Many international companies operating in Hungary are in the process of adapting their business strategies to conditions caused by the crisis. Such changes are to be carefully considered also from a tax point of view, as shifts in the profit or loss situation within a group are examined with particular interest during tax audits.
While it is an important task for the management to coordinate the business areas involved, the company's tax policy and transfer prices should also be taken into account reviewed for the necessity of adjustments. In particular, the following three areas deserve special attention from management when adjustments to business strategies within the Group are taking place:
During economic downturns tax authorities always examine in audits which group companies bear losses and to what extent. Most international companies outsource mainly routine functions in Hungary, while the important strategic and control functions remain with the parent company abroad. Thus, while the most important functions and risks are borne by the principal within the group, these companies are also considered to have the highest profit potential. Routine companies, including many Hungarian subsidiaries, are remunerated with lower transfer pricing margins.
In this context, the question arises in what proportion group level losses should be distributed among group companies. In many cases, relatively high losses at subsidiaries may arise, which are regularly questioned by the tax authorities on the grounds that they are not compatible with the company's relatively low profit potential. Therefore, while it is prudent for the group to mitigate such losses with various methods such as the ones described below, it is important to make sure that the result remains in line with the transfer pricing rules of the OECD as applicable in Hungary.
The options available to bridge liquidity shortages and financial losses often involve granting new intra-company loans or restructuring existing financing solutions. From a tax and transfer pricing point of view, it should be taken into account that the interest rate on the internal loan should be in line with the type of financing. The terms and conditions that are considered as acceptable vary accordingly, e.g. in the case of short-term or long-term liquidity or in the case of earmarked loans, such as construction financing or the financing of day-to-day business. In addition to the possibly of changes in the duration and purpose of the loan, the creditworthiness of the borrower may also have changed which could make it necessary to include a risk premium in the loan interest rate.
Further options that affect the operating result and thus counteract loss situations can also be considered. Temporarily adjusting margins on deliveries of goods or increasing markups for production companies with routine functions are some of the possibilities to be considered. However, for such measures to be successful, the companies concerned must be able to demonstrate that the method chosen is in line with market conditions and could also be used by independent parties.
Similarly, the reduction or temporary suspension of license or franchise fees or the payment of compensation to loss-making subsidiaries may prove useful as a measure to mitigate financial loss. Here, too, it is important to make sure that the chosen solution meets the "arm's length" conditions in each case.
The reduction or relocation of production capacities within a group can take place with a temporary or long-term perspective. Intra-group trading companies may also be reorganized, causing a shift in the vertical or horizontal trading conditions at the level of the individual entities.
These and similar changes in the value chain are in most cases also relevant for tax purposes and fall into the category of business restructurings by way of relocation of functions. A simple example of a relocation of a function is the transfer of a customer base from a subsidiary to a related company. Functional relocations are treated like the transfer of assets from a tax perspective and are valued based on the transferred future profit potential. Accordingly, transfers of functions must be valued using an appropriate valuation method, such as the discounted cash flow method (DCF), and treated in the tax return in the same way as the transfer of an asset.
In this context, it is also worth mentioning a special feature of Hungarian tax law that transactions between domestic entities are also considered transfer pricing relevant, not only with respect to the relationship between domestic and foreign group members. For this reason, changes in the value chain should also be reviewed for their transfer pricing relevance in Hungary.
At the beginning of the crisis many companies thought of home office solutions as temporary, however by now they have become a permanent feature in many parts of the world. In a publication of April 2020 the OECD came to the conclusion that the home office could not constitute a taxable permanent establishment for a company due to the lack of permanence and control of the premises. However, if home office scenarios are viewed critically and in a more differentiated manner, it cannot be ruled out that the Hungarian tax authority will not agree with the view oft he OECD. Thus, remote work for a foreign company by employees residing in Hungary could create a permanent establishment in Hungary. The same applies to distance working by foreigners for Hungarian companies, but in the opposite direction.
Lack of travel by a company's foreign management may cause a change in the tax liability based on the place of management for a Hungarian company. This may be a case if the management of a Hungarian company is normally carried out by foreign managers in Hungary, who are now predominantly working abroad, possibly at their home office. This may shift the place of management of the Hungarian company (home office abroad) to that foreign country, creating unlimited tax liability there.
Another undesirable effect of the crisis is the extension of the duration of construction sites and assembly activities. If the six- or twelve-month tax-free period is exceeded, tax liability as a permanent establishment arises at the place of construction or assembly activities. Similar situations sometimes occur also otherwise for technical reasons and are usually not easy to solve. Therefore, it is advisable to clarify the situation with the tax authorities well ahead and seek an amicable solution in view of the exceptional situation caused by the crisis.
Losses incurred by companies registered in Hungary can be carried forward for 5 years, however they can only be used up to the extent of 50 percent of the tax base. Therefore, it is in many cases advisable to draw different Hungarian members of an international group together and create a group for the purposes of Hungarian corporate income tax, enabling higher levels of loss carry-forwards.
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