The 2017 tax change that triggered the biggest reaction among companies was the introduction of the uniform 9% corporate tax rate. It is worth checking out how foreign investors respond to this change, and how this decision by the government will affect their Hungarian investments.
Corporate tax rate cut may favour large corporations
Those foreign investors whose Hungarian subsidiaries have a corporate tax base of less than HUF 500 million will experience a minor, 1 percentage point decrease when preparing their 2017 corporate tax returns, similar to local SMEs. For them, the corporate tax rate cut is mainly psychological in nature. Large corporations whose tax bases are multiples of the HUF 500 million mark that enjoyed the favourable 10% tax rate so far stand to win much more with this reduction in corporate tax.
This seemingly favourable situation is nuanced by two factors in the case of large corporations operating in Hungary.
1. Corporate tax base and corporate tax allowances
One factor is that Act LXXXI of 1996 on Corporate and Dividend Tax defines significant corporate tax base and corporate tax allowances not only for SMEs, but also for large corporations that carry out major projects or significant research and development activities.
1.a. Development reserve
Companies may allocate a reserve that can be taken into account as a disallowed item for tax purposes, up to 50% of their pre-tax profits, but no more than HUF 500 million. The development reserve allocated in this way can be used to buy tangible assets. In the case of tangible assets acquired from the development reserve, no depreciation can be claimed in corporate tax up to the amount of the development reserve used. In such cases, depreciation is essentially charged earlier. The amount of the development reserve can be used for projects within four years.
1.b. Double deductibility of direct research and development costs
Another significant opportunity for lowering tax bases is that pre-tax profits can be decreased by the direct cost of research and development performed in the fiscal year in connection with the business activity, or in other words, the depreciation charged to an amount recognised as the capitalised value of experimental development may be used to decrease pre-tax profit. Thus the pre-tax profit may actually be decreased twice, with the costs of research and development or with the depreciation charged to the capitalised value.
1.c. 80% corporate tax allowance
The lower corporate tax achieved by decreasing the tax base can be further reduced with a direct tax allowance if a large corporation carries out a project with a value higher than HUF 3 billion (HUF 1 billion in the administrative territory of the beneficiary municipality, or HUF 100 million in certain industries), and fulfils certain additional conditions regarding future employment. In this case, an 80% corporate tax allowance applies for the fiscal year when the investment was commissioned, and in the following nine fiscal years.
Thanks to these three most significant allowances alone, even before 2017 it was possible to lower the effective corporate tax rate of a large corporation to 2-8%, which would have been 15-18% without the allowances. With an unchanged tax base or tax allowance, these companies can calculate with a uniform tax rate of 9% from 2017, thus their tax burden will be almost halved, dropping to 1-4%. However, the corporate tax saved in this way only makes up 1-4% of their tax base, or 1-2% of their pre-tax profit at most.
2. Business tax that exceeds corporate tax several fold
The fact that foreign companies take local business tax into account when calculating their “effective tax rate” further mitigates the effect of the tax-cutting measure. Since the local business tax base is several times the size of the corporate tax base (net sales revenue can only be reduced by material costs and mediated services), the seemingly innocent 2% tax can reach 6-10% of profit after tax. If we calculate with 6% only, the effective tax rate including corporate and business tax will be around 7-8%. Compared to the 8-12% of previous years, this represents a much smaller saving than the decrease of the 10 and 19% rates to the uniform 9% would imply.
Taxation conditions improving overall
Despite all this, the introduction of the 9% corporate tax rate points in the right direction, and together with the 5 percentage point decrease in the social contribution tax imposed on employees it could make Hungary a more appealing destination for investment. However, the gradual convergence of the local business tax base to the corporate tax base remains to be solved.