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Following the launch of a flat rate of corporation tax of 9% from the beginning of 2017 it is clear that international business can be well served by the use of Hungarian companies for a variety of business activity. The use of Hungarian companies as international holding companies and for ownership and exploition of IP is well known. However the new 9% corporation tax rate means that Hungarian companies will provide tax efficient trading vehicles for international trade, and for trade within Hungary itself.
Hungary is not an offshore financial centre, but its corporation tax rate is the lowest in the EU.
Not only is the Hungarian tax rate now the lowest in Europe, but losses can be carried forward for 5 years with a limit of 50% of current year taxable income. Losses may not be carried back.
There are also generous rules concerning tax deductions. All expenses incurred in the course of generating taxable income may be deducted (in addition to losses carried forward). Moreover, Hungarian companies can deduct 50% of their royalty income provided that this deduction does not exceed 50% of the company's total pre-tax profits. Hungary restricts the scope of IP rights subject to this deduction by limiting the deduction to IP rights developed in Hungary.
Dividends received by a Hungarian holding company are exempt from Hungarian taxation. Furthermore, capital gains realised from the disposal of subsidiary companies are also exempt, provided that the holding company holds not less than 10% of the shares of the subsidiary company for at least 1 year, and the company declares its ownership within 75 days of the date of acquisition of the shares.
Hungarian companies are subject to local business taxation. The tax base of the local business tax is turnover adjusted by certain costs, e.g. costs of goods sold. Dividends, royalties and capital gains are not subject to local business tax. The tax rate is determined by the local municipalities, and cannot exceed 2%. The tax rate is 2% in Budapest. Certain local municipalities do not levy this local business tax.
In addition to the low-tax regime for companies in Hungary, non-EU would-be investors such as international corporate groups and entrepreneurs will benefit from the fact that Hungary is an EU Member State and therefore a Hungarian company engages all the freedoms enshrined by the European Treaty e.g. freedom of establishment, and free movement of capital and services within the EU, provided that the Hungarian company is conducting genuine economic activity. These important European Treaty freedoms can therefore benefit non-EU investors who wish to set up Hungarian companies in order to take advantage of Hungary's low corporate tax rates.
Double tax treaties
Hungary has a good network of double tax treaties to mitigate international double taxation, including treaties with the EU Member States and countries such as Belarus, Brazil, Canada, China, Hong Kong, India, Kazakhstan, Russia, Singapore, Switzerland and USA. Additionally, Hungary benefits from all the EU Directives, such as the EU Parent / Subsidiary, Mergers and Interest and Royalty Directives.
Importantly, Hungarian companies pay no withholding tax on dividends, interest and royalties paid to non-Hungarian corporates (including offshore companies), although there is a withholding tax of 15% on such distributions paid to individuals. This suggests that non-residents of Hungary should invest via holding companies.
The net trading profit is subject to the 9% rate of Hungarian corporation tax, and potentially a local business tax on adjusted income at a rate up to 2%.
Dividends may be paid to the UK holding company without Hungarian withholding tax (and this should continue to be the case regardless of "Brexit").
The UK holding company will be exempt from UK corporation tax on the dividends from Hungary (and this dividend exemption will continue to apply regardless of "Brexit").
The UK holding company may pay dividends (arising from its own Hungarian dividend income) to its non-UK resident shareholders, without UK withholding tax. The UK company can also obtain the "substantial shareholder exemption" to exempt capital gains from the sale of the Hungarian company from UK corporation tax, subject to meeting certain conditions, the most important of which is that the Hungarian company is a trading company and the UK company is a member of a trading group¹. Any structure of this kind will of course need to take account of the OECD's multilateral instrument to implement the tax treaty related BEPS measures.
The Hungarian Kft, or Limited Liability company is the preferred corporate vehicle for inward investment into Hungary, and for international investors to conduct business internationally.
A Kft may have a single shareholder and a single director who may be the same, or separate persons. Corporate Directors are permitted. The directors and shareholders of a Hungarian Kft need not be residents or nationals of Hungary but the location of directors and shareholders has a bearing on taxation outcomes.
Share capital requirements
A Kft must have a minimum paid up share capital of HUF3million (£8,660 approximately). Assuming evidence is provided of a bank deposit of at least this sum by the company's promoters, this will be sufficient evidence of capitalisation for incorporation purposes.
Incorporation normally takes 2-3 weeks. Importantly, Jordans can organise director and banking services quickly and efficiently in Hungary for appropriate cases. Local professional directors can open corporate bank accounts in Hungary and administer the accounts, subject to obtaining satisfactory KYC.
Jordans can also organise local accounting and audit services (the appointment of an auditor is mandatory if a Hungarian company's average annual net sales for two consecutive business years exceeds HUF300million (£866,330 approximately)). In addition, any Hungarian company, whether small, medium or large, and which is subject to a consolidation outside Hungary, also requires its accounts to be audited.
The Hungarian company is an attractive international corporate vehicle, which can be used by international (i.e. non-Hungarian resident) groups and entrepreneurs considering setting up businesses in Hungary as well as for international trading and investment.
Hungarian corporate tax rates are the lowest in the EU, and these low rates apply to both trading and investment income (in contrast to some other low-tax regimes that may provide low tax rates for trading income but higher tax rates for certain categories of non-trading income e.g. Ireland). Furthermore, director and banking relationships can be organised quickly and efficiently in Hungary for suitable cases, which is a very important consideration.
1 - These rules are likely to be reformed in the UK's 2017 Finance Act, with a view to relaxing the conditions for the tax exemption.