Transfer pricing: local business tax, adjustment to the median value

As the assessment basis is the sales revenue instead of the earning before tax value, it is possible that significant amount of local business tax would be payable even when earning before tax is low or negative. In particular, the issue is incurring at non-manufacturing or non-retail companies which have minimal costs relating to purchase of goods and therefore could have significant local business tax liability when corporate tax base is low or negative. 

The following simplified calculations shows the local business tax liabilities based on different main activities of the entities. 

Example for corporate tax and local business tax liability calculations of a service provider and a manufacturing entity

Information used for the calculation:

The above example shows that the local business tax base could be significantly higher than the corporate tax base. This could be also the case for some industrial or retail companies as well due to the different basis of the two tax types. 

When determining the transfer prices, Hungarian local business tax is frequently categorized as „revenue tax” in a corporate group instead of other cost and therefore it is not considered as a cost item during the transfer pricing calculation.  The result of this mistreatment could be a position where operating profit is not covering the local tax payment liability.  The applied 2-4% mark-up is barely covering the incurred corporate tax and local business tax payment liabilities and therefore the taxpayer would not achieve the supportable profitability level.  If the tax base need to be adjusted for corporate tax calculations, the local business tax base would also require a review. 

The new Section 18 paragraph (12) of the Hungarian Corporate Tax Act determines that as a general rule, if the transfer prices applied by the taxpayer are outside of the arm’s length range, the corporate tax base needs to be adjusted to the median of the range calculated from the comparable companies’ data. When the results achieved or the mark-ups applied by the related parties were not arm’s length (too low), the adjustment needs to be done to the median instead of the lower quartile of the range which might increase the tax payment liability for the Hungarian company.

Furthermore, the tax authorities during a tax authority audit could come to the conclusion that the relevant invoices/certificates need to be adjusted individually and new invoices should be issued based on the new transfer prices which could increase administrative burden.

For determining the transfer prices in a group the Hungarian local business tax should be categorized as a cost item and not as a revenue tax linked to operating profit level. This approach might differ from the ones followed by other countries for similar type of taxes.  

If the applied transfer prices are not considered in line with the Hungarian approach, 

In these cases, the applied mark-up or operating profit margin need to be adjusted to the median when calculating the relevant corporate tax base, and the cancelling and re-issuing of the invoices also might be required. 

Based on our experience, some taxpayers followed the practice to only make the adjustment to the lower quartile of the comparable range. We would like to raise the attention that this approach would not be compliant in general, and the adjustment needs to target the median value which might significantly increase the corporate tax liability. If the adjustment is required for corporate tax calculation purposes, further adjustment would also be needed for the local business tax calculation.