Hungary’s New Position in the Royalty Planning Industry by Dr Willem G. Kuiper and Dr Gabor Szabo
Although times are changing and more pressure is coming on Hungary to keep in line with the rest of the (most of the time high tax) member states, some interesting and attractive tax planning opportunities are still standing and they definitely put Hungary on the map of the international tax planning industry. One of them is the attractive royalty regime which is bound to be discovered by all the tax planners.New royalty structure is requiredWhatever makes a country interesting for royalty purposes, Hungary has it! In the past the Netherlands played significant role with numerous Dutch licensing (royalty) companies. They used to have a favourable system of advance rulings for obtaining rulings on the tax treatment of international flows of interest and royalties, but from 1st of April 2001 the former Dutch regime is no longer available. While it is still possible to apply for advance tax rulings in the Netherlands after this date, the new system is hardly attractive for purposes of tax planning because of the conditions to be met for obtaining a ruling (incl. the computation of an arm?s length price for the royalties payable). So, the Dutch conditions to obtain a ruling became very time consuming and more stringent in general. This made the system less attractive and made tax practitioners look for alternatives. Obviously, tax practitioners world-wide have been trying to develop alternative solutions for the tax-effective structuring of royalties (far before Hungary too), but many of these structures were complicated, artificial and/or expensive. So far, almost none of the structures were as effective and simple as under the former Dutch system of advance rulings. Nevertheless, it should not be ignored that many Dutch tax practitioners are still very experienced in setting-up tax effective royalty structures.For those of you are sitting behind your desk trying to figure out tax-effective structuring of royalties, lay back and don?t search any further for the answer lies in this article: the alternative solution is Hungary which has a very simple and straight-forward system of (inter-corporate) royalties. Taxation of royalties in Hungary First of all, the Hungarian corporate income tax rate is among the lowest in Europe, i.e. 16% of net profits. One of the incentives contained in Hungarian tax law is a provision according to which 50% of the pre-tax amount of the royalties received may be deducted from the tax base, this reducing the effective corporate tax rate on such royalties to 8%. It doesn?t matter if the company has other business activities also. There are no special conditions which have to be fulfilled. Moreover, there is no withholding tax on royalty paid. In addition the royalty (just like dividend and interest) income is exempt from the local business tax (2% of the net income), which however burdens any other kind of incomes. Finally, royalties paid out by Hungarian licensees or sub-licensors are tax-deductible, just as the self-developed IP?s research and development costs can be deducted from the corporate income tax base.Hungarian tax treaty networkHungary has a dense network of double taxation treaties concluded with 65 countries. Under many of these double taxation treaties, the withholding tax on royalties is reduced to 0%, while under some other treaties the rate is reduced to 5 or 10%. This is only of relevance for royalties received by a Hungarian (sub-) licensor, as royalties paid abroad by a Hungarian licensee are not subject to a withholding tax by virtue of Hungarian domestic law.The US ? Hungary tax treaty requires particular attention. One other important advantage of using Hungary is the possibility to channel US-source royalties to third parties in other countries without being hit by US anti-treaty shopping rules, such as the limitation on benefits. The current treaty between Hungary and the Untied States dates back from 1974 and it does not contain such a limitation-on-benefits provision. Although the United States initiated the renegotiation process recently, the experts don?t expect new or amended treaty before 2010 (actually no deadline is set).But this is just one of the examples of useful double tax treaties Hungary concluded. This country has one of the most treaties in the Central and Eastern European region. Other treaties worth mentioning are for instance with Japan (0% withholding tax on cultural royalties), Korea (0% withholding tax on all kind of royalties), Malaysia (covering also Labuan!) and Singapore. Hungary can also become an important gateway to the Far East! The transfer pricing rules still may cause problems ? The independent solutionIt can be seen that the ideal combination of the Hungarian royalty regime together with the extensive treaty-network, can make Hungary very attractive. Nevertheless the inter-group royalty-flows can face the problems of the transfer pricing rules also in Hungary. One of the few difficulties in current Hungarian tax practice is that it might be difficult (although not impossible) and time-consuming to obtain an advance tax ruling for transfer price. Although the Hungarian transfer pricing regulations represent the EU standards, the tax audit practice (particularly in the field of intangibles) is still behind to the Dutch one or the other ?oldies? of the EU. However it is only the question of time and the Hungarian tax auditors will apply these rules with the same efficiency very soon.