From 1 January 2021 the corporate taxation rules on creating a permanent establishment in Hungary were tightened in general. However, widening the definition of permanent establishment in domestic law to include service permanent establishments does not automatically generate a corporate tax payment liability in Hungary, including the additional administration, for all businesses. To see which entities have to consider the extended rules the most, Hungarian law and the current conventions for the avoidance of double taxation must be interpreted together.
Definition of service permanent establishments
Based on the Hungarian definition, you might first think that a corporate tax permanent establishment means a permanent business establishment, equipment and accessories used by the taxpayer in whole or in part for business activities.
However, under the amended legislation, from 2021 a corporate tax permanent establishment may also be created for foreign service providers who, in the absence of a physically identifiable place of business in Hungary, only carry out their activities through their employees or natural persons with whom they have some other legal relationship.
Yet another condition in Hungarian law for setting up service permanent establishments in Hungary is that the duration of the service provision in Hungary, whether continuous or interrupted, should exceed 183 days in any 12-month period. In addition, when calculating the service period, related and associated services must be taken into account together.
Hungarian definition and international conventions
For tax issues arising in international transactions, where two countries are involved in determining the tax liability, the bilateral tax conventions in force should always be examined. And the principle of the primacy of international conventions must always be taken into consideration during this review.
As discussed in our previous article, the Hungarian definition of a corporate tax permanent establishment is basically consistent with the OECD Model Tax Convention. However, there are deviations in several cases from the Tax Model Convention in the conventions for the avoidance of double taxation signed and adopted by the Contracting States.
It is important to clarify that if two states have an agreement in force on the avoidance of double taxation, service permanent establishments may only be created in Hungary if the convention concluded with the state where the service provider is resident sets forth the rules for such an arrangement.
However, only a limited number of conventions existing with Hungary provide for the creation of a permanent establishment for service provision. Apart from relatively recent conventions with more distant countries (such as the United Arab Emirates, Qatar or Saudi Arabia), there are hardly any conventions with countries geographically closer to Hungary that have been in force for a lengthy period (e.g. Slovakia, Czech Republic) in which such a provision can be found.
Moreover, contrary to the Hungarian definition of a permanent establishment, in some international conventions a service provision of a shorter duration (e.g. three or four months in the case of Indonesia or Armenia) may allow for the creation of a permanent establishment, rather than 183 days.
For states with which there is no convention in force for the avoidance of double taxation, the definition of the Hungarian Corporate Tax Act applies; in these cases, the provision of services for a period exceeding 183 days may give rise to a corporate tax permanent establishment.
Administrative obligations and other taxes
Service permanent establishments may result in a registration obligation in Hungary as well as corporate tax return and payment obligations. It often happens that the service provider and the recipient are related companies. In such cases, it must be examined separately whether there are any obligations on transfer pricing records under Hungarian rules. Justifying compliance with transfer pricing guidelines can be a challenge, especially when pricing cross-border management services.
In Hungarian law there are different definitions for the permanent establishment in the Companies Act, in the Local Tax Act, and even in the VAT Act, therefore the possibility of setting up a permanent establishment must be examined separately for the various tax types.
In the case of service arrangements with multiple parties it is not always easy to determine which business is likely to be exposed to the risk of service permanent establishments and to the associated administrative burden. To understand this, let’s look at the short example below.
A German parent company hires an independent Slovak company to provide consultancy (or management, as the case may be) services for a Hungarian subsidiary at a fixed location. The question arises as to whether the German, the Slovak, or even both companies can set up a permanent establishment in Hungary.
Under the arrangement, the Slovak company provides the service through its own employee to the German company as the client, which then acts as an intermediary for the Hungarian subsidiary. If the activities carried out in Hungary last for a total of at least six months in a 12-month period, the Slovak company must establish a corporate tax permanent establishment in Hungary under the convention with Slovakia. However, the German company should not be exposed to this risk, as it does not provide services through its own staff or through a natural person with whom it has another legal relationship.
If the same service is provided by a German company by authorising a Slovak private individual, then based on the provisions of the convention concluded with Germany, the risk of service permanent establishments in Hungary does not arise for the German company (nevertheless, personal income tax and employer registration issues may emerge).
In all cases, the risk of service permanent establishments therefore depends on the type of service, the circumstances in which it is provided, and the different provisions of the various conventions and local legislation. For these reasons, care should be taken when entering into a cross-border service contract to avoid tax risks.
If you need support regarding the tax treatment of complex cross-border service arrangements, assessing the risk of service permanent establishments or, where appropriate, the entire administration related to permanent establishments, you can rely on our colleagues. The tax advisory team at WTS Klient Hungary has significant expertise in the taxation of various international transactions. Feel free to contact us.