Hungary has traditionally maintained a very favorable corporate income tax environment for decades, making it a competitive option for international holding structures. Elements of this investor friendly system include zero withholding tax on dividends, royalties and interest to any corporate recipient, irrespective of being in or outside the European Union, as well as a generous participation exemption regime.
Introduction of Group Taxation in Corporate Income Tax
One important planning tool available in other jurisdictions but so far absent in Hungary was group taxation, allowing to set off profits and losses generated by different group entities. Consider, for example, a property investment/development group with various entities in different phases of their investments—one has just realized a huge profit from selling its investment, another is at the beginning of its development phase generating only losses. While on group level the profits could be zero, the first entity is taxed on the entire profit, while the latter’s losses cannot effectively be utilized, at least not in the short term.
To overcome this problem, and perhaps as a compensation for various anti-avoidance measures that had to be introduced due to the EU’s Anti-tax Avoidance Directive (“ATAD”), as of 2019 Hungarian corporate taxpayers may opt for group taxation. The new scheme, combined with a corporate tax rate of only 9 percent, as well as the availability of participation exemption rules and a general lack of withholding taxes, gives Hungarian companies an advantage which is still unique in the CEE (Central and East European) region.
The group taxation option is available for at least two Hungarian companies (including Hungarian branches of foreign companies) under 75 percent ultimate common control, subject to a number of further conditions. The new scheme will allow the utilization of losses generated by some group members against the positive tax base of others, up to a certain level.
In addition to the savings available on the amount of tax payable on group level, being part of a tax group also has the benefit of simplifying transfer pricing compliance tasks significantly. This is because group members are exempted from transfer pricing documentation requirements on transactions with other group members.
Nevertheless, careful consideration is recommended when deciding whether it makes sense to apply for the new regime, especially in light of the new interest limitation rules described below.
There is a rather tight deadline by which companies may opt for the application of the group taxation rules for 2019 (as the application must be submitted to the Hungarian Tax Authority by January 15, 2019), so quick and careful analysis is required for those wishing to immediately benefit from this new tax planning possibility.
Changing Interest Limitation and CFC Rules
The longstanding Hungarian thin capitalization rules disallowing companies to deduct interest expenses corresponding to inter-company debt over a 3:1 debt-to-equity ratio will be replaced by more sophisticated restrictions pursuant to the requirements of ATAD.
While the new rules will apply to bank financing so far exempt from thin capitalization rules, they will only capture larger financing arrangements for which the net interest expense exceeds 3 million euros ($3,428 million).
Complex rules allow carry forward of interest deduction capacity over a longer period and allow various options for group entities to limit their indebtedness either on a standalone or on a group basis.
Thus, depending on the specific circumstances of the taxpayer, the new rules may be more generous to some, while being more restrictive to others.
Hence, the financing of Hungarian affiliates may need to be reconsidered in order to accommodate these new rules. If Hungarian entities opted for the group corporate taxation rules, that would add further aspects to consider when planning the financing of the Hungarian operation, since the 3 million euro materiality threshold can be utilized by the whole group only once, rather than being available for each group member separately.
In order to comply with ATAD, rules for qualifying as a Controlled Foreign Company (“CFC”) have also been modified. The earlier possibility to save being qualified as a CFC in the case where the one of the shareholders was listed on a European Economic Area stock exchange will no longer apply.
From 2019 onward, Hungarian companies shall be able to demonstrate that income of their foreign subsidiary resident in a low tax jurisdiction was realized solely from genuine business transactions and that significant personnel functions in connection with the assets and risks of the foreign subsidiary are not performed by the Hungarian company.
Further, a materiality level (based on profit level and income from non-commercial activities) has also been introduced under which there is no need to assess the CFC status.
Other Important Amendments
The hugely popular “cafeteria” compensation system, allowing employees to choose the desired in-kind benefit up to a predetermined cap from a list of available items specified by the employer, has essentially been killed, with favorable and practical tax treatment now limited to a rather narrow scope of items only.
Against a longstanding history of a complex compensation scheme offered to employees, apparently the government now wishes to channel all compensation provided to employees to become part of the normal salary and therefore more transparent.
Changes in value-added tax ("VAT") are outlined below.
VAT rules regarding single and multi-purpose vouchers have been aligned with changes to the EU VAT Directive.
Fifty percent of VAT incurred on the leasing fee of company cars will be deductible without further proof on the ratio of business vs private use, as a deemed ratio of business use. It will, however, still be possible to deduct a higher ratio of input VAT if higher ratio of business use is supported by a logbook.
The temporary reduced 5 percent VAT rate applicable for the sale of new residential property has been extended until 2023 for projects already in possession of building permits. This may cause a huge competitive advantage for qualifying projects and a significant difference in prices (or profitability) of residential property coming to the market after 2019.
Planning Points for 2019
- Check whether it is worthwhile to opt for group taxation for all or some of your Hungarian subsidiaries and how conditions of eligibility could be met.
- Review financing structures in place to optimize interest deductibility.
- Reconsider employee compensation schemes to focus on remaining options qualifying for favorable treatment.
Eszter Kalman is Senior Counsel and Head of Tax and Judit Kresz is Senior Associate with CMS Hungary.