Hungary - Taxation of cross-border mergers and acquisitions
Taxation of cross-border mergers and acquisitions for Hungary.
Taxation of cross-border mergers and acquisitions for Hungary.
This overview of the Hungarian regime for mergers and acquisitions (M&A) and related tax issues discusses only statutory frameworks for acquisitions in Hungary. It does not consider any specific contractual arrangements that may affect such transactions.
The primary legislation governing the form and regulation of companies is ACT V of 2013 on the Civil Code (the Civil Code), effective since 15 March 2014. As a result of the accession of Hungary to the European Union (EU) on 1 May 2004, new forms of business associations have been integrated into the Hungarian company law legislation, such as the European economic interest grouping and the societas Europaea (SE).
In the past few years, the Hungarian parliament approved several tax law changes that might have implications for M&A transactions in Hungary. The key tax law changes are as follows.
- As of 1 January 2017, the statutory corporate income tax (CIT) rate in Hungary is 9 percent (flat rate).
- As of 1 January 2012, the provisions on carry forward losses have changed significantly. According to the new rules, tax losses may only be utilized for up to 50 percent of the tax base (calculated without utilization of carry forward losses), and further restrictions may apply on changes in ownership structure and/or transformations (mergers, demergers). As of 1 January 2015, the rules on tax loss carry forward became even stricter, with a general 5-year time limitation introduced for tax losses arising in 2015 or later. Tax losses generated before the end of 2014 may be utilized by the end of 2030. Further restrictions may apply on the amount of tax loss carry forward in the event of a change in ownership structure and/or transformation (merger, demerger) (see ‘Purchase of shares’ for details).
Asset purchase or share purchase
An acquisition in Hungary usually takes the form of a purchase of shares of a company, as opposed to its business and assets, because capital gains on the sale of shares may be exempt from taxation, while the purchase of assets might be subject to value-added tax (VAT). The advantages and disadvantages of asset and share purchases are compared later in the report.
Purchase of assets
According to Hungarian legislation, a gain from the sale of assets is taxable for the company that sells those assets. The gain becomes part of the general tax base and is subject to 9 percent CIT.
Generally, the sale of assets is also subject to the standard VAT rate, which is currently 27 percent.
In addition, transfers of immovable property, vehicles and rights related to them are subject to transfer tax. The transfer tax base is the market value of the assets transferred. The standard rate of the tax is 4 percent for real estate up to 1 billion Hungarian forint (HUF) and 2 percent on the excess amount. The amount of the tax cannot exceed HUF200 million per plot number.
Therefore, the transfer of the real estate and any other asset mentioned earlier may trigger a transfer tax liability payable by the buyer.
The transfer pricing rules apply to sales of assets between related parties. In Hungary, the transfer pricing rules broadly comply with the Organisation for Economic Co-operation and Development (OECD) transfer pricing guidelines. The transfer pricing rules allow the tax authorities to adjust taxable profits where transactions between related parties are not at arm’s length prices.
Under changes to the Hungarian Accounting Law announced in 2016, goodwill and badwill can only arise in stand-alone financial statements if the acquisition is realized through item-by-item recording of assets and liabilities (i.e. asset deal). Goodwill and badwill cannot arise where the entity obtains qualified majority influence through the acquisition of interest in another company. In line with this treatment, the consideration (purchase price) paid on a purchase of interest is considered as the book value of the participation.
Under a transitional rule, where the book value of goodwill or badwill cannot be presented separately based on these new rules, an amendment should be made to the 2016 opening balance of the related participation. However, the goodwill or badwill should remain on the books where:
- the value of the badwill exceeds the 2016 opening balance of the related participation, and
- the relating participation can no longer be found in the books.
As of 1 January 2016, goodwill is depreciated over 5 to 10 years for accounting purposes if its useful lifetime cannot be estimated. A 10 percent tax depreciation may also be claimed for CIT purposes, if a declaration is made in the respective tax return that the circumstances of both presenting and canceling the goodwill in the books was in line with its intended purpose (i.e. not abusive). The previous regime did not allow the ordinary depreciation of goodwill for accounting purposes; however, an extraordinary depreciation might have been accounted for on goodwill (e.g. if the book value permanently and significantly exceeded the market value), which qualified as tax-deductible for CIT purposes.
For goodwill or badwill that may remain in the books despite the 2016 changes, the taxpayer may choose between applying the new rules or continuing with the rules that were in effect at the time the goodwill was recorded in the books.
The purchase price of the assets may be depreciated for tax purposes. The Act on Corporate Income and Dividend Tax stipulates the depreciation rates to be used for various assets. The depreciation rates for tax and accounting purposes may differ for certain assets.
According to the Hungarian legislation, any gain from the sale of assets is taxable for the company that sells them. The gain is part of the general tax base and subject to 9 percent CIT. The transfer pricing rules apply to sales of assets between related parties.
In general, the sale of assets is subject to the standard VAT rate, currently 27 percent. As of 1 January 2013, the transfer of a business unit may be out of scope of VAT if all of the following conditions are met.
- The acquirer acquired the business line with the aim of further operation.
- The acquirer is a Hungarian tax-resident entity (or becomes a Hungarian tax-resident as a result of the in-kind contribution).
- The acquirer undertakes an obligation to assume the rights and obligations prescribed under the Act on VAT in connection with the assets acquired (with certain exceptions) at the time of acquisition (e.g. monitoring period for properties).
- The acquirer does not have any legal status that would violate the above obligation (e.g. VAT-exempt activity).
- The activity of the business line is limited to the supply of goods and services giving rise to deduct the VAT.
- Where the acquired assets include real estate, if the seller opted for a VAT-able sale of real estate or the sale of real estate is otherwise VAT-able (e.g. new real estate), the buyer is obliged to opt for a VAT-able sale of real estate.
If these conditions are not met, the transfer of a business unit would be regarded as a single service provision based on the current approach of the Ministry for National Economy and the Tax Authority. Thus, the whole purchase price of the business unit would be subject to VAT at a rate of 27 percent.
If the assets to be sold include real property, as noted earlier, the buyer is liable to pay real estate transfer tax. As of 1 January 2010, the standard rate of the tax is 4 percent for real estate up to HUF1 billion and 2 percent on the excess amount. The tax is capped at HUF200 million.
No real estate transfer duty liability arises if the transfer is a result of a preferential transformation or preferential exchange of shares as defined by the CIT law and the acquirer is established (or has its place of effective management) in a state where:
- the effective CIT rate of the acquirer is at least 9 percent
- in the case of zero or negative financial result, the nominal CIT rate of the country is at least 9 percent
- the general domestic law of the acquirer’s country stipulates at least 9 percent tax on income from the sale of the participation.
Purchase of shares
As an incentive for establishing holding companies in Hungary, domestic or foreign participations could be considered as announced participations, which are reported to the tax authority within 75 days following the acquisition. (The participation limit is abolished as of 1 January 2018, and the reporting deadline was extended from 1 January 2014.) The capital gains on such participations held for at least 1 year are exempt from CIT. An investment cannot be treated as an announced participation, and therefore the special rules cannot be applied, if it is in a controlled foreign company (CFC). The rules for CFCs are discussed later in the report.
As of 1 January 2012, no further reporting is necessary if only the value of the reported shareholdings increases but the percentage of these shareholdings remains unchanged.
In a share acquisition, the buyer may benefit from existing supply or technology contracts of the target company and also from all permits, licenses and authorizations of the target company, unless the agreement between the parties stipulates otherwise.
Capital gains derived from the sale of shares in a Hungarian real estate company (REC) are generally taxable. Hungarian regulations define a REC as a company that owns among its assets at least 75 percent Hungarian-located real estate. As of 1 January 2014, the book value is considered for this purpose instead of the market value. The capital gains on the sale of REC shares are taxable if the quota/shareholders of the REC or a related party are resident in a country that does not have a tax treaty with Hungary or has a treaty allowing the taxation of capital gains in Hungary. Of course, any applicable double tax treaty might override this rule.
Tax indemnities and warranties
In a share acquisition, the buyer is taking over the target company together with all related liabilities, including tax liabilities. It is common practice for the buyer to conduct a due diligence investigation of the target company to identify potential risks. In addition, the buyer may require indemnities and warranties from the seller.
The tax losses generated by the target company transfer with the target company, so the target company keeps its tax losses after the sale of shares. However, due to several tax law changes, the potential utilization of such losses is subject to strict criteria.
As of 1 January 2012, tax losses may only be utilized for up to 50 percent of the tax base (calculated without the utilization of tax losses). This rule should also apply to tax losses previously carried forward. As of 1 January 2015, a general 5-year time limitation applies for tax losses arising in 2015 or later. Tax losses generated until the end of 2014 may be utilized by the end of 2030.
On a corporate restructuring (e.g. merger), previous losses can only be utilized by the legal successor: where the new owner (or its related-party company) acquiring direct or indirect majority influence in the successor had the same influence in the legal predecessor before the transformation (on the day preceding the effective date of the merger); and where the successor realizes revenue from at least one activity pursued by the legal predecessor for the 2 tax years following the merger. The activity test does not apply on liquidation or where the legal predecessor’s original activity was a holding activity.
Change in ownership restrictions may apply to the utilization of tax losses in the case of acquisitions. If the new owner acquiring direct or indirect majority influence was not related to the taxpayer continuously in the 2 tax years before the acquisition, available tax losses can only be utilized: where the acquired company carries out its activity for at least 2 years after the acquisition and it realizes revenue from this activity in both tax years; or where the company is listed on a stock exchange. The activity criteria requires the target company to continue and realize income from its activity without significant changes (e.g. holding activity instead of production activity is not allowed).
As of 1 January 2015, a further limitation was introduced on the utilization of available tax losses after group restructurings (e.g. mergers) and acquisitions. Under this limitation, tax losses may only be utilized in the proportion of the annual net revenues generated from the continued activities to the average revenue generated from such activities in the preceding 3 tax years.
The purchase of shares in an REC may be subject to real estate transfer tax where the buyer holds 75 percent or more of the shares.
Real estate transfer tax is payable by the buyer of the shares. The base of the transfer tax is the market value of the real estate transferred, prorated to the ownership ratio. As of 1 January 2010, the standard rate of the tax is 4 percent for real estate up to HUF1 billion and 2 percent on the excess amount. The tax is capped at HUF200 million per plot number. Therefore, if a real estate property is registered under several different plot numbers at the Land Registry, it qualifies as several separate real estate properties for transfer tax purposes. Starting in 2014, only share deals in RECs are subject to transfer tax (those having at least 75 percent real estate asset ratio for accounting purposes) and the activity criteria (i.e. application to only companies carrying on activity in real estate) no longer applies.
If an acquisition of shares is deemed a preferential exchange of shares, the gain on the shares may be deferred if all criteria set out in the Act on Corporate Income and Dividend Tax are met. In a preferential exchange of shares, a company (the acquiring company) acquires an interest in the issued capital of another company (the acquired company) in exchange for issuing to the acquired company’s member(s) or shareholder(s) — in exchange for their securities — securities representing the issued capital of the former company. If applicable, the acquiring company makes a cash payment not exceeding 10 percent of the nominal value or, in the absence of a nominal value, of the accounting par value of the securities issued in exchange, provided that the acquiring company obtains a majority of the voting rights in the acquired company or increases its holding if it already held a majority of the voting rights before the transaction.
As of 1 January 2012, tax on the preferential exchange of shares can only be deferred if there is a real economic or commercial rationale for such transactions.
Choice of acquisition vehicle
A foreign buyer has various options as its acquisition vehicle for the purchase of assets and shares, each of which might have different tax consequences.
Local holding company
The use of a Hungarian holding company might be favorable where the Hungarian company used a loan to finance the acquisition and could deduct interest paid on the debt from its CIT base.
A Hungarian holding company could also be used as a special-purpose vehicle in the case of a privileged transformation.
The Hungarian Tax Office recently started to challenge schemes involving the pushdown of debt into operations. Pre-clearance in the form of a binding ruling is strongly recommended.
Foreign parent company
The use of a foreign parent company generally would not have Hungarian CIT implications at the level of the foreign parent company (unless an applicable tax treaty allows for taxation of the capital gains of RECs).
Hungary does not levy withholding tax (WHT) on dividends paid by a Hungarian company.
Hungarian WHT on interest, royalties and certain service fees was abolished as of 1 January 2011.
Non-resident intermediate holding company
An intermediate holding company might be advantageous where the intermediate holding company is resident in a country that has a more favorable tax treaty with Hungary such that the tax on capital gains or dividends might be deferred or eliminated. Hungary has an extensive treaty network. The table at the end of the report shows the WHT rates agreed upon in the tax treaties concluded with Hungary.
In most cases, non-residents who do not wish to establish a Hungarian-registered company can conduct business in Hungary through branches registered with the Hungarian Court of Registration. Hungarian branches are treated similarly to any other CIT payer. Accordingly, profit transfers from the branch to the headquarters are considered as dividends, although they are not liable to WHT.
A Hungarian branch is subject to Hungarian CIT at 9 percent. The tax base of a branch is calculated based on the accounting profit of the branch, modified by the additions and deductions set out in the Act on Corporate Income and Dividend Tax.
The pre-tax profit of the branch should also be:
- decreased by the indirect head office costs (up to a maximum prorated based on the ratio between the turnover of the branch and the turnover of the foreign entity)
- increased by 5 percent of the income not attributed to the branch but earned through the branch
- increased by operating costs and expenses and overhead of the branch charged to the pre-tax profit or loss.
Relevant tax treaties may override these rules. As of 25 June 2015, amendments to the Hungarian CIT legislation require application of a progressive exemption method, provided the underlying tax treaty allows it. Under this method, when determining the Hungarian branch’s CIT base, the income taxable abroad is also considered.
There are no special tax rules for joint ventures in Hungary.
Choice of acquisition funding
A company may consider the following ways of financing the acquisition:
- equity financing
- debt financing through a loan (either provided directly by a shareholder or via a related or unrelated third party)
- a combination of equity and debt financing.
The main advantage of using debt for funding an acquisition as opposed to equity is the potential tax-deductibility of interest payments (see below). The debt might be borrowed from a related party or a bank. In the case of debt financing from a related party, interest deduction limitation (former thin capitalization) and transfer pricing rules should be considered.
Deductibility of interest
From 1 January 2019, new interest deduction limitation rules entered into effect as Hungary has adopted the EU Anti-Tax Avoidance Directive (ATAD) I. The former, equity-based, thin capitalization rule was replaced by a provision limiting the interest deductions based on the net borrowing costs and a so-called ‘tax EBITDA’ (earnings before interest, taxes, depreciation and amortization).
The concept of net borrowing costs took a profit and loss approach, considering the ‘expense’ balance of borrowing costs and (taxable) interest and similar income (financing costs higher than interest-type income). Net borrowing costs can be recognized in the corporate tax base up to 30 percent of the tax EBITDA or HUF939,810,000, whichever is higher. Special rules are applicable to tax groups for CIT purposes.
Application of the new interest deduction limitation rules is mandatory in Hungary from 1 January 2019. However, based on grandfathering rules, loans concluded before 17 June 2016 and not modified thereafter are subject to the former thin capitalization rules, unless the taxpayer opts to apply the new interest deduction limitation rules instead.
According to the former equity-based thin capitalization regulation, all interest-bearing liabilities are subject to thin capitalization rules in Hungary, except those from financial institutions and — as of 1 January 2012 — interest-free liabilities against related parties. According to the rules, the average daily amount of the equity must be compared with the average daily amount of loans. Under these rules, ‘liability’ means the average daily balance of outstanding loans, outstanding debt securities offered privately, bills payable (except for bills payable on suppliers’ debts and bank loans) and interest-free related-party liabilities.
The amount of liabilities could be decreased by the daily average amount of financial receivables, and receivables from supplied goods and services are not considered against liabilities. ‘Equity’ means the average daily balance of subscribed capital, capital reserve, profit reserve and tied-up reserves. Thus, the former thin capitalization regulation covered interest on loans granted by related and unrelated parties and also extended to bonds and other loan securities issued exclusively to one party (closed securities).
If the ratio exceeds 1:3, the portion of the interest exceeding the limit is non-deductible for CIT purposes. There are no other restrictions regarding interest payments. As a result, all interest not subject to thin capitalization rules on an entity’s external borrowings is tax-deductible on the same basis the interest is recognized for accounting purposes. However, general transfer pricing rules should also be taken into account; the interest applied between related parties should be at arm’s length.
If the interest payment is not at arm’s length, the CIT base of the company should be modified accordingly. If the payable interest rate is higher than the arm’s length interest rate, the CIT should be increased by the difference. By contrast, the tax base can be reduced where the interest is lower than the arm’s length rate, provided this difference is subject to an income tax at the creditor’s level.
Taxpayers are obliged to prepare detailed transfer pricing documentation by the deadline for the submission of the company’s annual CIT return. These records do not have to be filed with the tax return itself but must be available at the time of the tax authority investigations.
Interest income is exempt from local business tax in all cases (except for banks and licensed financial service providers). Recently, debt pushdowns have been subject to increased scrutiny by the Hungarian Tax Office, and many cases are now pending before the office and/or Hungarian courts. Before entering any such transaction, applying for a binding ruling is highly recommended. For now, there remains a relatively good chance for a positive result.
In line with the accounting practice changes, foreign taxes that correspond to corporate tax do not have to be added to pre-tax profits since these taxes are not accounted for as expenditures in the profit and loss.
Withholding tax on debt and methods to reduce or eliminate it
Hungary has concluded a comprehensive network of bilateral tax treaties for the avoidance of double taxation, based mainly on the OECD Model convention. These treaties set reduced rates of WHT for dividends, royalties and interest income. For royalties and interest paid from Hungary, domestic legislation provides unilateral exemption, irrespective of double tax treaties.
Checklist for debt funding
- Consider whether the level of profits would enable the deductibility of interest.
- Consider the net borrowing costs to the tax EBITDA for the purposes of interest limitation rules.
- Set arm’s length interest rates and prepare transfer pricing documentation.
In certain cases, the use of equity might be more advantageous for the buyer to fund an acquisition.
Due to the new interest limitation rules the net borrowing costs should be considered to the tax EBITDA.
Hungary has also passed the new anti-hybrid rules according to the provisions of ATAD II, which are effective from 1 January 2020. In the case of hybrid mismatches, generally the legal treatment or classification of a transaction under the same set of conditions between related parties is different in the countries in question and this mismatch in legal interpretation or classification results in tax avoidance. In other cases, a hybrid entity mismatch occurs if an entity is treated as transparent for tax purposes by one jurisdiction and as non-transparent by another jurisdiction. Therefore, taxpayers entering into transactions resulting in hybrid mismatches would not be allowed to treat related costs and expenses as tax-deductible for corporate income tax purposes in Hungary.
There are no special tax rules for the treatment of discounted securities in Hungary. The tax treatment of such securities follows the accounting treatment.
The taxation of capital gains derived from preferential transformation may be deferred, if all prescribed criteria for the preferential transformation in the Act on Corporate Income and Dividend Tax are met.
In addition to pure share and asset deals, mergers can provide further tax planning opportunities in Hungary. According to the Hungarian accounting rules, a merger may take place at book value or market value. For a merger at book value, the value of the assets and liabilities of the dissolving party is the same in the books of the legal successor. In this case, there are no tax consequences. For a merger at market value, the assets and liabilities of the dissolving party are revalued to market value.
According to the corporate tax law, any revaluation difference is taxable in the final tax return of the dissolving party. It is possible to defer the taxation of the revaluation difference where the merger is deemed to be preferential in line with the EU Mergers Directive.
A former advantage of a merger was that the losses of the legal predecessor could be carried forward during a transformation, taking into account the general rules; however, due to the amendments to the Act on Corporate Income and Dividend Tax, the restrictions noted earlier should be considered and the amount of carry forward losses would be limited.
Concerns of the seller
As noted earlier, capital gains generally are subject to 9 percent CIT, but may be tax-exempt if the capital gain is realized on an announced participation and all other criteria are met.
Generally, Hungary does not tax gains realized by non-resident companies, so a capital gain realized by a non-resident on the sale of shares in a Hungarian company is not subject to CIT. However, as of 1 January 2010, if the shares qualify as shares in a real estate company, capital gains on the sale of such shares are subject to CIT at 9 percent in certain cases, unless the selling company is registered in a country with which Hungary has a tax treaty that disallows source-country taxation.
If the seller of the shares is an individual, the capital gain on the sale of shares is probably subject to personal income tax.
Company law and accounting
The new Civil Code includes the general provisions on how companies may be formed, operated, reorganized and dissolved in Hungary. A separate act — Act on Transformations — includes detailed rules regarding transformations, mergers, demergers and termination without legal successor of legal persons.
The Civil Code recognizes four basic legal forms for carrying out business activities.
According to the new Civil Code, business associations with legal personality may be unlimited partnerships in the form Közkereseti társaság (Kkt.) and Betéti társaság (Bt.), or companies with limited liability in the form of either a limited liability company (Korlátolt felelösségü társaság — Kft.) or a company limited by shares, of which there are two types: private limited companies (Zártkörüen müködö részvénytársaság — Zrt.) and public limited companies (Nyilvánosan müködö részvénytársaság — Nyrt.).
The most common types of companies in Hungary are limited liability companies and private limited companies. Generally, when a company changes company form (such as a transformation from Kft. to Zrt.), the accounting and tax rules for mergers are applicable, including the rule that allows the assets and liabilities of a transforming party to be revalued to market value during the transformation.
According to the Civil Code, business associations may change company form, which means the transformation of the company to another type of business association (such as a transformation from Kft. to Zrt. as mentioned above) in line with the restrictions determined by the Civil Code. According to the Civil Code, business associations may also merge (amalgamation and assimilation) and demerge (division and separation). In assimilation, the target business association terminates and its assets devolve to the surviving business association as legal successor. The company that survives the merger becomes the general legal successor of the non-survivor.
An amalgamation is a process in which two companies merge into a newly formed company and simultaneously the merging companies cease to exist. The new company is the general legal successor of all properties, rights and obligations (liabilities) of the former companies.
For all forms of business associations, if the business association’s supreme body has resolved in favor of the merger, the executive officers of the combining business associations have to prepare the draft merger agreement. The required content of this agreement is set out in the Civil Code and the respective rules of the Act on Transformations.
Pursuant to the Civil Code, a demerger may take the form of a division or a separation. The supreme body of a business association may divide the demerged business association into several business associations.
In a division, the business association being divided terminates and its assets devolve to the business associations being established as legal successors through transformation.
In the course of a separation, the business association from which separation is effected continues to operate in its previous form following alteration of the articles of association, and a new business association is established with the participation of the separating members (shareholders) and use of part of the assets of the business association.
The supreme body of the business association also examines which members intend to become members of the legal successor business association. Members of the original business association can become members of one or all of the legal successor business associations. The executive officers of the business association prepare the draft terms of the demerger with content required by the Civil Code and the respective rules of the Act on Transformations.
The legal successors of demerging business associations are liable for the obligations of the original business association before demerger in accordance with the demerging agreement.
There is no pre-company period for a new business association coming into being through transformation. The new business association may choose any corporate form for operation, provided the requirements on the subscribed capital as well as further legal prerequisites for the given corporate form are met.
The members (shareholders) of the legal predecessor business associations may be declared liable for the obligations of the successor if the legal successor was unable to meet them.
Should an unlimited liability member of a business association become a limited liability member in the course of the transformation, that member remains liable on an unlimited basis for the obligations of the legal predecessor acquired before the transformation for 5 years after the transformation.
Limited liability members (shareholders) leaving a business association in the course of a transformation remain liable on a limited basis for the obligations of the legal predecessor for 5 years after the transformation.
The business association’s supreme body must pass a resolution on the transformation on two occasions. On the first occasion, based on the proposal of the executive officers and the supervisory board, the business association’s supreme body must establish whether the members of the business association agree on the intention to transform and decide into what form of business association the business association shall transform. If the business association’s supreme body agrees on the transformation, the executive officers shall prepare:
- the draft balance sheet and an inventory of assets of the business association undergoing transformation
- the draft (opening) balance sheet, an inventory of assets and draft articles of association of the business association being established through the transformation
- the proposal on rendering accounts with those persons not intending to take part in the legal successor business association as members.
The business association’s supreme body must then resolve to approve these drafts. Within 8 days of the second decision, the business association must publicly announce its decision on its transformation.
A business association undergoing transformation may revalue its assets and liabilities as shown in the balance sheet of the report prepared pursuant to the Accounting Act.
If a business association does not possess equity corresponding to the minimum subscribed capital prescribed for its form of business association in 2 consecutive years, and the members (shareholders) of the business association do not provide for the necessary equity within 3 months after approval of the report prepared pursuant to the Accounting Act for the second year, the business association is required to resolve for transformation into a different business association within 60 days after the deadline expires.
The transformation is effective as of its date of registration by the companies’ court. The business association being established through transformation is the legal successor of the business association undergoing transformation. The legal successor is entitled to the rights of the legal predecessor, and the obligations of the legal predecessor passes to the legal successor, including obligations contained in any collective agreement concluded with the employees.
Merging companies must prepare balance sheets and inventories of assets on two occasions: drafts must be prepared to support the decision of the owners on the merger; and final documents must be prepared on the date of the merger (i.e. the date when the merger is registered by the court).
Companies ceasing operations (which merge into others) as a result of the merger must prepare annual financial statements on the date of the merger. The merger date constitutes a year-end for such companies, such that all closing procedures must be carried out with reference to this date.
The date of the merger does not constitute a year-end for companies continuing to operate in the same company form after the merger, so they must not close their books — the transformation must be accounted for in the normal course of bookkeeping.
A balance sheet prepared pursuant to the Accounting Act may be accepted as the draft balance sheet of the business association undergoing transformation if the reference date is no more than 6 months earlier than the second decision on the transformation.
Pursuant to the Accounting Act, a business association undergoing transformation may revalue its assets and liabilities as shown in the balance sheet of the report prepared. The draft balance sheet and an inventory of assets must be examined by an auditor and, if a supervisory board operates at the business association, by the supervisory board. The usual auditor of the business association is not entitled to conduct this examination. The value of the assets of the business association and the amount of its equity may not be established at a value that is higher than the value accepted by the auditor.
As of 1 January 2019, taxpayers are able to opt for a group taxation regime for CIT purposes. Group taxation is available to related companies resident in Hungary for tax purposes, provided that such related companies have at least 75 percent direct or indirect control over each other, have the same year-end date and prepare their financial statements based on the same accounting standards (Hungarian General Anti-Avoidance rules (GAAR) and International Financial Reporting Standards (IFRS)).
By opting for group taxation, group members are able to offset their operating losses and tax incentives (becoming available following the date when the group taxation was entered into by the members) against the positive tax base, or tax payable of another group member if certain conditions are met, as well as apply simpler transfer pricing rules to the intragroup transactions.
Group taxation can be chosen for VAT purposes as well.
Hungary’s transfer pricing rules broadly comply with the OECD transfer pricing guidelines. The rules allow the tax authorities to adjust taxable profits where transactions between related parties are not at arm’s length. The current legislation prescribes not only the methods applicable for determining a fair market price but also the way in which these must be applied. The taxpayer may calculate the fair market price using any method, provided it can prove that the market price cannot be determined by the methods included in the Act on Corporate Income and Dividend Tax and that the alternative method suits the purpose.
Since 2005, these rules should also be applied to transactions where registered capital or capital reserve is provided in the form of non-cash items, reduction of registered capital or in-kind withdrawal in the case of termination without successor, if this is provided by or to a related party of the company.
Taxpayers are obliged to produce detailed transfer pricing documentation. This documentation should be prepared by the deadline for the submission of the annual CIT return of the company. These records do not have to be filed with the tax return itself but must be available at the time of the tax authority investigations.
‘Related parties’ are defined in the Act on Corporate Income and Dividend Tax to include the following parties for transfer pricing purposes:
- the taxpayer and an entity in which the taxpayer has a majority interest, whether directly or indirectly, according to the provisions of the Civil Code, which means that it controls more than 50 percent of the votes
- the taxpayer and an entity that has a majority interest in the taxpayer, whether directly or indirectly, according to the provisions of the Civil Code
- the taxpayer and another entity where a third party has a majority interest in both the taxpayer and such other entity, whether directly or indirectly, according to the provisions of the Civil Code
- a foreign enterprise, its domestic place of business, and the business premises of the foreign enterprise, the domestic place of business of a foreign enterprise and the entity that is in the relationship defined earlier with the foreign enterprise
- the taxpayer and its foreign place of business, and the foreign place of business of the taxpayer and such entity that is in the relationship defined earlier
- as of 1 January 2015, the taxpayer and the other person may qualify as related party if dominating influence is exercised in business and financial decisions due to common management.
Majority interest also occurs where any party has the right to appoint or dismiss the majority of executive officers and supervisory board members. The voting rights of close relatives are taken into account jointly.
The default penalty for not preparing the transfer pricing documentation is HUF2 million for each missing or incomplete document set. As of 1 January 2012, the default penalty could be increased for repeated transgressions.
The documentation can be prepared in a language other than Hungarian.
There are no special rules for dual resident companies in Hungary.
Foreign investments of a local target company
The Act on Corporate Income and Dividend Tax includes CFC provisions, which aim to prevent Hungarian companies from transferring their profits to low-tax jurisdictions. In order to be compliant with ATAD I, the definition of CFC was modified from 1 January 2019. The basic concept remained unchanged; however, the concept of real economic presence has been replaced by the genuine arrangement concept. According to the legislation in effect from 1 January 2019, ‘CFC’ is defined as a foreign entity, in which a Hungarian tax resident company (by itself or together with its associated enterprises):
- holds a direct or indirect participation of more than 50 percent of the voting rights
- owns directly or indirectly more than 50 percent of registered capital, or
- is entitled to receive more than 50 percent of the after-tax profit of that foreign entity
and, simultaneously, the actual corporate tax paid by the foreign entity is less than half of what the foreign entity would have paid if it were a Hungarian resident entity (using Hungarian accounting and tax rules). As a result, a foreign entity with an effective tax rate lower than about 4.5 percent (assuming the foreign rules are largely identical to the Hungarian rules) is described by the following CFC definition.
- A non-Hungarian branch/permanent establishment (PE) of a Hungarian resident company if the actual corporate tax paid by this non-Hungarian branch/PE is less than half of what its theoretical tax liability would have been if it were located within Hungary.
A foreign company or PE is not considered as a CFC in the given tax year, if
- its income arises from genuine arrangements (which must be proved by the taxpayer)
- its accounting profits do not exceed a certain limit, while its non-trading income does not exceed the threshold set by the law, or its accounting profits do not represent more than 10 percent of its operating costs for the tax year in question.
However, as an exemption from the general CFC rule implemented from ATAD I, a PE does not qualify as a CFC if the PE is located outside the EU or European Economic Area and that state has concluded a Double Taxation Treaty with Hungary, which prescribes that the income attributable to the PE shall be exempted from tax in Hungary.
Furthermore, as of 1 January 2021, companies having a tax residence or branches located in a non-cooperative jurisdiction for tax purposes are treated as CFCs. Based on the Hungarian regulation the following countries are listed as non-cooperative jurisdictions: American Samoa, Anguilla, Barbados, Fiji, Guam, Palau, Panama, Samoa, Seychelles, Trinidad and Tobago, American Virgin Islands and Vanuatu.
The application of Hungarian CFC rules may trigger various tax consequences. Hungary introduced a new anti-deferral rule as of 2010 for any undistributed profits in the CFC at the level of the Hungarian corporate shareholder.
Additionally, dividends distributed by a CFC cannot benefit from the participation exemption and thus are included in the Hungarian company’s CIT base. Further, capital gains derived from the sale of participations in a CFC cannot benefit from the available participation exemption for CIT purposes and so they are fully taxable in Hungary.
Realized capital losses and expenses related to a reduction in the value of a holding in a CFC, or from the disposal of such holding, increase the CIT base of a resident company insofar as the losses and expenses exceed the income booked in relation to the same transaction.
Payments made to CFCs may not be deductible for CIT purposes unless the taxpayer proves they are directly related to the operation of its business.
Comparison of asset and share purchases
Advantages of asset purchases
- No assets other than those specifically identified by the buyer are transferred.
- No employment or contractual relationships need to be assumed from the seller unless the buyer wishes to do so; thus the buyer could offer employment to the people it needs under revised salary and working conditions.
- Purchase price may be depreciated for tax purposes.
- Historical tax liabilities of the seller are not inherited.
Disadvantages of asset purchases
- Possible need to renegotiate supply, employment and technology agreements.
- If real estate is transferred, real estate transfer tax applies.
- Arm’s length consideration should be paid on the transfer of selected assets between related parties.
- VAT is due on the asset acquisition, which can lead to cash flow timing issues and, in the worst case, a VAT cost.
Advantages of share purchases
- Potentially lower capital outlay (purchase net assets only).
- May benefit from tax losses of the target company (subject to certain criteria as of 2012).
- May gain benefit of existing supply or technology contracts.
- No VAT to pay.
- Buyer may benefit from all permits, licenses and authorizations, unless stipulated otherwise.
Disadvantages of share purchases
- Buyer automatically acquires any liabilities of the target company (including tax liabilities).
- Liable for any claims or previous liabilities of the target.
- Could be subject to real estate transfer tax as of 2010.
KPMG in Hungary
KPMG Tanácsadó Kft Váci út 31
T: +36 1 887 73 29
This country document does not include COVID-19 tax measures and government reliefs announced by the Hungarian government. Please refer below to the KPMG link for referring jurisdictional tax measures and government reliefs in response to COVID-19.
Click here — COVID-19 tax measures and government reliefs
This country document is updated as of January 31 2021.