Tuesday, 3 January 2017

New rules relating to controlled foreign companies and other low-taxed income

The fourth tax package published on 19 December 2016 completely redefines the rules of controlled foreign companies and the system of sanctions applied against them. The amendments will take effect on the 30th day following promulgation (18 January 2017); however, taxpayers may choose the application of the new rules as early as in the 2016 tax year. The rules conform to the European Union’s anti-tax avoidance recommendations, but the rapid introduction makes it almost impossible to prepare for the changes.

The most important change for corporations is the amendment of the CFC-rules. From next year, Hungarian entities that own, directly or indirectly, a controlled foreign company will also be required to pay tax – under certain other conditions - on the controlled foreign company’s income from its passive activities. Such passive income will include interest income and income from other financial assets, income from intellectual property rights, income from shares and from holding and removing shares, income from financial leasing activity, income from insurance, banking and other financial activity, as well as income from intercompany sale and purchase of goods and services, if they have no or little economic valued added. Another tax base increasing item will be the impairment loss and exchange difference related to the shareholding of controlled foreign companies. Dividends received from controlled foreign companies will continue to be subject to tax i.e. denying of the participation exemption provisions. Hungarian taxpayers will be obliged to prove the CFC qualification of their business partners.

A controlled foreign company may be a foreign individual in which a Hungarian corporate taxpayer – alone or together with its related parties – is entitled to hold more than 50% of the voting rights, registered capital or profit if the tax corresponding to the corporate income tax actually paid by the foreign individual does not reach half of such tax payable in Hungary. The foreign entity may be exempt from sanctions if it can be clearly established that it maintains appropriate staff, equipment, assets and premises to carry out effective business activity. Effective business activity means engagement in production, processing, agricultural, service, investment or trading activity using own resources and employees, and if revenue generated from the above activity reaches at least half of the total revenue. All related companies and premises operating in the given foreign country must be taken into account in the calculation. Exemption from this rule may be available for companies listed in a registered stock exchange.

Parallel to the above, the rules concerning controlled foreign companies will no longer constitute a part of the personal income tax legislation, while sanctions on income from low-tax countries will be extended. Interests and dividends received from entities having their registered office in a low-tax country, as well as exchange gains and divestments related to such shareholdings will qualify as other income of a Hungarian tax resident individual from the date of promulgation of the amendment. Interest from a non-convention country will also be treated as other income. Other income falls taxation with 15% PIT and 22% SSC in 2017.

The Stability Savings Account, which provided preferential tax treatment and in some cases even a kind of tax amnesty for non-declared foreign income, will also be eliminated.

Nevertheless, in a transitional period between 1 January and 30 June 2017 preferential tax payment, and in certain cases tax exemption, will be allowed by way of tax incentive for repatriation of income; and tax exempt acquisition of participations.

A tax incentive is available for the repatriation of financial assets held by individual taxpayers on foreign bank accounts and acquired before 30 June 2016.  Such income may be subject to a reduced tax rate of 10% if transferred to a newly opened Hungarian or other EEA bank account by 30 June 2017.

Within the period of 1 January 2017 to 30 June 2017, the acquisition of shares and participations free of charge or at a price lower than the market price may be exempt from Hungarian personal and corporate income taxes and any other duties for the individual or entity acquiring the shares/participations. As a pre-condition for the tax exemption, such acquisition must be notified to the tax authorities. Moreover, if the acquisition is made not for free, the acquisition cost must be debited on a bank account held in an EEA country. However, any future profit deriving from the alienation of such shares/participations will be taxable at the time of the disposal, because the participation exemption rules will not be applicable for them. The exemption has some further conditions too: (i) it is available only for participations in a company resident in an OECD or a cooperative country, (ii) the shares must not be traded on the stock market, (iii) the acquiring individual should not realize in-come other than self-employment, and (iv) if the participation that acquired is in a Hungarian company, the seller must be a foreign entity.