Hungary: Transfer Pricing Rules

The importance of related party transactions has been reinforced by a recent guideline issued by the Hungarian Tax Authority ("APEH"). In this guideline, APEH has expressed that in the future, it would increasingly focus on related parties and their transactions, by carrying out parallel audits of these entities, and examining their transfer pricing arrangements.

Related party transactions are regulated by rules from several different areas of Hungarian tax law. These include the rules of Hungarian domestic corporate tax, value added tax ("VAT"), tax procedures and also certain international tax rules, such as Hungary's double tax treaties.

Regarding corporate tax, it should be mentioned that domestic Hungarian rules currently in force, in particular the Act on Corporate Tax and Dividend Tax of 1996 ("Corporate Tax Act"), already contain the "arm's length principle". The same principle is also included in the OECD's 1995 Transfer Pricing Guidelines, the provisions of which should be followed by Hungary as an OECD member state. In addition, a recent decree ("Decree"), effective from 1 September 2003, details the obligations of related parties to maintain registers of their transactions.

The Corporate Tax Act provides a definition of related parties, used in substance by the other laws of Hungary as well. This definition basically states that any two persons, one of which is holding more than 50% of the voting stock of the other, or has a significant influence on the composition of the board and/or supervisory board of the other, are generally regarded as related parties. This also applies when a third party has a similar influence on two other persons (which makes these latter two persons "related"), and the definition is also to be applied with respect to a non-Hungarian entity and its Hungarian permanent establishment(s).

Another important definition within the Corporate Tax Act is the "arm's length principle". This means that related parties are required to apply market prices and conditions to their transactions. If they fail to do so, they must adjust these prices appropriately for the purposes of taxation. There are three different "pre-set" methods for establishing market prices: (i) the "comparable uncontrolled price method", (ii) the "resale price method" and (iii) the "cost plus method". If duly justified, other methods may be used as well. The consequence of failing to apply market prices, or failing to adjust transfer prices to market prices is that APEH has the right, in the course of a tax audit, to make any necessary adjustments, levy fines and late payment interest.

It should also be noted that the same "arm's length principle" must be complied with for cross-border transactions and the principle also appears in Hungary's double tax treaties.

As mentioned before, the Decree details the documentation requirements of related party transactions. It requires related parties to maintain registers of the details of their transactions. Although most companies subject to corporate tax are required to maintain such registers, companies which qualify as "small" or "micro-enterprises" under the applicable regulations are exempt from this obligation.

As a general rule, the provisions of the Decree are applicable to every agreement concluded after 1 September 2003.

The above-mentioned register must be based on the individual agreements (either written or oral) of related parties, and must include data which is relevant for establishing the market price of the given transaction. This also means that no register is needed if related parties do not enter into contractual relations. Required data include, for instance: (i) the corporate name, seat and tax number of the related party; (ii) details, based on which the applicable market price can be established; (iii) a description of the "transfer pricing method" applied; (iv) a description of any conditions influencing the applicable market price; etc.

As a general principle, the Decree states that all reasonable efforts must be made to acquire information relevant for the transaction and the transfer prices applied. However the preparation of the register should not result in unreasonable costs and effort for the taxpayer.

There are certain relaxations made regarding the obligation to maintain the register, such as the possibility of keeping common registers for similar, or closely linked agreements, or an exemption for agreements concluded with individuals (other than private entrepreneurs), or agreements, between disadvantageously positioned enterprises, which are aimed at joint purchases or sales, etc. In addition, there is generally an option to maintain a simplified register if the net fair market value of the transaction in question does not exceed HUF 50,000,000 (approx. EURO 200,000). This simplified register should only include the corporate name, seat and tax number of the related party, the subject and the date of concluding (or amending) the agreement, the applicable market price and the date of the preparation and/or modification of the register.

Another obligation of related parties is to report to APEH the conclusion of their (oral or written) agreements within 15 days. Unlike the keeping of a register, this obligation is only to be fulfilled upon the conclusion of the first agreement with a particular related party, and has the sole aim to inform APEH of a newly established contractual relationship. Again, APEH has the right to levy a fine if one fails to duly report a new relationship.

Last but not least, VAT rules also contain some relevant provisions. VAT must be charged on the market price of the services rendered, or the goods supplied between related parties, if the applied transfer price is significantly lower than the market price applicable at the time of the supply. Again, any entity not complying with these rules may risk a fine and late payment interest, in addition to the collection of the adjusted amount of VAT.