In the summer months, many businesses start their next annual planning. The finance and controlling departments can start to calculate profits in light of the sales revenue plans of the sales team and the wage cost estimations of the HR department. At this point, taxes depending directly or indirectly on profits soon come to the fore. Year after year, the moment comes when we are repeatedly taken aback by the unexpectedly high local business tax lurking behind the percentage rate of corporate tax.
Why are we surprised?
We are prone to form opinions based on appearances. And the 2% rate of local business tax can easily throw us off guard. It is generally accepted among company managers that local governments also need the taxes of the companies operating in their area. The 2% rate actually seems quite fair.
I often wonder whether all company managers in Hungary are aware that the base for local business tax is many times that of corporate tax. Although we officially consider local business tax to be an income tax, the tax base comprising net sales revenue less only a few material-type expenses is more reminiscent of a sales tax. When calculating the local business tax base, neither the costs of service invoices that make up serious amounts at businesses, nor total wage-type expenses, depreciation or other expenses can be deducted. Do not be surprised if your business pays a local business tax that greatly exceeds the level of corporate tax.
Systemic error that needs fixing
Investments that drive economic growth naturally enjoy the support of economic policymakers. The use of EU funds for economic development purposes (primarily through the support of small and medium-sized companies) and state funds provided for the investments of multinational companies significantly reinforce the investments of businesses that underlie long-term growth. As part of economic policy, tax policy should focus on encouraging investments. We see good examples of this in the case of corporate tax, just think about the generous tax-cutting opportunities of development tax allowances. However, regarding local business tax in Hungary, we see no signs of any similar efforts. In the years following the commissioning of investments, depreciation is the expense that companies can account for. However, this expense does not decrease the local business tax liability of the companies.
We see a similar anomaly in employees’ wage-type expenses. The wage agreement concluded at the end of 2016 offers a historical chance for employees in Hungary for an accelerated increase of wages. The government is contributing to realising this economic policy goal by decreasing the social contribution tax, and employers, in turn, by increasing gross salaries. Local business tax ignores this intention. No matter how much wage-type expenses of companies grow, the local business tax base remains unchanged, so the amount of tax does not decrease either. With constant sales revenues and expenses excluding wages, the increased wage-type expenses decrease the pre-tax profit, but the local business tax, which theoretically counts as a profit tax, remains unchanged.
Another danger: property tax
As a result of the above, profit-generating enterprises can “only” complain that a significant portion of their expenses does not affect their local business tax. But what should businesses say that make losses, even only temporarily?
A company can book even 15-20% of its net sales revenue as a loss, but it can still be sure that the base for its business tax will definitely be positive, so it will still have a local business tax obligation.
Operating a business always comes with risks for the owners. A booked loss decreases a company’s assets. However, further decreasing assets by having companies pay what is theoretically a profit-based local business tax should definitely be avoided. It is good to know that in Germany, which is often referred to as an example, the constitutional court qualified all similar interventions by the tax authority as unconstitutional as they endanger freedom of ownership.
What is the solution?
Local business tax is the third largest income-generating tax after sales taxes and personal income tax at the level of the national economy. It is obvious that with the current rate of 2%, there is no chance of bringing this tax base close to the corporate tax base. In Hungary local business tax plays an important role in the financing of local governments, so there is no real chance for it to be drastically reduced. With a gradual increase in the tax rate and a simultaneous, gradual approval of the deduction of the afore-mentioned expenses from the tax base, local business tax revenue would remain unchanged and, parallel to this, a greater proportion of company profits would be expressed in the amount of tax payable.
Prior to making an investment decision, serious investors always calculate the so-called effective tax burden based on the taxes charged in the given country. If we stop communicating economic policy merely at the level of tax rates, and show our regional tax benefit for potential investors in terms of the effective tax burden in the area of income taxes, including the advantage of transparency, which should not be underestimated, we can achieve serious economic development.
Let’s get to it!
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