The basic purpose of companies is to operate profitably, to make a profit.  However, changes in the economic environment or sudden, unexpected events affecting the company can result in losses for a given financial year.

When is there a problem with capital adequacy?

If the gains of previous years cover the losses of the reporting year, the company’s capital adequacy is not at risk. The scenario might be different, though, if the company previously paid out the profits of earlier years to the owners against the retained earnings, as a dividend. In such cases, even a smaller loss can cause headaches in terms of capital adequacy. The same issue may arise if a single loss exceeds the accumulated profit of previous years. With continuous losses, however, it is obvious that the company will sooner or later be unable to meet the statutory requirements without continuously ensuring its capital adequacy.

An issue with capital adequacy can arise if

• the company’s equity has fallen to half of its share capital due to a loss; or
• the company’s equity does not reach the registered capital prescribed for the given type of company in two complete and consecutive financial years.

What should be done in these cases?

If the company’s equity has fallen to half of its share capital following a loss, the managing director must immediately convene the members’ meeting or initiate the passing of a resolution without a meeting to take the necessary action. It is important for the owner to adopt a decision that ensures the company’s equity at least reaches the amount of its share capital. The relevant resolutions of the members’ meeting must be implemented within three months.

A capital situation can be resolved in various ways in Hungary, and below we will examine these one by one.

Additional capital contribution

The owner may only decide to make an additional capital contribution if the articles of association of the entity specifically provide for this as an option, and also include the conditions for this. In the absence of such provisions, making an additional capital contribution is not possible. If the owner would still like to opt for this, they first have to amend the articles of association.

The members’ meeting decides on the amount of the additional capital contribution and how to pay it, in line with the articles of association. This does not require any registration at the Court of Registration.

If the causes for the additional capital contribution no longer apply, the amount of the contribution must be paid back to the owner. The law does not specify the repayment rules in more detail, so the particular provisions for this should be given in the articles of association.

Capital increase

Since the company’s capital must at least be equal to its share capital according to the Hungarian Civil Code, it is important that the capital increase is made with a premium, i.e. the owner must provide the company with the assets in excess of the amount of the registered capital increase. As usual, this capital increase can be a cash or a non-cash contribution.

The capital increase must be registered at the Court of Registration.

Registered capital decrease

A company may decrease its registered capital to solve its capital adequacy problem if its registered capital exceeds the minimum requirements specified by law, and its equity also remains above this amount, despite the losses. The company may reduce its registered capital by transferring part of it to its retained earnings or capital reserve, with the proviso that, if its retained earnings are negative, the transfer must first be carried out to compensate for the negative retained earnings.

Any decrease in registered capital must be registered at the Court of Registration.

Change of company form

To restore capital adequacy, the company’s owner may decide to change the form of the company too. Naturally, the company form chosen should be such that the company is able to meet its capital requirements. Please note that changing the form of company qualifies as a transformation, and thus the general rules of transformations must be adhered to. Of course, finalising the process is also subject to registration at the Court of Registration. Due to the rules pertaining to transformations in Hungary, this can be considered the most time-consuming way of resolving capital issues.

What else can be done?

If these or other measures suitable for restoring the capital situation are not applicable, the owner must decide to terminate the company without succession.

The rules on capital adequacy explained in this article pertain to limited liability companies in Hungary. For companies limited by shares, the rules are different. Feel free to contact our experts if you need more detailed information. Also do not hesitate to contact us if we may be of assistance with any of the capital resolution methods included in our article, be it a transformation or a voluntary liquidation.

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The new ruling on factoring applies where a taxpayer (principal) in Poland uses a factoring contract to assign to another party (factor) so-called “own receivables”, meaning claims from the taxpayer’s earlier sales of goods or services to a third party (debtor).

Previous problems

Previously there was no uniform approach on how the taxpayer should recognise tax-deductible costs on such a transaction. The interpretation uncertainty arose from Article 16(1)(39) of the Polish CIT Act, which says that losses on sales of receivables for consideration are not tax-deductible, except where the receivables have been wholly or partly accounted for as income receivables, in which case the amount of the receivable that has been accounted for in this way may be deducted for tax purposes.

Clarification of calculation 

This ruling on factoring resolves the interpretation uncertainty to confirm two essential points:

• the amount to be taken into account when calculating tax-deductible costs in such a situation is the gross amount receivable (i.e. the full amount, including VAT); and

• the limit under Article 16(1)(39) of the CIT Act only applies to losses which are deductible up to what was previously recognised as the income receivable at the net amount.

The ruling on factoring ends interpretation disputes in Poland about how to calculate tax-deductible costs in those situations, and in this sense, it is positive. It also shows taxpayers how to properly calculate those costs:

• Determine whether and how much cost has been incurred for the purposes of the CIT Act; this will generally be the nominal gross amount of the sold receivables.
• Determine if the sale of receivables has generated a loss.
• If no loss is involved, then the cost will be tax-deductible in full.
• If there is a loss, and the sold receivables have been accounted for as an income receivable, then it is necessary to determine the proportion of the loss to that income.
• If the loss is higher than the income, the difference should be deducted from the cost and it is only the cost so decreased that may be deducted for tax purposes.
• If the loss is lower than or equal to the income, then the cost is tax-deductible in full.

Further aspects of the ruling on factoring

It is good to know that the ruling on factoring does not have any retroactive effect. However, it is worth examining past transactions and verifying whether the argumentation behind the ruling may be applied in the event of potential corrections.

The ruling on factoring also makes it clear that taxpayers in Poland assigning their own receivables to factors under factoring contracts should recognise income “again” because this transaction is separate from the original sale of goods or services.

If you would like to know more about the new ruling on factoring and how to calculate tax-deductible costs attributable to the sale of own receivables under factoring contracts, please visit the homepage of WTS&SAJA Sp. z o.o., the exclusive representative of WTS Global for Poland.

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Postponement of deadline for 2019 financial statements due to coronavirus pandemic

This year, business entities (excluding public-interest entities) received an extension until 30 September 2020 for the preparation, disclosure, filing and publishing of 2019 financial statements compiled in accordance with the Act on Accounting. 

Taxpayers whose tax obligations (corporate tax, small business tax, income tax on energy providers, local business tax and innovation contribution) were due by 31 May 2020 may decide, as an exception, to meet these obligations for this year by 30 September 2020. If you miss the new deadline, however, you can count on receiving penalties.

The coronavirus pandemic impacted on a number of Hungarian businesses unfavourably. These impacts must already be presented in the 2019 financial statements. For companies where the 2019 financial statements have not yet been published, this must be considered when closing the year. Based on the experiences gained in previous months, Hungarian companies may already be able to quantify these impacts, possibly recording accruals/deferrals, provisions or impairment too.

Changes to development reserves and equity

Changes to the development reserve may already have an effect on the content of the 2019 financial statements and the corporate tax return. This is because a new bill allowing Hungarian businesses to use up to 100% of their pre-tax profit to allocate a development reserve was recently approved. This choice can already be applied to fiscal years beginning in 2019 with a self-revision of corporate tax returns already filed, or with an accounting revision of prepared 2019 financial statements. The ceiling for the development reserve (HUF 10 billion – roughly EUR 29 million) and the rules for using it remain unchanged. If such a reserve is recorded then an allocated reserve must be accounted for by way of a transfer from retained earnings, which then creates a dividend payment limit for the company.

If a company is running a loss it is worth keeping an eye on the equity throughout the year too. Owners are often only notified of an equity loss when approving the financial statements. However, complying with the provisions on equity is not only necessary from a legal point of view. Capital adequacy provides important information for business partners and creditors too. Note that the amount of critical equity is different for each type of company, such as for a Kft. (limited liability company) or for an Rt. (company limited by shares).

Changes to additional capital contribution 

Additional payments received to cover losses must be shown under the allocated reserve at the company. It is recommended to draw owners’ attention to the fact that under the provisions of the new Hungarian Civil Code, additional contributions – if permitted by the articles of association of the given company – may be made not only as cash contributions but also from a member’s loan as well. This is because a receivable can be provided as a non-cash contribution too, provided the debtor acknowledges it or it is based on a final court resolution. Additional contributions can therefore be made through a non-cash service compliant with the requirements of non-cash contributions.

In the case above, the asset transferred as contribution must be recorded at the owner (member) of the company pursuant to the rules on sales, parallel to the movement of the asset, with the proviso that the receivable thus created shall reduce retained earnings by the same amount.

The owner (member) of the company may decide to waive the receivable derived from the additional contribution. An amendment to the Hungarian Act on Accounting which took effect on 1 January 2020 settles the accounting thereof, declaring that in such a case the amount of the additional contribution must be recorded as an addition to retained earnings against the allocated reserve at the company. This change must first be applied in the financial statements of the 2020 financial year, but it can already be applied for the 2019 financial statements too. Naturally, if the owners would like to use this option, they first need to review the transfer from a tax perspective as well.

Change to other method of settling equity 

The new rule amending the registration of capital increases was announced at the end of 2019 and it took effect the next day. Previously, capital increases had to be recorded in the accounting records on the same day they were registered at the court of registration. Now, however, businesses may choose the date of the change. Under the Hungarian Act on Accounting, in their accounting records companies can record any changes in registered capital derived from increasing the capital, share capital, founders’ assets or other shares as of the date of the change, if the change date differs from the registration date. 

These changes benefit Hungarian businesses because they provide the owners with greater scope to treat issues arising from equity. What remains unchanged, though, is that both additional contributions and capital increases are subject to a resolution passed by the owners (members), while registration at the court of registration is mandatory for capital increases too. If the articles of association do not enable additional contributions to be made, the articles can be modified, which is also subject to registration at the court of registration.

Before an owner decision is made it is always worth consulting a lawyer, tax consultant and accountant to ensure all transactions are compliant with the rules and are carried out in the company’s best interest. The professionals at WTS Klient Hungary are here to help.

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Obligation to top up tax advances now partly optional, and decisions required in other matters too

In previous years, the top-up deadline of 20 December forced business entities to reach the most optimal decisions for themselves during the reporting year, as part of their preparations for the annual closing.

This year the compulsory top-up system for tax has partly been abolished, which does not mean, however, that the usual calculations are (partly or fully) obsolete, or that making many business decisions before the annual closing has become unnecessary.

Aspects relating to exchange rate losses and gains worth taking into account before the annual closing

Having followed the exchange rate trends of recent times, what responsible leader would not consider the impact of exchange rate losses on their year-end result, on dividend payments, or even on planned loans, leasing arrangements, tenders, etc.? For example, generating a loss can be an obstacle to requesting a tax refund on excise tax. On the other hand, a significant exchange rate gain (followed by a loss in the following year) may not necessarily be a cause for great joy either.

Let us take a simple example, in which we only consider the impact of exchange rate losses and gains. In both A and B in the example below it is true that the pre-tax result in the previous two years was zero, i.e. the exchange rate gain and loss balanced each other out in this two-year period. However, the amount of corporate tax is different. If the exchange rate gain is realised first, the corporate tax liability will be higher since the company cannot use up loss carry forwards before they are actually incurred.

In certain cases of accounting, it is possible to recognise accruals and deferrals with regard to exchange rate losses, and reduce or increase the corporate tax base with regard to exchange rate gains and losses.

For businesses exposed to significant exchange rate fluctuations, it is worth considering changing the accounting currency. These decisions have to be made during the reporting year, before the annual closing. Just consider that the accounting in the next year should be carried out in the new foreign currency, so the new books must be opened in this currency too. This decision obviously entails company law tasks as well.

What other choices should (also) be considered as the annual closing approaches?

A new and compulsory rule from 2020 means sales must be accounted for in line with the percentage of completion, which is an option applicable for 2019 annual reports too. Bear in mind though that accounting sales revenues in proportion to the percentage of completion will increase the local business tax base!

The ceiling for development reserves per tax year has been raised to HUF 10 billion (roughly EUR 30 million). These options can influence equity and tax bases. The Hungarian Act on Accounting and the Corporate Tax Act contain several other options that are worth considering before the annual closing.

If the figures suggest that the company’s equity will not comply with regulations following the annual closing, it might be a good idea to decide on forgiving receivables or making free transfers, and implementing this during the reporting year. Depending on the corporate tax base, these methods might be the most cost-effective solutions for restoring equity.

For companies contemplating terminating their operations this year, or for entities under voluntary liquidation already, it might be a wise decision to postpone the closure (especially if the voluntary termination is being prompted by insolvent clients). This is because the VAT on amounts recognised in the books as irrecoverable debts may be reclaimed from 2020, more precisely, they may be considered retrospectively as items deductible for tax purposes. As is common with favourable tax amendments, there are a number of conditions which should all be met to actually qualify for claiming them. The legal amendment also pertains to receivables where the date of performance for the supply of goods or services underlying the irrecoverable debt falls after 31 December 2015.

As the examples detailed above clearly show, it is indeed justified to consider which accounting and taxation options available for a given company might reduce a reporting-year loss. Furthermore, companies have a number of possibilities with regard to taxation in the following year(s), where the changes need to be reported to the NAV in the reporting year.

The experts of WTS Klient Hungary have been serving clients for more than 20 years, helping them make optimal business decisions for their companies. Feel free to contact us if you are uncertain about what decisions to make or which options to choose based on our article.

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Loss carry forwards

Taxpayers may use their negative tax base from given fiscal years as a deductible item for tax bases in following years, in line with the prevailing rules. This is what we refer to as loss carry forwards.

Over time, the rules regarding loss carry forwards and using them have changed many times. Different rules apply for business entities operating under unchanged circumstances, companies established via transformation, continuing to operate after transformation, or real estate investment entities, etc. In this article we focus on the time aspect of using losses generated in various fiscal years. 

Losses generated prior to 2009

In line with the rules effective before 2003, losses could be used in the following 5 fiscal years, and if such losses were not used by the taxpayer they have now expired. From 2004 losses could be carried forward indefinitely, although some cases of loss carry forwards were subject to authorisation. This authorisation was necessary for losses generated in a company’s fourth fiscal year after its foundation or afterwards, if the following conditions were met:

• sales revenues in the given fiscal year did not amount to 50% of the costs and expenses accounted for;
• the company had a negative tax base in the two previous fiscal years.

If neither of these conditions were met by the taxpayer, recognising loss carry forwards required no authorisation. From 2005, the rules changed somewhat. From then on, loss carry forwards needed authorising if

• the company had a pre-tax loss in the given year and
• revenues in the given tax year did not reach 50% of the costs and expenses accounted for, or
• the company had a negative tax base in the two previous fiscal years. 

New changes

Hungarian legislators accepted a new modification with the 2009 year-end tax amendments which could be applied for loss carry forwards in 2009. Losses generated from then on could be carried forward indefinitely and without authorisation.

Current rules

According to legislation in effect in Hungary since 2015 the negative tax base of a given fiscal year can be used by the taxpayer in the next 5 fiscal years. The law includes a transitional rule with regard to losses carried forward indefinitely from a previous period. Losses generated in a fiscal year no later than the one including 31 December 2014 may be used as deductibles for tax purposes until no later than the fiscal year including 31 December 2025.

The legislative amendment extended this deadline until 2030, meaning that companies may deduct such losses from their tax base in their corporate tax return for the fiscal year including 31 December 2030.

The fact that the law prescribes a FIFO rule for using such losses, i.e. earlier losses must be used up first, has created a unique situation. Companies that have substantial loss carry forwards from a period before 2015 may not necessarily be able to use their losses incurred after 2015 since these expire in five years.

The following table shows with a few examples how loss carry forwards can be used with regard to a normal financial year. It is clear that if a company does not use its pre-2015 losses until 2020, it will not be able to use any loss generated in 2020.

Loss carry forwards and the use thereof is a key issue. Without proper records we run the risk of losing the possibility to use these losses, or the other way round, we use the losses but fail to pay attention to the restricting rules. In this respect we only need to think of the 50% threshold applicable since 2012, according to which loss carry forwards of previous years may reduce the pre-tax profit by up to 50% of the given fiscal year’s tax base without the losses.

If you wish to know what options your company has with regard to loss carry forwards, and how to use them, and you need expert help, please do not hesitate to contact the tax advisers at WTS Klient Hungary.

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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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