Choosing exchange rates 

If businesses have their assets and liabilities in a currency other than their bookkeeping currency, these must be translated into the currency of their choice at a fixed exchange rate, which then enables them to be recognised in the books. To this end they can choose the average of the buying and selling rates of a credit institution chosen by the company, or apply the official foreign exchange rate published by the National Bank of Hungary or the European Central Bank.

Eligible currencies 

When setting up a business in Hungary, it is easy to think automatically of the Hungarian forint to keep your books in and fulfil your reporting obligations. But it is worthwhile considering whether this really is the best option for your company. Of course, you can choose to use the Hungarian forint. However, if it is deemed a more optimal solution, there is nothing stopping you choosing the euro or US dollar. This can happen, for example, if the parent company’s accounts or most of the invoices received from partners are in a particular currency. In any case, selecting a currency requires careful consideration, as the next time it can be changed is for the third financial year following the decision, and the accounting policies and articles of association must be amended accordingly too. Although this change used to be only possible for the fifth financial year at the earliest, and has now been reduced to three years, it still means a lengthy period.

You can also decide to choose a different currency from the euro or the US dollar, but this is subject to conditions. This is possible if the currency of the company’s primary business environment is not one of the above-mentioned currencies, and more than 25% of its income, costs and expenses, financial assets and liabilities are denominated in that currency.

In terms of selecting a currency it is also important to note that, as of 2019, the Hungarian Act on Accounting requires that the currency used for reporting and accounting must be the same as the currency recorded in the articles of association. Among other things, this means that the registered capital cannot be recorded in a currency other than the currency you later want to keep your books in.

Importance of selecting a currency 

Essentially, choosing the right currency is not significant because of how you can review your accounting records, although this may be taken into account in the case of reporting in a different currency. What is much more important is the effect of realised and unrealised exchange rate differences arising from transactions in other currencies. The incessant and unpredictable movement of exchange rates constantly affects the results of a company. So if you know that the large and significant transactions of the company will mainly be in a particular currency, when selecting a currency you should aim to avoid any problems with this.

Let’s look at what this might mean in concrete terms:

In the case of accounting in Hungarian forints, income is booked based on the difference between the exchange rate when the invoice is recorded and the exchange rate when it is settled, which is included in the corporate tax base at the end of the year, thus increasing your tax liability. By contrast, in the case of euro accounting, no exchange rate difference had to be accounted for, so this has no impact on your result.

Of course, it is also possible for an exchange loss to arise upon settlement of the invoice, which reduces profit and hence the tax liability as an expense on financial transactions.

It is also worth noting the impact of the mandatory year-end revaluations, where all foreign currency items must be recorded in forints using the chosen exchange rate as of the reporting date of the financial year.

Our example shows how much of an impact gains from exchange rate differences can have on your company, as they can significantly increase your tax liability, but also, exchange differences can even turn your profit into a loss. This impact can be reduced by making the best choice for your company when selecting a currency.

Changing currency 

If there is a change in the company’s operations, or if it becomes clear in the meantime that the chosen currency is not the most optimal, it is possible to switch currency. We covered this in detail in an earlier publication.

Since selecting a currency and switching currencies are complex processes comprising accounting, tax, legal and IT challenges, it is advisable to do your research and ask for help as to what really is the best solution for your company. Do not hesitate to contact our financial and accounting advisers, they will be happy to help.

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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.

A A few thoughts on choosing the small business tax bejegyzés először WTS Klient Hungary | tax | accounting | payroll | advisory | HR services | digital solutions | state aid-én jelent meg.

Even where there is no IFRS reporting requirement from the parent company, it is still worthwhile contemplating a switch to IFRS because IFRS financial statements are prepared in a format that is considerably easier for international clients, future partners and investors to use and interpret.

Once the Hungarian company is convinced that it can opt for IFRS bookkeeping and could meet the requirements, there is nothing left other than to examine the accounting aspects of the IFRS transition and the steps involved. After the strategic aspects of IFRS transition in this article we deal with these steps.

Deciding the date and the currency for the IFRS transition

The first step is to decide the date for the IFRS transition, what the date for introducing IFRS should be. This is not really an accounting issue, but determining the date of the switch does entail some vital accounting steps and tasks.

If the company wants to prepare its first IFRS annual report on the 2019 financial year, then the reporting date for the IFRS report will be 31 December 2019, and for the sake of comparability, an IFRS report needs to be compiled as of 31 December 2018 as well, which will include the transition balance sheet as of 1 January 2018. So in this case, under IFRS, the IFRS transition date will be 1 January 2018.

The company also has to determine which currency to keep its accounting records in, and which currency the financial statements should be presented in. Under IFRS, companies can have different currencies to keep their books (functional currency) and prepare their reports (presentation currency). According to IFRS, companies must keep their accounting records in the currency of the primary economic environment in which they operate. In contrast to the IFRS system, the Hungarian Act on Accounting offers a choice of currencies for bookkeeping and reporting: HUF, EUR or USD.

In the next step the company has to examine evaluation procedures applied so far, the classifications of assets and liabilities and its own accounting policies; these have to be modified to ensure they comply with IFRS rules. It is important to mention that IFRS does not provide mandatory frameworks (for the income statement or balance sheet for example), but instead specifies guidelines and procedures. Companies have to design their own processes and evaluation t methods, ensuring that they are consistent with basic IFRS principles and the company’s circumstances. 

Aspects of preparation of transition balance sheet

For those applying IFRS for the first time, IFRS 1 First-time Adoption of International Financial Reporting Standards governs the transition from a different accounting system to IFRS. First-time adopters of IFRS are considered to be those presenting their financial statements under IFRS for the first time.

According to IFRS 1, the transition balance sheet must be prepared as if the company had always applied IFRS. When compiling an opening balance sheet under IFRS:

• all assets considered marketable under IFRS must be recognised;
• all assets not considered marketable under IFRS must be omitted;
• assets must be classified in accordance with IFRS, and
• evaluated under IFRS;
• any differences between the two accounting systems must be recognised against the profit reserve, or, if more obvious, then against another item of equity.

There are of course cases where it is not possible to apply the basic principles, and so IFRS 1 formulates two exceptions to the application of the basic principles:

• the prohibition of retrospective application, when it is not necessary to act as if the company has always applied IFRS;

• relief and simplifications in certain situations.

The standard details exactly when these exceptions can be employed.

Challenges during classifying assets and liabilities

IFRS essentially uses the same categories of assets and equity/liabilities as the Accounting Act, but despite this, it is not as easy to classify and evaluating assets and liabilities as it might appear at first glance. For example, there are categories within IFRS that the Hungarian Accounting Act does not separate. One typical example of this is investment property. The Accounting Act treats properties for investment and for own use together, and does not prescribe any special presentation or evaluation obligations. If they support the company’s activity for more than one year then the properties are recognised under fixed assets, if they are held for sale then they are recognised under inventories. So the company has to decide which asset category to assign its properties to under IFRS, and measure them accordingly. In the event of any measurement difference, this must be recognised in equity.

So during an IFRS transition it is crucial to start in good time with identifying the company’s assets and liabilities, evaluate and recognising them under IFRS, and collecting all other information that may be required for the company to present its financial statements prepared under IFRS.

You can read about the strategic aspects of IFRS transition here, about its legal aspects here, and about its tax implications here.

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