Abolition of Solidarity Surtax: New Opportunities for Holdings

Hungary has traditionally been a popular jurisdiction for many international licensing and financing holdings for various reasons. The planned abolition of the 4% solidarity surtax is likely to boost this trend, attracting even more foreign investors to Hungary.

Solidarity surtax was introduced with effect from September 1 2006 in order to improve the balance of Hungary’s national budget. As a result, the 16% income tax liability for corporate entities was effectively increased to 20%. Solidarity surtax was always intended as a temporary measure, to be abolished as soon as the central budget had been sufficiently balanced, and was announced as such. Although the measure has not yet been passed by Parliament, the surtax is due to be abolished on January 1 2009, as confirmed by Prime Minister Ferenc Gyurcsány at the Hungarian Embassy in Paris on May 22 2008 and on other occasions.

The abolition of solidarity surtax will have obvious benefits, adding to the advantageous features of Hungary’s tax legislation. It will make Hungary's effective corporate income tax burden the lowest in Central Europe from 2009, as the table below shows.

However, a reduction in the corporate income tax burden will not be the only benefit to flow from the abolition of solidarity surtax, which will also lend further momentum to a Hungarian holding regime that already enjoys great popularity among foreign investors. This popularity is based not only on the low corporate income tax rate, but also on the government's consistent, long-term policy of attracting foreign investors by means of tax incentives, including a highly beneficial tax regime for licensing and financing activities.

One such benefit is the preferential corporate income tax regime for royalty and related-party interest income: within certain limits, only 50% of royalty income is taxable. Similarly, only 50% of the interest received from related parties in excess of interest paid to them is included in the corporate income tax base. Thus, the effective corporate income tax rate for these types of income will be 8% from 2009 - the most competitive rate in Central Europe.(1) Moreover, no restrictions apply to the deduction of royalty and interest payments from the corporate income tax base, provided that such deductions serve a business purpose and meet transfer pricing requirements, if applicable.

Royalties and related party interest are not the only types of corporate income to benefit from preferential rules. The introduction of the participation exemption regime in 2007 resulted in the total exemption from corporate income tax of capital gains accrued on reported shares of at least 30% and held for at least one year. This rule is especially advantageous for certain forms of corporate transformation. The benefits of the tax regime are not restricted to income; the abolition of corporate withholding tax was a significant step towards the creation of a tax-friendly environment for international investors in the past few years.

Despite a number of advantages, Hungary is not yet as widely known as it should be for its tax advantages for international investment. However, the forthcoming abolition of solidarity surtax is expected to raise its profile among investors.

For further information on this topic please contact Orsolya Bardosi or Szabolcs Erdős at Gide Loyrette Nouel by telephone (+36 1 411 74 00) or by fax (+36 1 411 74 40) or by email (orsolya.bardosi@gide.com or szabolcs.erdos@gide.com).

Endnotes

(1) At present, solidarity surtax raises this to 12%.