Category: Hungary

As to the pending issue of the preferential VAT rate of 5% for new residential properties, finally the new tax laws approved by the Hungarian Parliament in November 2018 will remain to ensure the reduced VAT rate of 5% in case the date of completion of the residential properties is after 31 December 2019, provided that certain conditions are all met on 31 December 2019. These conditions are that a) the sale and purchase agreement has been submitted to the land registry office, b) the residential property can be considered as a structurally complete building (shell and core) and c) the seller of the residential makes a declaration to the tax authority on the compliance of the conditions included in points a) and b).

The amendment also includes the definition of the structurally complete residential building, which is a building where the external bordering structures have been prepared (with walling, floor and roof structure, doors and windows and depending on the construction documentation, with chimney, balcony and external stair structure).

Furthermore, according to the tax package, the reduced VAT rate would be applicable until 31 December 2023 in case of the sale of those new residential properties which have a final building permit on 1 November 2018.

According to the real estate developers, the proposal of the Hungarian Government has clearly favourable effects on the market, however, it would be more advantageous if the above deadline of 1 November 2018 would be extended until 31 March 2019.

By Gabriella Galik, Partner, KCG Partners Law Firm

The finance ministers of the European Union Member States support the request of the Hungarian Government relating to the tax reduction and simplification for small enterprises. According to this decision, the limit for VAT exemption for small enterprises might be increased to HUF 12 million. This legislative amendment would affect more than 600,000 taxpayers. If the Hungarian Parliament adopts this change, this amount will be equal to the income limit of the taxpayers falling under the scope of the Act on the Fixed-Rate Tax of Low Tax-Bracket, which is also HUF 12 million. Due to this change, the companies with a revenue up to HUF 1 million per month could also apply for this type of tax liability.

The increase of the limit of the revenue will also reduce the administration burden of taxpayers falling under the scope of the Act on the Fixed-Rate Tax of Low Tax-Bracket. It means in practice that these taxpayers need to complete a value added tax return only once a year. The change is based on the proposal of the biggest tax advisory companies.

By Eszter Kamocsay-Berta, Managing Partner, KCG Partners Law Firm

According to some sources from the Hungarian Prime Minister’s Office, a lifelong personal income tax exemption is planned to be applied to mothers with at least three children. With this tax cut, the Hungarian Government would intend to encourage families to have more children, and to increase the fertility rate in Hungary, which is one of the lowest in Europe. This measure could result in approximately HUF 100 billion (~EUR 285 million) loss of revenue for the Government budget, which is 5% of the total personal income tax revenue. On the other hand, it is difficult to estimate how this tax exemption will affect the fertility rate or the women re-entering the labour market.

This tax benefit would affect every woman who is raising or raised three or more children, and it would complement the existing tax benefits. The number of the women in question is around 173,000. A woman with an average income, returning to the job market at age 39 and having 3 children could save HUF 18 million (~EUR 55.000) until retirement. It is estimated that due to the tax cut the income position of the affected women could increase by 11% annually.

By Gabriella Galik, Partner, KCG Partners Law Firm

Guidance No. 12/2018 (II.27) of the Hungarian National Bank entered into effect on July 1, 2018 (the “Guidance”). Although the Guidance is non-binding, financial institutions are expected to comply with its provisions. In this article, we provide a list of the most important points of the Guidance and predict market reactions based on our ongoing mandates and information obtained from our clients.

The Guidance makes clear that although the Hungarian National Bank (the HNB) is satisfied with the increased activity of the banks in real estate financing, it expects all lenders to be very cautious and selective with their projects. The memory of the vulnerability of the Hungarian banks at the time of Lehman’s fall is still deeply engraved in controllers’ minds and they do not want to deal with a similarly massive number of defaulted real estate projects again.

The Guidance sets forth a detailed checklist for quarterly reviews. The HNB informally communicated that in its view the banks have already been performing quarterly reviews, so the practice is only confirmed. While there is certainly much truth in this statement, the problem is that the HNB expects the principles reflected in the Guidance’s checklist to be applied in all projects – and while a detailed quarterly review is certainly best practice for most projects, that might not be true, for instance, for an office building with one or two tenants. Anyhow, the banks will include the relevant provisions of the Guidance among the information covenants in the facility agreements, so most of the administrative burden will be placed on the borrowers. 

The HNB also expects the banks to apply three months’ debt service reserve account if the average debt service coverage is below 1.2. The entire market seems to agree that this is merely a codification of existing market practice, and this is a point that will not cause difficulties when structuring new deals.

Finally, the HNB expects everyone to apply a 25% cash-sweep if the total amortization period of a loan is longer than 20 years in the case of new office buildings and retail real estates, or more than 15 years in all other cases. This is the most-discussed and criticized provision of the Guidance, and many of our clients have already approached the HNB for clarification on this issue. While we wait for further communication in this respect, certain points are particularly problematic. Maybe the most important issue is that the Guidance does not define any methodology for calculating the total amortization period, which leaves room for insecurity and even “tricky” solutions. For instance, if the interest rate is not fixed, how can possible increases/decreases for the next 20 years be calculated? Will indexation of the leasing fees be included? How can vacant areas, short term lease agreements, and break options be calculated? Many questions and the answers are yet to come.

Also, no one knows what a “new office building” is. If this term only refers to real estate development, this means that a developer will obtain a loan with better conditions than an investor buying a recently finished, quasi-new building. 

In certain ways, this provision of the Guidance may even be counter-productive and may result in banks losing their strongest clients, which is definitely not the aim of the HNB.  In practice, only the strongest borrowers can request terms extending beyond the rules of the Guidance. Borrowers with a gigantic sponsor can afford to request a five-year grace period, low amortization for the entire term, or a super-long final maturity. Some say that such clients will now opt for cross-border financers, such as the Austrian mothers of Hungarian banks, which are not subject to the Guidance. This may result in a number of synthetic participation deals from the Hungarian side, or Hungarian banks otherwise funding their mother companies. 

Notwithstanding all the above, until further clarification, there may be space for creative interpretations. The cash sweep mechanism may be simply priced in quarterly instalments: a lender expecting 4% amortization may only include 2% in the repayment schedule, with the rest to be paid under the cash-sweep. Also, bear in mind that there is only a best effort obligation to apply the Guidance in case of existing deals. This may mean extending the term instead of a refinancing, or increasing an existing facility in case of any top-up loans. The HNB will need to decide whether these practices comply with the Guidance.

By Erika Papp, Managing Partner, and Sandor Kovacs, Associate, CMS Hungary

This Article was originally published in Issue 5.8 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.

The European Council adopted an amendment to the Posting of Workers Directive on 21 June 2018. The purpose of the revised Directive was to ensure fair competition for companies and better protection for workers who have been sent by their employers to perform services in another EU Member State on a temporary basis. Under the new regime, all of the host country’s remuneration rules should apply to posted workers, so that the posted workers could get equal pay for equal work in the same place.

The Hungarian Government submitted an action to the Court of Justice of the European Union on 3 October 2018 for the annulment of the modification of the Posting of Workers Directive. According to the Hungarian Government, the modification has detrimental impact on the enterprises in the region. It argues that the modification constitutes disproportionate restriction on the freedom to provide services which is one of the EU’s four fundamental freedoms. Therefore, the modification would significantly reduce EU’s competitiveness. Further, the Hungarian Government considers it unacceptable that the modification would extend the application of the Directive to the transport sector. The Government highlighted that Poland also submitted an annulment action against the modification of the Directive.

The EU Member States have to adopt the implementation provisions in their national laws until 30 July 2020 at the latest. However, the Hungarian Government expressed its hope that the Court of Justice of the European Union will annul the modification of the Directive before this date. 

By Rita Parkanyi, Partner, KCG Partners Law Firm

From 1 January 2020, the reduced tax rate of 5% applicable to the flats to be constructed or existing in a multi-unit residential building with a total net floor space not exceeding 150 square meters and to the single-unit residential building with a total net floor space not exceeding 300 square meters will be terminated and the general VAT rate of 27% will be applicable for the sales of such residential properties.

At the end of September 2018, the National Tax and Customs Office published a summary relating to the changes of the value added tax treatment of the residential properties. According to the summary, in principle, the tax rate effective at the time of performance shall be applicable to the establishment of the VAT. The summary distinguishes three cases on the basis of the date of performance subject to the method of sale of the residential building. For example, in case of the actual handover to the customer of a property made by constructing and installing works and to be registered in the real estate register (whether or not the customer has provided all or any part of the materials necessary for construction), the date of the performance is the date indicated in the protocol documenting the entire handover of the property. The summary determines two further cases for the date of performance of property sales.

The summary also clarifies that in case of partial performance, the instalments performed until 31 December 2019 are subject to the VAT tax rate of 5% and the instalments paid after this date are subject to the tax rate of 27%. Similarly, the advance payment received or credited prior to 1 January 2020 will fall under the tax rate of 5%. In addition, the buyer may also pay the full amount of the purchase price to the seller as advance payment regardless of the completion level of the new residential building.

By Eszter Kamocsay-Berta, Managing Partner, KCG Partners Law Firm

The Hungarian Government recently adopted Act no. LVII of 2018 on the Control of Investments Detrimental to the Interests of Hungarian National Security (the “Act”). Previously we wrote about a similar legislative proposal [see here] (the “Proposal”) which aimed at establishing a similar control mechanism. However, the Act has a more sophisticated approach on the control and approval procedure than the earlier proposal had. Pursuant to the Act, investors from outside the EU, Switzerland and EEA countries who wish to invest in Hungary must obtain prior approval from the minister to be designated by a governmental decree (“Minister”) which has not yet been adopted.

The scope of the Act

Compared with the Proposal, the Act has an extended scope: It applies not only to an investor from outside the EU, Switzerland and EEA, but also to a company established in the EU, Switzerland or an EEA member state, if it has a shareholder from outside the EU, Switzerland or EEA that holds the majority of the votes in such company or has a decisive influence [1] in it (“Foreign Investor”).

The Foreign Investor must obtain the prior approval of the Minister if it intends to:

• directly or indirectly acquire more than a 25 % interest (in the case of a publicly listed company a 10 % interest) in an existing or yet to be established company with its registered seat in Hungary, provided that this company pursues activities that are deemed sensitive for national security (“Hungarian Company”) or
• acquire decisive influence in a Hungarian Company pursuant to the Hungarian Civil Code, or
• establish a branch office in Hungary; or
• acquire a right to operate or use sensitive infrastructure or assets.

The Act contains additional rules to prevent the circumvention of its objectives. Because of this, the Minister’s prior approval is required when a Foreign Investor acquires an interest of less than a 25 % but this acquisition results in more than a 25 % interest in the respective Hungarian Company being held by (several) Foreign Investors. The prior approval must be obtained also when an established company changes its activity to an activity deemed sensitive for national security.

These activities include activities:

• that are classically considered sensitive, e.g. manufacturing of arms, dual-use items and secret service equipment; 
• falling under the Hungarian Gas Act and Water Supply Act, Electricity Act, Credit Institutions Act and the Electronic Communications Services Act; and
• involving the creation, development and operation of communication systems of the Hungarian State and Hungarian municipalities. 

The approval procedure

Pursuant to the Act, the Minister will have 60 days to decide whether or not to approve the Foreign Investor’s request based on consideration of national security aspects. The Minister may extend the deadline by up to 60 days. In the course of the approval procedure, the Foreign Investors’ entire ownership structure and its ultimate beneficial owner must be disclosed. If the Minister refuses the request, the Foreign Investor will only have a limited right to appeal against the decision to the Municipal Court of Budapest (in Hungarian: Fővárosi Törvényszék).

Prohibitions, pre-emption right in favour of the Hungarian State and fines

As a general rule, the Foreign Investor may be registered as a shareholder in the list of shareholders or the book of shares solely with the prior approval of the Minister. The right to operate or use the infrastructure, equipment and facilities necessary for the Hungarian Company’s activities may be granted only after the issue of such approval. The minister’s approval also constitutes a pre-requisite for other approval proceedings related to sensitive industries. Furthermore, the Foreign Investor will be subject to a mandatory reporting obligation.

If the Minister prohibits the acquisition, the Foreign Investor must sell its shares or eliminate its influence in the Hungarian Company or the Hungarian Company must modify its activity within three months. During the sale, the respective ownership share will be encumbered by an ex lege pre-emption right in favour of the Hungarian State. If the Foreign Investor acquired the right to operate a sensitive infrastructure or asset that falls under the Act and has not obtained the approval for it, the Minister must initiate an action before court to declare the underlying transaction  or agreement unenforceable.

In the case of any violation of the Act, the Minister may also impose a fine of a maximum of approx. EUR 3,100 for natural persons and approx. EUR 31,000 for legal persons.

Summary

The Act could pose a considerable impediment to third-country investors because the Minister may block the transaction if it is detrimental to the Hungarian national security interests, and the transaction may not be closed without the Minister’s approval. It is also unclear what constitutes an investment detrimental to the interest of the country. The Act will be supplemented by a governmental decree which will provide more detailed rules. The Act will enter into force on 1 January 2019. Before commencing a transaction aimed at the investment in a Hungarian Company, Foreign Investors are highly recommended to involve a Hungarian licenced attorney at law.

Furthermore, the Act seems to run in parallel to a similar proposal of the European Commission issued in September 2017 for a Regulation establishing a framework for control of FDI in the EU. As mentioned in the European Commission’s proposal, today nearly half of the EU Member States have control mechanisms for foreign direct investment in place (e.g. Germany, Poland, Austria) and the European Commission has prepared its own draft rules about such control. It remains to be seen how the Hungarian and the EU control of FDI will be compatible with each other.

By Kinga Hetenyi, Partner, Adrián Menczelesz, Associate, Schoenherr