Hungary provides a highly competitive tax environment for enterprises involved in R&D activities. In this article we will provide an insight to the currently tax benefit system and reveal the brand new service of the Hungarian Intellectual Property Office which can be used to eliminate the risk that the tax authority may reject the eligibility of an R&D cost deduction for tax allowance purposes.
From a taxation perspective Hungary has become one of the most preferable countries for the creation and exploitation of intellectual property rights. The legislator gave a new swing to the process that took off a few years ago by amending the legal regulations in January 2012 which attracted the attention of multinational companies in the pharmaceutical sector.
The new legal concept introduces the category of “registered intangible assets” by which the spectrum of tax benefits is considerably widened, securing Hungary’s position as well-known centre for the creation and exploitation of IP rights.
15% tax advantage compared to the neighboring countries
The concept of the Hungarian company taxation rules provide preferable royalty taxation allowing the application of the company tax rate of 10% up to the profit margin of 500 million Hungarian Forints. This advantage is further enhanced by the possibility to deduct 50% of the royalty from the tax base. As a result of these incentives the effective tax rate can be decreased to 5%. Meanwhile in the neighboring countries, such as Slovakia, Romania, and Austria the tax rate is significantly higher (9%, 16% and 25% respectively).
By careful and well calculated tax-planning an international company group can reduce its tax burden to an exceptionally low level, especially as in Hungary the profits originating from the exploitation of IP rights – unlike the profits achieved by any other activity – are not subject to local taxes, the rate of which would be 2%.
No Withholding tax
The attractive company tax rate alone would not offer an efficient solution if, either upon receipt of the royalties, or the payment thereof, in the country of the payment the profit were heavily affected by a significant amount of withholding tax. It is important to note that concerning royalties Hungary has a very attractive double taxation system, whereby companies initiating royalty payments to Hungary are only subject to a minimal amount or no withholding tax at all. Further, Hungary does not levy tax on the dividends payable to foreign entities, thus the profit generated by the royalty payments may be paid free of tax to the foreign owners , regardless of the existence of any double taxation treaty with the respective country. This legal background contributed to the popularity of a company structure where Hungarian companies generating profit by the exploitation of IP rights are owned by offshore entities (registered mostly in tax havens).
Tax benefits of research and innovation activities
Nevertheless the research and innovation activities realized by a Hungarian company provide further tax benefits to the already existing advantages of royalty taxation rules. Direct expenses of basic research and experimental innovation activities of a company can reduce the company tax base by double; the research and innovation costs may not only be counted as expenses, but also be considered as reducing items by the calculation of the company tax base. Such expenses include the salaries of the employees conducting research or the purchase price of the instruments and materials procured for the R&D activities. Further benefits may also be available if such activities are performed in cooperation with the Hungarian Academy of Sciences, a higher education institution or a co-founded research institution.
The tax incentives available in connection with R&D do not only affect the company taxation obligations favorably but also the amount payable as local industrial tax or innovation tax - the amount of which is 0.3% of the net annual, corrected income - since the direct expenses of the own research and innovation activities may be deducted from the tax base of the local industrial tax and the innovative contribution respectively.
From 1 January 2012 due to the changes of the legal regulations, a company would meet the criteria of own research and innovation activities by financing another company’s activities under a research and innovation agreement. The new regulation provides the opportunity for a company group to include the Hungarian branch to the tax beneficiaries without having to establish actual innovation activities and facilities in Hungary. By participation in the financial founding of the research and innovation activities, the Hungarian entity is deemed to be eligible for the taxation benefits even without direct participation therein.
Registered intangible assets
The new regulation on registered intangible assets provides that the any intellectual property acquired following 1 January 2012 may be sold tax-free. For the tax exemption the following two criteria must be met: (i) the company acquiring the respective intellectual property shall report the acquisition within 60 days from the date of the transaction, (ii) and the transfer must take place at least one year after the acquisition thereof.
Should the case arise that the company cannot take advantage of the exemption for any reason, the law provides further possibilities. If a company sells intellectual property profitably, but did not apply for the tax exemption, the profit shall not be subject of tax if it is turned into the acquisition of another intellectual property right. Upon such new acquisition the company may choose to apply the new registered intangible asset taxation rule to the respective intellectual property, securing thereby definitive tax-exemption.
The new institution of registered intangible assets provides numerous tax-planning options and opportunities in Hungary for multinational company groups. If a company group would facilitate a development adding further value to the intellectual property through a Hungarian company, such intellectual property may thereafter be transferred for a higher value to another company of the group registered in a foreign country for exploitation without any tax payment obligation. By cooperation of a Hungarian project company the revaluation and then the utilization of intellectual property rights in the most profitable way - from taxation perspectives - may easily be realized.
Classification of R&D activities
The uncertainty of the application of the regulations, and of tax-planning seem to be eliminated as of 2012, as now companies may request the Hungarian Intellectual Property Office (“HIPO”) to officially establish the R&D status of their activities. If no change occurred in the circumstances of the company or in the governing legal regulations, the official opinion of the HIPO remains binding for the tax authority. Companies now have the opportunity to request a prior evaluation of their eligibility for the tax benefits, avoiding the risk of an examination by the tax authority delivering different results.
For businesses it is of utmost importance to eliminate uncertainties and contradictions arising form future assessments of R&D activities. One of the major concerns is a follow-up audit by the Tax Authority establishing that the R&D activity in question is not eligible for tax benefits. In order to mitigate this risk the Hungarian Government decided to empower the HIPO to evaluate R&D projects.
The Act on Research and Development and Technological Innovation (R&D Act) provides the Hungarian framework on fostering R&D activities. This legislation defines three categories: pure basic research, targeted basic research and experimental development. These together are referred to as research and development. The decision made by HIPO can be used for both tax benefit purposes in tax administration procedure and validation of R&D activities in publicly-founded projects. It is important to note that the HIPO is entitled to evaluate projects which commence after submission of the request. However the R&D Act introduces the possibility to refer questions to the HIPO in an ongoing tax investigation since the tax authority can decide to request the HIPO to deliver an expert opinion on the eligibility of the project for R&D tax benefit.
HIPO’s evaluation is subject to payment of a fee. The basic fee is HUF 83,000 (approx. EUR 300), while the additional fee for determining the ratio of pure basic research, targeted basic research and experimental development within the same project is HUF 20,000 (approx. EUR 75). An additional fee of HUF 30,000 (approx. EUR 110) applies if the HIPO shall also evaluate whether the contribution to the project meets the criteria of own R&D activity as set forth in the act on corporate income tax.
On 24 September 2012 the HIPO published detailed guidelines on its evaluation methods. This document is based on the latest edition of the Frascati Manual, the internationally recognized methodology for collecting and using R&D statistics. While the Hungarian manual does not go into the same details as the Frascati Manual, it contains the most important evaluation aspects and examples of R&D activities including cases on the borderline between R&D and other industrial activities. For example, in relation to clinical trials, the Hungarian manual also provides that trial phases which take place before permission to manufacture, i.e. phases 1, 2 and 3, are to be considered R&D. Testing the drug after approval and manufacture, i.e. phase 4, should only be treated as R&D if it involves further scientific or technological advance.
The introduction of the manual also reveals that one of the reasons behind its publication was that the references to the Frascati Manual were removed from Hungarian tax regulations as of 1 January 2012. This caused uncertainties as to the evaluation criteria of R&D activities and the HIPO has urged the state to fill this gap. While the manual published by HIPO does not have direct effect since it is not hard law, it provides important guidance in this field.
The manual is available on HIPO’s website
Hungary has been a favorable location for IP investment due to its advantageous taxation system and this has just been developing during the past years. With the latest changes of tax legislation the last uncertainties also seem to have been removed.
Other cases on the EU and National Life Sciences developments newsletter for October 2012