INSIGHT: Hungary Introduces Exit Tax and Hybrid Mismatch Rules

The recent efforts in international taxation, with the aim of allowing countries to effectively exercise their tax sovereignty, have not left Hungary unaffected.

Hungary, as an open economy, and very much dependent on foreign investments, is in a complex situation: on the one hand Hungary seeks to attract inbound investments by, inter alia, operating a favorable corporate income tax (CIT) regime (e.g. the CIT has a flat rate of 9%, no withholding tax is imposed on payments made to companies, participation exemption can be relied on to exempt capital gains arising on the sale of shares from taxation, etc.), but on the other hand Hungary is vested in preventing the erosion of its tax base by aggressive tax planning.

Consequently, Hungary is committed to combating harmful tax practices by implementing the recommendations set out in the BEPS Action Plan proposed by the Organization for Economic Co-operation and Development (OECD) and the provisions of the Anti-Tax Avoidance Directive (ATAD) of the EU (certain rules of the ATAD have already been implemented and are applicable from January 1, 2019, e.g. the rules on controlled foreign companies and on the interest limitation).

The Summer Tax Package, promulgated on July 23, 2019, transposed into Hungarian law the provisions of the ATAD on exit taxation and the hybrid mismatch rules set out in Council Directive (EU) 2017/952 with such rules being applicable from January 1, 2020.

Exit Tax on Corporate Income Taxpayers

By levying an exit tax, Hungary will be able to tax the economic value of capital gains yet unrealized at the time of exit created in its territory.

Hungary has incorporated the ATAD provisions on exit taxation into Act LXXXI of 1996 on the Corporate Income Tax (Act on CIT) as an item, increasing the CIT base.

As a general note, the CIT base should be established on the basis of the total revenues less costs and expenses (“pre-tax profit”) as determined in the financial statements prepared in accordance with the Hungarian accounting standards. For the purpose of determining the CIT base, the pre-tax profit has to be modified by certain tax base increasing items and also certain tax base decreasing items may be applied as set out by the Act on CIT.

The exit tax will be charged on the market value of the transferred assets and activities established in accordance with the rules on transfer pricing as at the time of their exit less their value established for tax purposes. Moreover, the exit could entail the application of additional tax base increasing or decreasing items, provided that the relevant conditions are fulfilled also.

Any one of the following events may trigger the exit tax:

• a taxpayer transfers assets from its Hungarian head office to its permanent establishment (PE) in another country if Hungary no longer has the right to tax the transferred assets due to the transfer;
• a taxpayer transfers assets from its Hungarian PE to its head office or another PE in another country, provided that Hungary no longer has the right to tax the transferred assets due to the transfer;
• a taxpayer transfers its tax residence to another country, except for those assets which remain effectively connected with a PE located in Hungary;
• a taxpayer transfers the business carried on by its Hungarian PE to another country if Hungary no longer has the right to tax the transferred assets due to the transfer.

Despite the above, exit tax will not apply to asset transfers related to the financing of securities, assets posted as collateral or where the asset transfer takes place in order to meet prudential capital requirements or for the purpose of liquidity management, provided that the assets are set to revert to Hungary within 12 months.

The taxpayer may opt to defer the exit tax by paying five equal installments over five years if it transfers its tax residence to another EU member state, or to a third country that is party to the Agreement on the European Economic Area with which either Hungary or the EU has concluded an agreement on mutual assistance in tax matters being equivalent to Council Directive 2010/24/EU.

The taxpayer would forfeit this tax deferral benefit and the outstanding amount of the exit tax would become immediately due and payable if:

(a) transferred assets or the business carried on by the PE of the taxpayer are sold or otherwise disposed of;

(b) transferred assets are subsequently transferred to a third country;

(c) the taxpayer’s tax residence is subsequently transferred to a third country;

(d) the taxpayer goes bankrupt or is wound up;

(e) payment of a due installment is delayed by 30 days;

except if either Hungary or the EU has concluded an agreement on mutual assistance in tax matters being equivalent to Council Directive 2010/24/EU with the third country referred to in cases (b) and (c).

If assets, tax residence or the business carried on by a PE is transferred from an EU member state to Hungary, the starting value of the assets for Hungarian tax purposes will be the value established by this member state, unless this does not reflect the market value, in which case its market value will be taken into account.

Rules on Hybrid Mismatches

The implementation of the rules on hybrid mismatches will enable Hungary to tackle double deduction or deduction without inclusion outcomes that result from the differences in the legal characterization of payments, financial instruments and entities, or in the allocation of payments under the laws of two or more jurisdictions.

Either one of the following scenarios may qualify as a hybrid mismatch provided that it occurs between related parties or under a structured arrangement:

(a) a financing or equity return is paid that would be taxed under the rules for taxing debt, equity or derivatives, if due to a mismatch in the legal characterization, the payment is deducted from the tax base of the payer at the latest in the tax period that commences within 12 months of the end of the payer’s tax period, while the payment is not included in the tax base of the payee and it is reasonable to expect that it will not be included in a future tax period either;

(b) a payment to a hybrid entity is deducted from the tax base of the payer to the extent the payment is not included in either the tax base of the hybrid entity or in that of the persons having participation in the hybrid entity due to a mismatch in the allocation of the payment;

(c) a payment to an entity with one or more PEs that is deducted from the tax base of the payer to the extent the payment is not included in either the tax base of the head office or in that of its PEs due to a mismatch in the allocation of the payment;

(d) a payment to a disregarded PE is deducted from the tax base of the payer to the extent the payment is not included in either the tax base of the PE or in that of the person to which the PE relates;

(e) a payment by a hybrid entity that is deducted from its tax base to the extent the payment is not included in the tax base of the payee due to the fact that the payment is disregarded under the laws of the payee jurisdiction;

(f) a deemed payment between the head office and the PE or between two or more PEs that is deducted from the tax base of the deemed payer to the extent the payment is not included in the tax base of the payee due to the fact that the payment is disregarded under the laws of the payee jurisdiction; or

(g) the amount that is deducted from the tax base of the taxpayer (i.e., subject to CIT in Hungary) where the same amount is also deducted from the tax base of a foreign person.

A taxpayer is a related party of another person or entity if one of them holds directly or indirectly a participation in terms of voting rights or capital ownership of at least 50% or is entitled to receive at least 50% of the profits of the other.

If a person acts together with another person in respect of the voting rights or capital ownership, then their participation should be aggregated when assessing whether the person meets the above-mentioned thresholds. Also, a taxpayer and an entity that are in the same consolidated group for financial accounting purposes would also be related parties if the same management has dominating influence relating to business and financial policy in both of them.

“Structured arrangement” is defined as an arrangement involving a hybrid mismatch where the mismatch outcome is priced into the terms of the arrangement, or it is the goal of the arrangement, unless the party to such arrangement was not aware and could not reasonably have been expected to be aware of the hybrid mismatch and did not share in the value of the tax benefit resulting from the hybrid mismatch.

“Hybrid entity” covers any entity or arrangement that is regarded as a taxable entity under the laws of one jurisdiction and whose income or expenditure is treated as income or expenditure of one or more other persons under the laws of another jurisdiction.

“Disregarded PE” means any activity that is treated as giving rise to a PE under the laws of the head office jurisdiction and is not treated as giving rise to a PE under the laws of the other jurisdiction.

Notwithstanding the above, no hybrid mismatch would arise in scenario (a) if the payer is engaged in the business of regularly buying and selling financial instruments on its own account, the underlying return on the transferred financial instrument is treated for tax purposes as derived simultaneously by more than one of the parties to that arrangement and the payer jurisdiction requires the payer to include as income all amounts received in relation to the transferred financial instrument.

Furthermore, hybrid mismatch would not arise in scenarios (e), (f) or (g) either to the extent that the income connected to the deducted amount is to be included in the tax base in both the payer and the payee jurisdiction.

If a hybrid mismatch occurs, the taxpayer is not entitled to the deduction if it is the payer in scenarios (a) to (f).

Also, in scenarios (a) and (e), the payment should be included in the tax base of the taxpayer if it is the payee and the deduction is not denied to the payer.

In addition, if the payment in scenario (d) is not included in the tax base of the disregarded PE, the taxpayer should include the income that would otherwise be attributed to the disregarded PE except if Hungary is required to exempt the income under a double tax convention concluded with a third country. The hybrid mismatch rules contain further provisions in case of double deduction scenarios.

Planning Points

In Hungary, hybrid structures are not commonplace in tax planning. Therefore, it remains to be seen how the Hungarian tax office will apply the hybrid mismatch rules or, indeed, have the resources to detect and assess hybrid mismatches.

Nevertheless, the new legislation will require Hungarian taxpayers to review their related transactions (mostly financing arrangements) to assess whether they could fall under the hybrid mismatch rules and, if so, take the necessary measures to comply with the legislation.

János Pásztor is a Senior Associate at Wolf Theiss, Hungary

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.