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%).
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;
- 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.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.