Cabinet d'avocat Jalsovszky

You only need to ask – security-related bankruptcy rules are to change


Although the new Civil Code that took effect in 2014 made it impossible to use a good few commonly used types of loan security, since then the legislature has gradually restored them to their rightful place. Indeed, the amendments to the Bankruptcy Act coming into effect on 1 July will go further than the previous rules, giving security options and security assignments, the same priority status as mortgages. This case is a good example of the effective cooperation between the legislature and the banking industry in Hungary.


The two years of exile

The new Civil Code that took effect more than three years ago caused a thorough shake-up of the system of loan securities. Among other novelties, in 2014 the security option and the security assignment effectively disappeared from the radar. Thus all agreements under which the borrower granted the bank a purchase option in respect of an asset (such as a property) to be exercised in the event of insolvency became null and void. The assignment of receivables as a form of loan security was similarly ‘blacklisted’.

The banks’ credit departments reacted to the new rules by developing various new forms of loan security. But security option and security assignment were sorely missed.


The period of rehabilitation

In response to the unceasing demands of the market, the legislature decided, last July, to change the Civil Code’s rules on security. As a part of this, from last year it again became possible to request a call option or assignment of receivables from borrowers as security for their loans. This meant that, in addition to the classic mortgage-type securities, the previously used securities could be used once more. However, such securities were still not supported by other statutory provisions closely related to lending, such as the bankruptcy-law rules.


The ball is rolling on

You could say that July is the month of change... as this July will see more changes to the rules on loan security. Pursuant to the recently passed amendments, the beneficiaries of security assignments and security options will be judged on an equal footing with the beneficiaries of mortgages in case of a liquidation procedure.

Claims that are secured with a mortgage have always enjoyed priority in the event of a borrower’s insolvency: the beneficiaries of the mortgage would get their money before the other creditors. The legislation entering into force in July also grants this special status to the beneficiaries of security options and security assignments: if the debtor goes into liquidation, the beneficiaries of these rights will have their claims met before the other creditors of the bankrupt company (including the tax authority).

It is important to bear in mind, however, that even from July not just any security options or security assignments will behave like a mortgage in the course of insolvency proceedings. In order for the beneficiaries of such rights to have priority, it is necessary for the beneficiary of the security option or security assignment (usually the bank) to be registered in the register of loan securities (in the case of a property, the land registry). Registration puts these loan securities permanently in the public domain, as the register of loan securities is accessible by anyone, so third parties can also be notified of the establishment of such securities.



It does not take much research to understand what a major role an upturn in lending can play in the economic life of a country. From this perspective the recently passed amendments are certainly to be welcomed, as they give banks a greater sense of security, thus making them more willing to lend. An even more positive message, however, is sent out by the cooperation that this case exemplifies: the sensible recommendations of the banking industry were given a fair hearing by the legislature.

Domiciliation service providers under threat


A recently revealed ministerial decree could render the operation of domiciliation service providers in Hungary untenable – at least for those who provide this service at a high professional standard. As the new piece of law contains no explanation, the question that springs to mind is: who does the new legislation favour?

Domiciliation services cater to a genuine market demand, and are well-known in all countries that have a welldeveloped corporate culture. Domiciliation services are mainly used by businesses that do not necessarily need to have a physical office for their Hungarian operation, or who believe that a professional service provider is capable of performing their administrative tasks more efficiently.

While it is often assumed that companies who use domiciliation services are phantom firms, in reality this could not be further from the truth. Indeed, by using a domiciliation service, these companies are actually ensuring that – unlike phantom firms – their domiciliation genuinely serves as a point of contact. In many cases millions of euros pass through companies that use domiciliation service providers, frequently in order to enable multinational corporate groups to benefit from Hungary’s internationally competitive tax regime (which the Hungarian government has defined as a legitimate purpose on several occasions).

In such cases, the domiciliation service providers usually provide the physical and human resources for the company’s administration operation, such as telephone lines or receptionists to take the calls. They take delivery of the company’s official documents, handle its post, and file and archive the company’s paperwork.


A gradual tightening of the rules

In recent years the government has implemented numerous measures that made it difficult for certain operators to provide domiciliation services, or which even expressly prohibited them from doing so. For example, a few years ago law firms were excluded from the group of companies permitted to provide domiciliation services, and from the beginning of this year the law on tax procedure was amended: firstly the use of a domiciliation service was made subject to a reporting obligation, and secondly the use of such a service could give grounds for classifying the client as a “high-risk taxpayer”. The explanatory statement underlying the amendments claims that the use of domiciliation services was often motivated by a desire to impede and obstruct official audits and supervision. With effect from this July, however, the Ministry has introduced another twist in the story, which effectively renders the professional operation of domiciliation services untenable.


No ownership - no domiciliation service

While the new piece of law introduces numerous new provisions relating to the operation of domiciliation service providers with effect from 1 July (for example, it rules out fixed-term agreements, and contains stipulations relating to the management of documents and the receipt of deliveries), it also makes the provision of domiciliation services subject to a very severe legal requirement. Specifically, in the future domiciliation services can only be provided in a property that is solely owned by the service provider, or for which the service provider’s usage right has been registered in the property register. Existing domiciliation service providers have to comply with this rule from 1 September.

The majority of professional domiciliation service providers in Hungary today provide these services from rented offices. All the reputable companies with an international presence that also provide similar services abroad, many of which are listed on the stock exchange, currently rent offices in Hungary, and it is from these offices that they serve their clientele consisting of large, multinational corporations. Because they do not hold title to the office premises, in future they will be prevented from providing the domiciliation service.

And the option of registering a usage right, as mentioned in the decree, does not represent a realistic alternative either. Firstly, it is highly unlikely that the owners of the office buildings, which are usually large, multinational investors, would permit the registration of such a clearly visible encumbrance on their real estate assets. Secondly, however, it is precisely the provisions of the Civil Code relating to usage rights that make this an untenable solution, as the law states that a usage right is an entitlement that cannot be transferred or ceded. Therefore, according to the explanatory part of the Civil Code, the beneficiary of the usage right cannot provide a domiciliation to other businesses.


So why is this happening?

The new regulations are likely to make operation impossible for domiciliation service providers who perform their activity in a rented property, providing a high quality of service. This begs the question of what the underlying purpose of the legislation might have been. What justification is there for the fact that the regulations will lead to the shutting down of precisely those service providers whose operation is vindicated by rational and legitimate business-policy considerations? Unfortunately, as no justification was attached to the decree, these questions remain unanswered.

ESOP – the latest craze


SOP (Employee Share Ownership Programme) entities have been springing up like mushrooms in Hungary since last year, and the acronym itself has become something of a buzzword. And this is hardly surprising, as ESOP entities can be a tax efficient vehicle for paying out work incomes. Caution is advised, however: alongside the many advantages, the regulations also conceal a number of pitfalls.

What is an ESOP?

An ESOP is an entity created by an employer to hold securities issued by it or by its parent company, for the benefit of employees. So rather than awarding shares directly to employees, the employer or its owner sets up an ESOP entity, and transfers the shares to that entity instead. The company’s employees each receive a membership share in the ESOP entity, and in this way they gain access to the yield on the securities transferred to the ESOP.

Although the employees become owners of the ESOP entity, their shares only entitle them to receive payments through the entity; they have no voting rights or any influence in the running of the ESOP entity or, through it, in the running of the employer.

The biggest advantage of ESOPs lies in their taxation: income received by employees through the ESOP is taxed as capital income (that is, at a rate of 15%), and as such the award is not liable for the employer’s and the employee’s social security contributions. Another important element of the favourable tax regime is the exemption from tax on the acquisition, by employees, of their shares in the ESOP entity: if the employer were to award securities directly to the employees for free or at a discount, this benefit would be liable for tax, and what is more, this tax would be payable at the high rates applicable to salaries.

A wide range of opportunities

Under the classic type of scheme, the ESOP entity holds a proportion of the employer’s shares for the benefit of the employees, and the profit deriving from the dividend earned on the shares is distributed among the employees, also as dividend. The wording of the law, however, allows significantly greater freedom than this in terms of how ESOPs can be used.

There is no prohibition on the ESOP entity holding bonds or other securities issued by the employer, instead of shares, and distributing the yield on these among the employees. There is also no restriction on paying out to the employees the capital gain from the sale or redemption of the security itself. It is also possible to set up facilities where the payments are only partially dependent, or not dependent at all, on the yield of the security.

The system also allows flexibility as, in addition to the employer’s securities, the securities of its parent company can also be included in the ESOP scheme. This way, even companies operating as limited liability companies (kft) can enjoy the benefits of an ESOP. If the employer itself is unable to create an ESOP entity (because an equity share in a kft. is not classified as a security) but its parent company is a private company limited by shares (zrt), or if a holding company operating as a zrt. is established as the employer’s owner specifically for the purpose of creating an ESOP entity, then the shares of that holding company can be held by the ESOP entity.

What do you need to watch out for?

There are several things to bear in mind when setting up an ESOP, however. The basic document regulating payments to employees is the remuneration policy, which specifies the extent of each employee’s entitlement to the income generated in the ESOP. The law, however, imposes several conditions that must be taken into consideration when drawing up the remuneration policy. For example, the remuneration policy must be carefully phrased to ensure that it contains no unwarranted discrimination between employees, and care must be taken to comply with the statutory requirement imposing that payments must be contingent on the predetermined improvement in the company’s operating profit or on other performance ratios.

Maintaining control, as owner, of the employer’s company is a similarly thorny issue. The appropriate structure and system of contracts need to be elaborated, so as to ensure that the transfer of some of the employer’s shares to the ESOP does not, under any circumstances, result in a curtailing of the owner’s decision-making rights.

And finally, it is important to understand that the ESOP is not suitable, either technically or in terms of its intended purpose, as an alternative channel for regular salary payments. The ESOP is, principally, a vehicle for the payment of bonuses and other performance-based awards.

The operation was successful… the patient is deceased

There is no use of winning a lawsuit against the tax authority if the enterprise goes bankrupt before the judgement is rendered. And such an outcome is by no means uncommon, as under the current laws the tax authority can initiate enforcement proceedings against a business while the suit is still in progress. What’s more, experience shows that the tax authority doesn’t shy away from enforcement even in the absence of the solid legal grounds for pursuing that route.There is no use of winning a lawsuit against the tax authority if the enterprise goes bankrupt before the judgement is rendered. And such an outcome is by no means uncommon, as under the current laws the tax authority can initiate enforcement proceedings against a business while the suit is still in progress. What’s more, experience shows that the tax authority doesn’t shy away from enforcement even in the absence of solid legal grounds for pursuing that route.

The tax authority’s second-instance decision assessing a tax debt is a final and enforceable decision. This means that the tax debt assessed by the tax authority and approved upon an appeal may be enforced by the tax authority against the taxpayer even if the taxpayer disputes it and takes the decision to court. It is good to know that the tax authority has both a dedicated team and an IT system – for the purpose to watch and wait for the day the decision becomes enforceable, and that collects the funds from the taxpayer’s account the very next day. The tax authority is not even obliged to notify the taxpayer that collection has been ordered, so taxpayers can often find themselves in the unpleasant situation of wanting to make a payment from their account only to find that there are no longer sufficient funds on the account for them to do so.

Enforcement can also cause serious problems for taxpayers over the longer term: there aren’t many taxpayers who wouldn’t miss the funds snatched from their account through enforcement. In several cases taxpayers have actually gone bankrupt due to the enforcement of the tax authority’s decision before having a chance to pursue their claim in court. The tax authority’s enforcement option also gives rise to an unequal situation in the litigation process: here, it is the taxpayers who are chasing their money; it is them who are in a vulnerable position and it is them who have a vested interest in the court proceeding and its rapid completion.

So how can you protect yourself?

In light of the above, it’s no wonder that one of the key junctures in the struggle between the taxpayer and the tax authority is fending off or delaying the tax authority’s enforcement option. There are several ways to do that. When filing a complaint against the tax authority, in their statements of claim, the taxpayers can request the court to suspend enforcement. If the court upholds the claim, enforcement cannot be carried out until the court has passed judgement. Unfortunately, courts only decide to suspend enforcement in a relatively small number of cases – and the reasons and methods that help to achieve such suspension usually differ from court to court and from judge to judge. Moreover, the request must also be timed carefully: although taxpayers have 30 days from delivery of the tax authority’s decision to file a complaint, the decision becomes enforceable on the 16th day. In other words, if someone files its complaint on the 20th day, it’s possible that even if the court decides to suspend enforcement, the tax authority will have already ordered it.

The taxpayer may also submit a request to the tax authority for payment in instalments or for deferred payment. However, when it comes to evaluating such requests, the tax authority is even stricter and more rigid than the courts, and rarely grants such a request.

Who gains time, gains life. This is particularly true when it comes to requests for the suspension of enforcement: even if such requests aren’t successful, enforcement cannot be carried out while they are being evaluated. What’s more, all these decisions can be appealed one by one, and this takes time, which also gives the taxpayer some breathing space. And by the time all options have been exhausted, the taxpayer may – with some luck – get to the point where at least the first hearing takes place.

If the tax authority collects unlawfully

Regrettably, the experience of recent years shows that there are many cases where the tax authority enforces a decision without an appropriate legal basis for doing so. Perhaps due to an administrative error or for some other reason, the tax authority may submit a collection order against the taxpayer’s account during a period when enforcement has been suspended under a point of law. And that can indeed come as a nasty shock to the taxpayer.

Although it is possible to seek remedy, usually in the form of an objection to enforcement, if the tax authority takes such action, this takes time to evaluate. Quite often the taxpayer misses business opportunities during this period, and may ultimately go into liquidation. And even if ordinary operation can be restored later on, the taxpayer has very little chance of being reimbursed for the resulting loss.

OK, so what’s the conclusion?

One of the most important stages in the tussle with the tax authority is when the tax authority’s second-instance decision becomes enforceable – regardless of whether the taxpayer challenges the decision in court. Therefore, it is a good idea to collect arguments in advance so that the taxpayer will have a fighting chance of requesting either the court or the tax authority to suspend enforcement or perhaps grant a deferral of payment. And at least as important as this is to have a fall-back strategy in place to prevent immediate enforcement if these efforts prove unsuccessful.

Looking at the issue from a broader perspective, one cannot be certain of the effectiveness of a legal environment that does not give taxpayers a solid opportunity to assert their opinion (different from that of the tax authority) in a court of law – an environment that is actually far more suited to bleeding the taxpayer white first. Legislators should think about whether maintaining the situation in its current form is, in any way, justified.

Still too many...

In our traditional beginning-of-year review, we again counted the number of taxes levied in Hungary today. This time we got 59. Although the number of taxes has decreased by one since last year, the scale and structure of the tax system has not changed. In terms of tax revenue generated, VAT continues to top the list, bringing in approximately HUF 3,300 billion in 2016.

L'article complet en anglais est disponible sur le site du cabinet.

End to an unjust fine?

Under current practice the Tax and Customs Administration (NAV) fines taxpayers that are caught with a VAT shortfall even if the budget has sustained no losses. An opinion recently published by the Advocate General of the European Court of Justice could spell the end for this extremely unfair and much criticised procedure.


L'article complet en anglais est disponible sur le site du cabinet.

Banks face another headache

Financing banks only had a short time to make use of the collateral structures transformed due to the revised pledge rules of the new Civil Code. A resolution recently passed by the Highest Court presents banks with a new challenge: financiers will, again, need to reconsider the collateral structures that have been developed and used over the years.


L'article complet en anglais est disponible sur le site du cabinet.

Dividends: a blessing or a curse?

While dividends are the result of a happy process, namely the profitable operation of one’s business, the restrictions and difficulties associated with dividend payment have always given grounds for frustration. Particularly troublesome is the treatment of dividends in the course of corporate acquisitions, as the buyer and the seller need to elaborate special techniques for sharing the dividends among themselves.

L'article complet en anglais est disponible sur le site du cabinet.

Hungary makes a brave move in international tax competition

While Hungary has long been a preferred place in international tax planning, with a flat 9% corporate tax rate recently introduced, the country has arrived to the forefront of the competition. Adding also the absence of withholding taxes, the participation exemption both on portfolio holdings and intellectual properties, coupled with all benefits of an EU–compliant tax legislation, Hungary is destined to become a popular place for tax experts.

L'article complet en anglais est disponible sur le site du cabinet.

Financial investors in jeopardy

A cartel case of key importance is currently awaiting a decision from the General Court of the European Union (GC). If the GC approves the decision of the European Commission, this will open the door for declaring financial investors liable, under cartel law, for the illegal practices of businesses in their portfolio companies, regardless of whether or not the investor was aware of the cartel activities.

L'article complet en anglais est disponible sur le site du cabinet.

Last nail in the coffin for the tax authority

In its latest decision, the European Court of Justice (ECJ) has ruled that the Hungarian tax authority (NAV) unlawfully refused to allow VAT deduction to taxpayers who could not have known that the invoice’s issuer was implied in tax fraud. A special twist in the so-called Signum case is that it was the court of first instance who referred the case to the ECJ, as opposed to the guidelines of Hungary’s supreme court. The decision will have a significant bearing on ongoing tax audits and tax-authority findings, especially in the agricultural and trade sectors.

L'article complet en anglais est disponible sur le site du cabinet.

‘Au naturel’, or packaged within a company? – The dilemmas of buying property

Back in the day, buyers and sellers were better off selling shares in a company with possession of the property, rather than the property itself; but over the years, legislators have chipped away steadily at the benefits of acquiring property through a company purchase. Contrary to common belief, however, buying real estate through a company can still bring a number of tax advantages; and the range of these is set to expand from January of next year.

L'article complet en anglais est disponible sur le site du cabinet.

Porcelain tax? Icing sugar tax? Vacuum cleaner tax?

Don’t worry! There aren’t any such taxes for the time being. But we do have taxes on tasteless buildings, boat tax, pony tax, telephone mast tax, tractor tax, and even arable land tax – just to mention a few of the municipal taxes that add spice to our everyday lives. We aren’t completely defenceless, however, if the local authorities do try and levy any of these taxes on us.

L'article complet en anglais est disponible sur le site du cabinet.

Auditor’s approval is no guarantee that NAV won’t fine you...

It’s common knowledge that in Hungary, calculation of the corporate tax liability is based on the items recognised in the accounting books. But a nasty surprise could lie in store for taxpayers who think they can apply the principles of accounting recognition fully in the course of calculating corporate tax.

L'article complet en anglais est disponible sur le site du cabinet.

After the facelift – here is the BEPS-proof Hungarian intellectual property tax regime

In order to bring Hungarian tax law in line with OECD’s recommendations delivered in “Action 5” of the “BEPS-package”, Hungary’s special tax regime on intellectual properties has been amended as of 1 July.

L'artcile complet en anglais est disponible sur le site du cabinet.

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