The Hungarian Minister of Finance recently announced an increase in the sales revenue limit for joining the small business tax (KIVA) system, from HUF 1 billion (roughly EUR 2.8 million) to HUF 3 billion (roughly EUR 8.4 million). This size of the increase together with the simultaneous lowering of the small business tax rate to 11% is already giving some of our Hungarian clients food for thought too. So it is worthwhile making some calculations before deciding whether to seriously consider making the switch.
Grounds for refusal from small business tax
Firstly, it is worth clarifying what the grounds for refusal are that mean you shouldn’t waste your invaluable time with further calculations. When making calculations for transitioning to KIVA, the main factors you must consider are the headcount limit of 50 employees and the figures of your related companies. If you manage to negotiate these and some other, less deal-breaking conditions, you can start calculating the real tax-saving potential.
Framework conditions for 2021
We can make relatively safe calculations for the first half of 2021. The small business tax rate will be 11%, while corporate tax will presumably remain at 9% during this period in Hungary. So during the calculations you have to assess whether your gross wage cost or your corporate tax base will be significantly higher. This is because by choosing the KIVA you will most certainly “get rid of” the 15.5% social contribution tax and the 1.5% vocational training contribution (a total contribution burden of 17%). This way, with a roughly identical gross wage cost and corporate tax base, the 11% small business tax will be more beneficial even if it must be paid not only instead of the contribution burden but also instead of the 9% corporate tax. Your tax savings will be reduced, but not entirely eliminated, by the fact that in this case the 17% contribution burden will not reduce your pre-tax profit, which also qualifies as the KIVA tax base (assuming in all these cases that a dividend payment resolution has been issued on the final profit).
“Unfortunately”, in the second half of the year the social contribution tax rate may be reduced in Hungary, which is driven by the government’s agreements with employers and employees if certain conditions are met. If the social contribution tax is decreased by two percentage points, it will already eliminate some of the benefits of the small business tax. Yet the savings of the first half year are secure, while the reduction of the social contribution tax has – albeit with a half-year delay – previously reduced the small business tax rate as well on two occasions. This way you do not have to be worried even after one year that you will be negatively impacted by changing to the small business tax.
Items modifying corporate tax base and role of corporate tax allowances
This scenario, i.e. that making the switch will most probably be beneficial if gross wages are identical or higher than the corporate tax base, is turned completely on its head by the distorting impact of the items reconciling the corporate tax base and possible corporate tax allowances. It suffices to think about the double (sometimes triple) deductibility of the costs of research and development activities, or the tax allowance for supporting spectator team sports, to see that it is not enough just to match the two amounts mentioned in last year’s annual financial statements to reach a decision. You have to thoroughly examine how your pre-tax profit and the actual corporate tax base relate to each other, and to what extent this impacts on your otherwise seemingly simple calculations.
Companies reinvesting profit – real tax benefit?
For our virtual calculations so far, we have taken into account the corporate tax base as one factor when determining the tax difference. It is also worth considering, though, what happens if your profit is not withdrawn from the company and disbursed in the form of a dividend, but is transferred to retained earnings and left in the company for development purposes in the coming years.
Since the KIVA base only comprises the profit defined as the dividend payment, it is clear that the small business tax represents a veritable tax saving if the dividend is not paid, as your company only pays the 11% wage cost instead of the 15.5% social contribution tax, the 1.5 % vocational training contribution and the 9% corporate tax. You should also note though that this saving is not final, since the profit held in the company and subsequently paid out as a dividend will also be part of the KIVA base, so here we are rather talking about an interest-free tax loan than a true tax benefit. On top of that, if the undistributed profit is used to finance investments, according to current rules it is possible as a corporate taxpayer to recognise the entire profit in the development reserve, which also results in an interest-free tax loan.
Small business tax from the government’s perspective
It is clear that the Hungarian government’s obvious intention is to increase the number of companies in the small business tax system. The reason for this might be that this tax type is much easier to calculate in terms of revenue flowing into the budget than corporate tax revenues, which fluctuate owing to the multitude of items reconciling tax bases as well as the tax allowances; what is more, this serves an important economic and political goal very well, namely, supporting parts of the SME sector which generate smaller profits but have high labour demands.
Despite all this, we suggest that before reaching a decision to switch you should make some thorough calculations for several years to support the move. You should also note that if you later want to return to corporate taxation, different rules will apply for that transition, meaning it can easily happen that an acquired tax benefit will be reduced or eliminated by the tax difference payable upon moving back.
Our taxation experts are happy to provide you with information about the rules for changing to the small business tax and about returning to corporate taxation, as well as about any other aspects for consideration when making the decision. Feel free to contact us.
