Taxation and liabilities arising from M&A or share sales

Taxation and liabilities arising from M&A or share sales

At the time of company or quota sales, sellers have a tax liability (an obligation to pay income tax), be they private individuals or companies. In connection with purchasing a company or quota, any duty payment obligations and potential subsequent uses of deferred losses must be examined.

Taxation of Hungarian private individuals upon selling a company

In the event that a private individual sells a quota – as a general rule, that is, in case of a private individual who is a Hungarian taxable person or in case of a Hungarian share –, a quota in a limited liability company, a limited partnership, and a general partnership is deemed as a security in respect of the PIT Act.

Pursuant to Section 67 of the PIT Act, income from the transfer of securities – that is, the revenue from transfer as reduced by the value paid for acquiring such securities and by associated additional costs – is deemed as income from exchange rate gains and is subject to 15 percent personal income tax (PIT).

In addition to PIT, there is a 14 percent healthcare contribution payment obligation as well, which – however – is maximized. The upper limit of health care contribution payment for the current year is HUF 450,000, which includes health insurance contributions paid by the private individual both in kind and in cash, any health service contributions paid, and the 14 percent healthcare contribution paid for any other income. If, for example, the health insurance contribution paid by a private individual having regard to their wage from employment reaches HUF 450,000 in the current year, they will not have an obligation to pay a healthcare contribution.

If the seller is a private individual who is a taxable person abroad, then applicable conventions are also required to be examined. The exchange rate gain from the alienation of securities is typically taxable in the state where the alienator is established.

In the event that a private individual transfers securities issued by a company established in a state with low tax rates, then the part of the revenue received for alienation which exceeds the value appropriated for acquiring such securities shall be deemed as the private individual’s other income.  After such other income, the PIT payable is 15 percent, and the healthcare contribution payable is 19.5 percent. In the event that the provider of such income (the buyer) is a paying agent, then the paying agent shall be obligated to pay such healthcare contribution. Otherwise, private individuals are required to pay 19.5 percent healthcare contribution under the proviso that in such a case, 84% of the income determined is required to be taken into consideration.

Taxation of a Hungarian company as seller upon company sales

In the event that a Hungarian company sells its share in another company, then the difference between the value of the share derecognized (book value) and the counter value received as revenue shall be the corporate tax base. The standard corporate tax rate is 9 percent as from 2017.

If the share sold is deemed as a notified share under the Corporate Tax Act (meaning that the acquisition of the share in the degree as determined by the legal regulation currently effective at the time of acquisition has been reported to the tax authority),then the exchange rate gain realized by the sale will be exempted from corporate tax, in the form of an item to decrease the tax base. A further condition for this is that the taxpayer has registered such share among their assets on an on-going basis for at least a year before the sale. If there is a loss on the sale of a notified share, then it will increase the result before taxation, that is, the tax base.

If the sale is directed to a related undertaking and the purchase price is lower than the market price, then the pre-tax result is required to be increased by the amount of the difference, so a corporate tax payment liability is generated in this regard as well.

In the event that the seller is a foreign company (e.g. a company having a real property),the applicable conventions will need to be examined.

It is an important step to report share acquisition when acquiring a company

The institution of notified share is an opportunity worthwhile to make use of at all company acquisitions. As from 01 January 2018, quota acquisition can be reported to the tax authority, regardless of the degree of a share acquired. Such disclosure brings about the legal effect that the tax base can be later on reduced by the exchange rate gain from the alienation of a share held for at least one year; at the same time, it should also be taken into account that if the taxpayer realizes n exchange rate loss in connection with the sale of a notified share, the amount thereof will increase the tax base.

Such disclosure is required to be made to the tax authority, subject to a 75-day limitation period. The date of acquisition shall be the date of entry by the court of registration, and in the absence of an entry by the court of registration, the date of entry into effect of the legal transaction serving as a basis. A taxpayer established domestically shall apply this provision with the derogation that they will be entitled to report on shares acquired before obtaining resident status within 75 days of making the first legal representation.

It is a fundamental rule that the criteria always have to be met on the basis of the rules in effect on the date of acquiring the share. As opposed to earlier years, it is a favorable change that the regulatory minimum for acquiring a share was eliminated as from 01 January 2018 (it was 10% in 2017),so the legal consequences associated with notified shares can already be applied in case of even the smallest share acquisition.

The tax implications of company sales are associated with the market price by the Corporate Tax Act

In regard to corporate tax, the market price is the arm’s length price which is or would be enforced by independent parties in their transactions by and between each other in comparable circumstances. The market price does not equal to the book value.

The Corporate Tax Act specified various methods to determine the market price:

  1. Comparative price method, where the arm’s length price is the price applied by independent parties when selling a comparable asset or service at an economically comparable market.
  2. Resale price method, where the arm’s length price is the price applied in the sale of an asset or service in an unchanged form to independent parties, as reduced by the costs of the re-seller and by the usual profit.
  3. Cost and income method, where the arm’s length price is required to be specified as the prime cost increased by the usual profit.
  4. Net transaction profit method, which examines the net profit projected to the appropriate projection base (costs, turnover, assets) which is realized on the transaction by the taxpayer.
  5. Profit share method, in the course of which the aggregate profit from the transaction is required to be distributed between related undertakings on an economically justifiable basis in a proportion as would be performed by independent parties in such transaction.
  6. Another method, if the arm’s length price cannot be determined on the basis of paragraphs a-e.

The so-called fair value based valuation is classified among other methods; it is frequently used for company evaluation. If the parties to the transaction are related undertakings obligated to produce transfer price documentation  (meaning that they are not small-sized enterprises at company group level and/or the transaction value exceeds HUF 50 million),then the arm’s length price (benchmark) analysis will form part of the transfer price documentation, where the applicability of the methods above is required to be examined in the serial order prescribed and reasons should be given why the selected method (e.g. the fair value method) is the most suitable one for specifying the market price.

Management of losses when acquiring a company

Following company acquisition, deferred losses are not allowed to be used automatically by law at the target company (before the transaction).

The deferred losses of the target company can only be offset against the profits for the current or the subsequent tax years

  • if such company acquisition was performed within a company group, among related undertakings (the parties were related to each other in the course of the two tax years before obtaining majority control),or
  • if the shares of the company or of the company acquiring majority share are traded on the stock exchange, at least in part, or
  • if the company acquired continues to pursue its business for at least two years and the nature of such business activity does not considerably different from the former one (not including the case of termination without a legal successor).

Here the general requirement also applies according to which the amount of loss generated in the tax year can be recognized by the taxpayer in the course of the next five tax years, in a breakdown as decided by the taxpayer, under the proviso that in the cases above the company acquired may only use its deferred loss in the proportion legally prescribed. In a particular tax year, the deferred loss of earlier years may only be accounted for up to 50% of the tax base calculated without a loss. The five-year time limit for using the loss was introduced in 2015. Before that, by 31 December 2014, the losses of earlier years were allowed to be used without any time restrictions. The modification is related to a transitional provision, according to which deferred losses generated before 2015 may be enforced in the tax year including 31 December 2025, at the latest.