July is just around the corner. This is an important date for companies paying corporate tax because it signals the start of corporate tax advance payments for the current year, based on the profits of the previous year. What is the logic behind this system and how was it affected by the cut in the corporate tax rate this year? Besides this, is there really a need to top up corporate tax at the end of the year? These are the questions I will be seeking to answer in this article.
How does corporate tax finance the state budget?
For companies that prepare annual financial statements on the calendar year, the deadline for filing corporate tax returns is 31 May of the year following the reporting year. According to the original intention of the legislators, companies with payable corporate tax in excess of HUF 5 million (approx. EUR 16,000) have to pay the same amount in 12 equal instalments as a tax advance from July of the year after the reporting year to June in the following year (for tax amounts less than HUF 5 million (approx. EUR 16,000) the same applies just in 4 instalments, starting three months later). The logic behind this rule is that a given company should contribute to financing the state budget in a given year in Hungary, up to the level of its profit in the previous year, with regular and balanced tax advances.
This relatively well-established system was shaken up a little with the introduction of the new, uniform, single-rate corporate tax of 9% in 2017. For companies with a corporate tax base of less than HUF 500 million (approx. EUR 1.6 million) and therefore paying a preferential rate of 10%, this did not bring about any significant change, but for those with tax bases in excess of HUF 500 million (approx. EUR 1.6 million) and paying corporate tax of 19%, the legal amendment signalled a significant reduction. However, paying their previous year’s corporate tax amount as a tax advance meant these companies would likely have made considerable overpayments in comparison to their actual liabilities. The amendment to the law contained a relatively complex transitional rule to solve the problem.
Reduction in corporate tax advances too
It is easy to understand that the tax advance payable monthly from July 2017 to June 2018, which had to be recorded in the 2016 corporate tax return, no longer correlated with the previous year’s tax but with 9% of the previous year’s tax base. This way, companies pay tax advances over 12 months that tally with their tax payment liability assuming their tax base remains unchanged. However, something also had to be done with the surplus tax advances that would have been paid by these companies in the first half of 2017, compared to the amount of actual tax they had to pay in the first six months of 2017, again assuming an unchanged tax base. This resulted in the following transitional rule in Hungary:
“For taxpayers applying a 19% rate in 2015, the tax advance for the first half of 2017 is 50% of the amount equal to 9 nineteenths of the tax payable in 2015 plus HUF 20 million (approx. EUR 64,000), as determined by the NAV in a resolution by 15 January 2017.”
The “9 nineteenths” rule is just about understandable, but why did this have to be raised by HUF 20 million (approx. EUR 64,000)? Nobody in the profession has yet managed to figure this out. The preferential 10% tax payable on tax bases less than HUF 500 million (approx. EUR 1.6 million) clearly distorted the “9 nineteenths” ratio, but quite why this was rectified by adding HUF 20 million (approx. EUR 64,000) lacks all logical reasoning in my opinion. Given that we are not talking about actual tax payments, and only tax advances, it would perhaps have been simpler if the taxpayers subject to the 19% rate (too) could have halved their tax advance payments for the first half of 2017.
What is the point of topping up corporate tax payments?
Hungarian Taxpayers which had net sales revenues in excess of HUF 100 million (approx. EUR 320,000) in the year prior to the reporting year must estimate their entire annual tax liability by the 20th of the last month of the given financial year, and pay the difference between this amount and the tax advances already paid.
How does the system work?
Alongside the tax advance system outlined above, which itself is not overly simple, it makes no sense to have to estimate corporate tax by 20 December (or by the 20th of the last month of the financial year if the company follows a different financial year), and pay the difference taking the paid tax advances into account. Those who invented this extra payment liability clearly never worked at any company with responsibilities for calculating annual profits!
Eleven days prior to the reporting date, and often 2 or 3 months before the balance sheet preparation date, not even companies with the most sophisticated IT systems know their profit for the reporting year. The pre-tax profit and thus the corporate tax base are heavily influenced by year-end accruals, turnover-related bonuses and group accounting. There are also many items that can increase or decrease a company’s corporate tax base, and it is not easy taking these into account months before the financial statements are prepared either.
If the tax advances paid during the year and the top-up payment at the end of the year are collectively less than 90% of the actual corporate tax payment liability, which is assessed only 5 months later, then a default penalty becomes payable amounting to 20% of the difference. And all because, several months before preparing its annual financial statements, the company did not know precisely how external factors would impact on its profit. What is more, the tax authority is unrelenting in its levying of default penalties. If the top-up payment is transferred one day late because the authorised signatory was perhaps not in Hungary the day before, the penalty is imposed in full amount and without exception.
I have my suspicions that this system serves only one purpose: in order to avoid the significant default penalty, companies pay tax advances and make their top-up payments at amounts which exceed their actual corporate tax payable, thereby financing the state budget interest-free for 5 months from the end of the year. With economic growth of 4% and a budget deficit of less than 2%, now is perhaps the time to abolish this economically unjustified system.