Will KATA Changes Whiten Economy or Prompt More Creative Bookkeeping?

Analysis

Might the new KATA regulations lead to an uptick in at least some cash-in-hand payments?

Photo by Janos L. Virag / Shutterstock.com

Changes in the small taxpayers’ flat-rate tax (KATA) may fail to achieve the lawmakers’ original goal, tax experts warn.

As of January 2021, a 40% tax is payable when crossing the annual income limit of HUF 12 million in cases where the sum of the amounts invoiced by a KATA taxpayer to an (unaffiliated) business partner exceeds HUF 3 million. The tax also applies to transactions between affiliates, regardless of the amount.

For domestic parties, the excess tax would be payable not by the taxpayer subject to KATA, but instead by the business partner receiving the invoice. If a KATA taxpayer receives income from a foreign affiliate or from a foreign customer where the income exceeds HUF 3 mln, the 40% tax will be payable by the KATA taxpayer. In this case, however, the tax base will be equal to 71.42% of the portion of the income that is in excess of HUF 3 mln.

Those who issue invoice to individuals, or who do not invoice an affiliate or those who do not invoice more than HUF 3 mln to a partner (who is not an individual) a year will continue to benefit from KATA as per the pre-January changes.

Unfortunately, practice shows that many business have already decided not to pay the extra 40%; they either don’t contract the enterprise/individual with KATA, chose a party whose offer is more favorable for them from a taxation viewpoint or pay a fee that is lower to avoid the payment.

This latter option is a compromise some experts also mention as a possibility to people to prevent them from losing their job/commission altogether. All the taxpayer need to do is to calculate the amount in a way that it forgoes the 40% extra to the receiver. That is, above the HUF 3 million limit they provide a 28.5% discount to the entity who pays them.

Legal Question

Whether this option is legally valid is a question debated by lawyers and has yet to be tested, but some experts/websites on tax have displayed examples of agreements where such terms were stated.

Further loopholes include not issuing an invoice above the limit and simply paying the extra in cash, or creating more unaffiliated enterprises to receive the invoice until the limit. These are obviously not the most transparent solutions, but are a possibility according to experts. When it comes large corporations, these “options” are ruled out: they either commission the taxpayer or not.

Those who find that KATA is no longer a viable (or perhaps more accurately a profitable) solution for them have several options to choose from. They can decide to pay a flat tax rate, or specific taxes as an individual entrepreneur.

They could also switch to other entity forms, such as a limited liability company or small business tax (KIVA).

Depending on the tax base, all will leave less in the taxpayer’s pocket than the original KATA scheme, but compared to the new KATA rules, some may end up being more favorable. There are numerous free calculators on the internet that describe in detail the amounts to be paid in each case.

It is too soon to tell what solutions taxpayers and receivers will favor in the long run. The government’s stated aim with the modification was to eliminate so-called concealed employment, where a company paid what was to all intents and purposes an employee through KATA rather than via a regular salary to avoid payroll costs.

But it may simply mean many will, as a result, lose their jobs, although only time will reveal the true extent of this. At this point, the fears of many associations that have fought against the modification appear to be coming true: The government makes a livelihood impossible for those who have never been employed but do provide service to larger entities.

Detailed Legislation

The fact is that many associations claim that currently employment and business commissions cannot be truly separated unless there is detailed legislation controlling both.

When it comes to paying taxes, there is hardly an ideal solution; certain parties will always be hurt. There are approximately 400,000 taxpayers subject to KATA in Hungary. This change is supposed to protect hundreds of thousands of taxpayers while it will inherently risk the livelihood of thousands (or tens of thousands.)

From a budgetary viewpoint, KATA’s effect is not that significant. The 2020 budget revenue allocation from KATA was HUF 192.6 billion but the final figure of HUF 158.2 bln fell well short of that, according to data from the Central Statistical Office.

The new KATA rules could certainly add some additional tens of billions of forints to central budget coffers, but compared to the tax revenues from value added tax (HUF 4.699 trillion) or excise duty at HUF 1.196 tln, it is marginal.

Overall, experts warn, the very original idea of KATA, simplifying taxation and drawing people into the system, therefore reducing tax avoidance and “black” employment, will largely be lost due to the modification.

The key to a more “disciplined” tax payment, not just for this type, but in any segment, would be more scrutiny, they claim.

This article was first published in the Budapest Business Journal print issue of February 26, 2021.

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