The time has come again to prepare financial statements, annual corporate tax returns and local business tax returns. For many companies belonging to a multinational group, this means that the pricing of transactions between related companies, year-end transfer pricing adjustments and the inclusion thereof in tax returns along with the obligation to prepare transfer pricing documentation are highlighted on the corporate agenda. In this article we cover the most important aspects of the individual tax types and draw attention to the challenges of local business tax.
Which tax types are affected by transfer pricing adjustments in Hungary?
Compliance with transfer pricing rules requires related companies to set the pricing of their intra-group transactions according to the arm’s length principle. Since this is not always possible for individual orders during the year, prices applied over the year are often adjusted by the parties to arm’s length prices at the end of the year. An intra-group review of transfer pricing adjustments is essentially necessary for the purposes of income taxes. However, in Hungary, in addition to corporate income tax, transfer pricing adjustments can also have an impact on the local business tax base (which type of tax carries turnover tax elements), or on the innovation contribution and even on VAT returns in certain cases.
How do you handle such adjustments?
Adjustments can be performed in several ways. The first question that usually arises is whether the adjustment should only appear as a corporate income tax base adjustment item, or as an accounting adjustment.
According to the rules of the Hungarian Act on Accounting and in line with underlying contractual provisions, related companies have a chance to include in their accounting records a subsequent adjustment of the consideration for assets and services sold and acquired in the ordinary course of business during a specified period as an adjustment of the original transaction amount, i.e. to adjust the consideration of their transactions to market price, thereby avoiding the tax base adjustment under the Corporate and Dividend Tax Act.
The Hungarian Act on Accounting stipulates that these adjustments must be reported (based on the accounting document issued for the subsequent adjustment) as part of the asset’s acquisition value; as a change to a cost or expense in the case of services purchased; and as net sales revenue in the case of sales.
Double taxation problems and the special status of local business tax
Of course, the accounting does not just affect corporate income tax, it is highly important for the purposes of local business tax as well. Local business tax is a tax type based on net sales revenue, so transfer pricing adjustments accounted for as other income would not essentially have an effect on the local business tax base, while the adjustment reported as part of the net sales revenue is subject to local business tax as well as corporate income tax.
Prior to the change in legislation valid from the 2021, the Act on Local Taxes did not include any specific rules for transfer pricing adjustments. However, it follows from the general rules of the Act on Rules of Taxation that upon calculating individual local business tax base components, related companies must consider if a tax base component is derived from a transaction in which the contractual price differs from arm’s length conditions.
For local business tax, adjustments due to the arm’s length price apply to related companies who are subject to this obligation under the Corporate and Dividend Tax Act. An entity obliged to apply arm’s length prices based on the Corporate and Dividend Tax Act may determine net sales revenues or the cost and expense decreasing net sales revenues on the basis of the arm’s length price defined under the Corporate and Dividend Tax Act. An adjustment aimed at reducing the tax base is only possible if the entity has a statement from its business partner that the latter performs an opposite tax base adjustment in the same amount. If the business partner is not subject to local business tax (a foreign entity, or a domestic entity that only has a registered office or permanent establishment in a municipality where local business tax is not applicable), the statement must specify that the entity will apply the adjustment in the tax type corresponding to local business tax or, in the absence of such a tax, in corporate income tax or in the foreign tax similar to corporate tax.
For multinational groups, taking local business tax into account has always been difficult, and it can make up a significant portion of total Hungarian tax liability. In the system of direct taxes, it would be ideal if transfer pricing adjustments worked for all companies affected, i.e. for example, a tax base increase due to transfer pricing adjustments in Germany would be matched with a tax base adjustment (deduction) at the Hungarian subsidiary. We can perform this under the framework of double tax treaties and their principles since such treaties include separate rules for the prices applied between related parties. However, not all tax treaties specify local business tax as a tax type that can be considered and this can lead to double taxation in the case of local business tax adjustments.
What happens to VAT?
To judge when transfer pricing adjustments modify the invoiced amount of previous product sales or service provision (this requires the correction of the invoices and VAT returns) and when we are only talking about other financial and profitability adjustments (where no correction invoice is issued and no direct link exists with a previous individual transaction), the underlying contractual agreement between the parties should be used as a basis.
In summary, year-end transfer pricing adjustments require a very thorough review to enable appropriate adjustments to be made for all tax types. Our transfer pricing experts will be happy to help you manage your transfer pricing adjustments and prepare the supporting documentation using the Amadeus TP Catalyst program.