NAV to increase rigor of audits on employees on cross-border assignments
Contrary to earlier tax authority practices, Hungarian affiliates of foreign companies employing employees of their non-resident mother company can expect increased rigor in audits, warns leading audit, tax and advisory services firm Mazars. According to Mazars, audits by the tax authority will focus on determining whether the “economic employer” of the employee is the foreign mother company or the Hungarian affiliate, as in the latter case the employee’s total wages will be taxable in Hungary.
Numerous Hungarian affiliates have employees from their foreign mother companies working for them, typically under a so-termed “service agreement”. In the case of long-term assignments, taxing employee incomes in Hungary has been a natural practice, but from now on employers will also have to worry about short-term cross-border assignments as the Hungarian Tax Authority declared its intention to conduct detailed audits of such agreements.
The location where the incomes are to be taxed is usually determined in bilateral treaties, and the majority of Hungary’s such treaties are based on the OECD Model Double Taxation Convention. Article 15 of the Convention sets out that incomes derived by an individual in respect of an employment in a country other than his country of residence shall be taxable only in the individual’s country of residence if the individual is present in the country of assignment for a period not exceeding 183 days and the remuneration is paid by, or on behalf of, an employer who is not a resident of the country of assignment.
It is, however, quite a simplified approach, as the qualification of the employer shall strictly be based on contentual criteria rather than formal ones, thus the question to be answered will be who is the true employer in economic sense. To do this, a so-termed “integration test” needs to be performed to determine which company’s operations the employee is an integral part of. Regarding the outcome of the integration test, it is key to determine which entity assumes responsibility or risk for the result of the employee’s work performance. Authority and controlling rights, the right to define skills, holiday and work schedules are also aspects to be considered.
The outcome of the test carries significant risk. If the Hungarian affiliate is the “economic employer”, the employee’s income will be taxable in Hungary from the very first moment of the cross-border assignment, regardless of the fact that the period of time spent in Hungary is less than 183 days or that the remuneration is paid by a non-resident employer.
“It may put increased administrative burdens on Hungarian affiliates, and, if the company commits malpractice, may result in significant tax arrears, leading to major fines and late payment penalties,” Sándor Szmicsek, tax partner and head of tax & legal advisory services at Mazars commented.
Although the “economic employer” concept is not new and the materially revised commentary of the OECD Model Convention published in the summer of 2010 emphasized the importance of this approach, the Hungarian Tax Authority has not seemed to give any consideration to this issue so far. The end of this era is clearly heralded by a guide published on the Tax Authority’s website, which says that from now on the Authority will follow the “contents have priority over format” principle and use the “economic employer” approach in all applications of double taxation treaties.
“It is recommended to have a thorough review of the contractual terms of employees working on cross-border assignments under service agreements, because it’s still not too late to fix them,” Szmicsek pointed out. The Tax Authority uses double standard as the fact that the Hungarian affiliate is qualified as the economic employer and thus the total income of the employee sent on cross-border assignment to Hungary becomes taxable in Hungary does not make the affiliate an employer in a legal sense, and therefore, according to the current position of the Hungarian Tax Authority, the receiving Hungarian entity is not entitled to give the non-resident employee fringe benefits with lower tax rates than that of the employment, he added.
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