According to the Act on Credit Institutions and Financial Enterprises, the credit and loan operations are financial services may be performed on a commercial scale subject to authorization. An exception to this is group financing, i.e. loans may be granted by affiliated companies to each other without the authorization of the Authority.
It is essential to define the term and conditions of the loan in writing, as in the absence of a loan agreement, the accounting and tax classification of the money granted may also become uncertain. For example, a loan that has existed for a long time can even be reclassified as a fund received without any further obligation. However, classification of long-term and short-term liabilities presented in the financial statements cannot be substantiated without this either.
Determination of interest rates
According to the provisions of the Civil Code, the loan provider is entitled to interest, the rate of which is freely agreed upon by the Parties concerned. A parent company may therefore decide to set an interest rate of even 0%, but in such a case the effect on tax liabilities must be examined.
Under the provisions of Corporate Tax Act and the Small Business Tax Act, if affiliated companies deviate from the arm’s length price for their transactions with each other, they will have tax base adjustment obligations. This provision also applies to interests on loans and credits as well. In the case of interest-free loans, for instance, the loan provider may have a foregone interest income, while the recipient has a foregone interest expense. The rule also applies when the Parties set a higher interest rate than the market rate.
If the loan provider is a private individual (not acting as a sole proprietor), there is no need to adjust the tax base in case of deviation from arm’s length price. In such a case, the tax liability of the private individual is regulated by the Personal Income Tax act.
Usual market interest rate
Based on our experiences with the Hungarian tax authority, it can be said that the usual market interest rate is worth examining mostly from the recipient’s side: for how much the company would receive the loan if it was received from another company or credit institution. To make a comparison, it is necessary to look at the terms and conditions of the loan: the amount, currency, duration, and collateral of the loan as well as the type of interest (fixed or variable, etc.).
A calculation is required to establish and support the tax base. To compare conditions on the market, the following options should be considered:
- publicly available interest rates published by the account-holding bank or credit institution
- requesting an offer from the account-holding bank under the same conditions
- statistical data published on the website of the Central Bank of Hungary
- international databases
- OECD guidelines
- use of a similar loan from a party independent of the Company (if there has been one before)
- Provision of a similar loan to a party independent from the Company (if this has arisen in the past)
It is also a good idea to have a contract (even years later) to document the market (or non-market) conditions, so that the terms are clear and available in the event of an inspection by the Hungarian tax authority. The loan agreement must include at least the following
- the amount and currency of the loan
- the rate, calculation, and payment date of interest
- the guarantees and security for the repayment of the loan
- the repayment date(s)
- the rate of default interest in the event of late payment.
Reporting to the tax authority of a loan received from or granted to an affiliated company
It is important to keep in mind the reporting and record-keeping obligations for affiliated companies. The Hungarian tax authority must be notified within 15 days of the first contract concluded with an affiliated company (or even a private individual) within the meaning of the Corporate Tax Act (an oral contract is also considered as such). If this is not done, the tax authority may impose a default penalty of up to HUF 500,000.
Transfer pricing documentation regulations
The transfer pricing documentation regulations apply to transactions with affiliated companies where the transaction value exceeds HUF 50 million. In the case of loans and credits, the amount of interest needs to be examined. For documentation purposes, all transactions must be considered when calculating the threshold. In the absence of documentation, a default penalty of up to HUF 2,000,000 may be imposed.
Higher volume of loans is affected. The interest deduction limitation rule in corporate tax affects higher volume of loans. The absolute limit of HUF 939 million set under the Corporate Tax Act exempts a wide range of Hungarian companies from this, as most Hungarian companies have financing costs not exceeding this amount per year.