Foreign companies wanting to set up operations in Hungary, but without establishing a Hungarian company, generally come to us with two questions. The first is whether their activity creates a permanent establishment (corporate tax permanent establishment) in Hungary from an income tax perspective. The second question is how the OECD’s BEPS actions and the action by the EU to combat tax evasion will have an impact in Hungary in practice.
Corporate tax permanent establishment – Hungarian definition
In an earlier article we looked in detail at the definition of a VAT fixed establishment, and what establishing a VAT fixed establishment involves. The definition in the Hungarian law on corporate tax differs from the definition of a VAT fixed establishment. In this case, it means a permanent business establishment, equipment and accessories used by the taxpayer in whole or in part for business activities, irrespective of the legal grounds on which the taxpayer is entitled to use them. If we compare this with the Commentary on the OECD Model Tax Convention, we find that the Hungarian definition is consistent with the Model Commentary definition and explanation, and the Hungarian legislation also lists the auxiliary activities that do not create a permanent establishment.
Of course, whether a corporate tax permanent establishment is created depends on the activity carried out by the foreign company in Hungary as well. This is not primarily a tax issue, but it is important to examine whether the nature of the activity necessitates the establishment of a company or at least a branch based on the provisions of the Act on Foreign Investments in Hungary. Questions about permanent establishments arise most frequently in relation to construction activity, sales/agency activity, and warehousing, together with goods supplies made from such storage facilities. In the case of construction, a period of 3 months is sufficient to create a permanent establishment based on Hungarian rules. Activities carried out by agents can require a permanent establishment if they can conclude a contract in Hungary on behalf of the foreign company. However, a warehouse shall not qualify as a permanent establishment if it is only there for the purpose of preparatory and auxiliary activities.
EU and OECD initiatives
The provisions of international conventions override Hungarian rules. For example, a German company can carry out construction and assembly activities in Hungary even for 11 months based on the treaty in force on the avoidance of double taxation. The reverse is also true of course, so a Hungarian construction company does not have to pay any income tax either on a construction project lasting 11 months in Germany. The EU Recommendation encourages Member States to revise their definition of permanent establishment in line with the wording agreed in BEPS. The aim is to address the current situation, whereby some companies exploit weaknesses in the definition to avoid having to register a corporate tax permanent establishment in the country where they are active.
In 2016 the OECD put together a Public Discussion Draft – Additional Guidance on the Attribution of Profits to Permanent Establishments 4 July – 5 September 2016, for Action 7 of the BEPS. This 40-page long discussion draft uses examples to present the stricter position of the OECD, mainly in relation to commissionaire arrangements and warehouses. If these new rules have to be applied in practice, the administrative burdens for global enterprises will certainly rise, and it will not be easy to determine how the profit earned on a given transaction, as the tax base, is split proportionally between the parent company and the permanent establishment. In Hungary, we cannot yet tell how these initiatives will be implemented in practice.
What does having a Hungarian corporate tax permanent establishment mean?
First and foremost, it means more administration. Once we have determined that a permanent establishment has been created, this has to be reported to the Hungarian tax authority (NAV) alongside requesting a tax number. If registration for corporate tax purposes is required besides an existing VAT registration in Hungary, this change has to be reported; the foreign company does not receive a new tax number, only one that can be used for corporate tax as well. Registering a permanent establishment means that tax returns have to be filed too. Failure to register can result in a default penalty. In principle this means anything up to HUF 500,000, or roughly EUR 1,600, and a separate default penalty can be imposed for unfiled tax returns. When calculating the tax payable by the permanent establishment, attention must be paid to the special tax-base modifying items under Hungarian law, in relation to management costs and expenses, and to transfer pricing rules. Assessing the tax base properly is crucial, since no tax authority in any country likes to relinquish tax revenues, and they come down hard on taxpayers who do not pay their taxes. In light of all this, when registering permanent establishments and calculating their tax bases we recommend engaging the help of our tax consultants.
