an entrepreneurial zone will no longer be available. Likewise, the investment benefits available to multinational enterprises can no longer be taken advantage of. Such benefits will only be available for investments started prior to 1 January 2003 and will cease altogether after 2011.
However, there are some advantageous changes. From 1 January 2003, provisions created for and dedicated to environmental purposes will be tax deductible. These new rules create tax-free resources, since environmental provisions will be tax deductible both in the year the provision is created and in the year that the provision is released.
If a taxpayer creates a reserve for development and investment purposes from distributable profit reserves and this amount is allocated as a non-distributable reserve then, in certain circumstances, that amount will be tax deductible, within certain limits, in the year in which the reserve is created. A taxpayer is entitled to release the non-distributable reserve within a specified period of time (if the reserve is created in 2002 then by the end of 2003; if the reserve is created after 1 January 2003 then by the end of the fourth tax year following the year of creating the reserve) but if it is not used for the sole purpose of investment and development an additional tax liability will arise.
The corporate tax rules applicable to related party transactions have become more stringent. If interest paid to related parties exceeds the amount of interest received from related parties 50 per cent 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 per cent 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 so that if Company A obtains a tax deduction for 100 per cent of the difference between the excess of interest paid to Company B over interest received from Company B then Company B will be taxed on 100 per cent of the excess of interest received from Company A over the interest paid to Company A.
In line with the relevant OECD guidelines, specific documentation will have to be prepared in the case of related party transactions (both domestic and cross-border). The documentation requirements will be published in the framework of a decree of the Hungarian Ministry of Finance in the near future and will apply for the tax year 2003. Taxpayers will be expected to have prepared the appropriate documentation by the time the relevant tax returns are filed (for the tax year 2003, in general, by 31 May 2004). However, this decree has not so far been issued yet it already applies to transactions covered by the corporate income tax return for 2003.
Personal Tax
The most significant changes relate to the rules applying to income arising from securities transactions.
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 per cent 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.
As from 1 January 2003, securities transferred to private individuals for no consideration will no longer constitute a benefit in kind. The nature of such income will be determined by looking at the nature of the legal relationship between the parties and all the relevant circumstances.
Previously where an employer transferred securities for no consideration to an employee who received them by virtue of the employment relationship this resulted in a 44 per cent personal income tax burden on the employer. Following the changes the personal income tax will be borne by the employee, at a maximum rate of 40 per cent.
The private individual members of a company (whether Hungarian or non-Hungarian but excluding tax haven companies) may obtain securities, free of Hungarian income tax where the securities are obtained on the capitalisation of distributable reserves. A tax liability (at the rate of 20%) will only arise when the securities are subsequently sold.
As from 1 January 2003, a major gap in the Hungarian tax rules has been closed by the introduction of the concept of "recognised share schemes" (i.e. stock options). The underlying principle of such schemes is that, if employees obtain securities in certain circumstances and hold them for a prescribed period of time, a tax liability will only arise if the securities are later sold. In order for such a scheme to qualify as "recognised", it must be registered with the Hungarian Ministry of Finance. Once the securities are sold, the rules on capital gains will apply; the applicable tax rate is currently 20 per cent.
VAT
As from 1 January 2003, the representative office of a non-Hungarian enterprise will qualify as a 'place of business' for VAT purposes. As a result, if the place of performance of a service is deemed to be the seat or the place of business of the recipient (e.g. telecommunications, engineering, legal and other professional services etc.) and the services are provided to a non-Hungarian enterprise via its Hungarian representative office, then (contrary to the old rules) Hungarian VAT will be charged.
In general, non-Hungarian enterprises can recover the input VAT (including the input VAT charged to them via their representative offices) under a special procedure, if certain conditions are satisfied and there are reciprocal arrangements in place in the other country for the recovery of input VAT by a Hungarian enterprise.
The introduction of the rules that provide that a representative office is a 'place of business' has created an anomaly regarding the right of input VAT recovery. This is because non-Hungarian persons with a seat or a place of activity established in Hungary are excluded from the special input VAT recovery procedure. The Hungarian government has promised to remedy this anomaly and amend the relevant procedural rules so that a non-Hungarian person charged VAT on supplies (treated as supplied outside Hungary e.g. telecommunications) made via the non-Hungarian person’s representative office can be recovered as input tax under the special procedure.
International Tax Law
Residence of Individuals, Personal Tax Benefits
A non-discrimination rule will apply from the date that Hungary joins the EU, which will make personal tax benefits equally available to EU citizens in respect of their income derived from Hungary, provided that at least 75 per cent of their worldwide income is Hungarian sourced and no similar benefits are available in their country of residence. This is designed to bring Hungarian law into line with the current practice and case law of the European Court of Justice.
From 1 January 2003, the principal deciding factor in establishing Hungarian tax residence will be 'Hungarian citizenship'. This replaces the previously applicable 'permanent home'. However, such efforts by Hungary to extend the scope of persons subject to Hungarian tax on their worldwide income are tempered by its double tax treaties, which prevail over domestic Hungarian law.
Parent/Subsidiary and Merger Directives
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 are exempt from dividend tax if the parent company (i.e. a company with at least a 25 per cent holding) has qualified as such for at least two years on the day of payment. This two year condition might be in contravention of the Directive in light of the fact that the European Court of Justice has ruled that "a Member State may not make the grant of the tax advantage provided for in Article 5 (1) of the Directive subject to the condition that, at the moment when profits are distributed, the parent company must have held a minimum of 25 per cent of the capital of the subsidiary for a period at least equal to that set by that Member State". Thus, it ought to be acceptable for the parent, for example, to give an undertaking to maintain its holding in the subsidiary for at least two years.
The provisions of the Merger Directive 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. 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 transaction (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).
Other Taxes
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.
For further information please contact Dr. Anna Bürchner at [email protected] or on 00 36 1 4834800.
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