Local Business Taxes

The Challenges of Municipality Taxes in Hungary

Companies operating in Hungary are required to pay local business tax at a maximum rate of 2% in addition to the 9% corporate income tax. In this article we discuss the two hotspots of local tax audits, the calculation and the allocation of the tax base.

The local business tax

The local business tax is a type of sales tax, the rate of which varies from municipality to municipality up to a maximum of 2%. There are special rules for calculating the tax base, and in some industries the municipality tax base may be significantly higher than the corporate income tax base.  If a business has several establishments, it must allocate the local business tax between the municipalities concerned.

Local business tax is to be paid on adjusted net sales. When calculating net sales, royalties received can be deducted, as well as certain special types of taxes accounted for by the company. Specific rules apply to certain types of enterprises, such as Hungarian branches of foreign companies.

The established net sales are reduced by the following factors:

• the cost of goods sold (COGS) and intermediated services rendered;
• the cost of subcontracted deliverables;
• material costs;
• the direct costs of basic research, applied research and experimental development accounted for in the tax year.

Limited tax base reduction

For the purposes of local business tax, the cost of goods sold (COGS) and intermediated services can be taken into account to a limited extent as a reduction factor when determining the tax base.

Intermediated services and subcontracting

The value of intermediated services reduces the tax base, but the definition of intermediated services is restrictive. If the service does not meet the specific requirements of municipality tax legislation, the tax base cannot be reduced. This causes a number of problems in practice, so it is important to document the services provided in writing so that it can retrospectively be demonstrated how the services were procured and provided.

An intermediated service is a service purchased by a taxable person on the basis of a written contract and resold as based on a written contract in an unchanged form. In the case of subcontracting, too, only supplies based on written contracts may be accepted in order to reduce the local business tax base.

Division of the tax base

If an entrepreneur carries out a permanent business activity in the area of ​​jurisdiction of several municipalities or abroad, the tax base must be allocated between the municipalities concerned.

The following three methods are used for allocation:

• the personnel expenses proportional method;
• the asset value proportional method;
• a combination of the above two methods, i.e. the complex method.

If the tax base exceeded HUF 100 million in the full tax year preceding the current year, only the complex apportionment method can be applied.

The main challenges of the local business tax

A number of restrictive factors need to be taken into account when calculating the local business tax base. They limit the applicability of tax base reduction items that seem simple at first sight by requiring a number of formalities. In order to calculate the tax base correctly, it is worthwhile to develop an accounting system that can also handle the special factors related to local business tax.

In connection with the above, special attention should also be paid to the correct valuation of assets, the separation of the depreciation of intangible assets, and the consideration of rents and leases in the allocation of the tax base. The same applies to the correct classification of employees with no fixed workplace for the purposes of local business tax, as well as to some special issues such as the deductibility of packaging costs from the tax base.

Tax incentives

Municipalities can provide companies with tax benefits and tax exemptions for businesses operating in their territory, the possibilities vary from municipality to municipality. In the case of investments, individual municipalities may even grant a full tax exemption to the investing company.