The “anti-offshore” law relating to the use of public funds, introduced in 2011, aimed to prevent off-shore companies with unidentifiable ownership structure from acquiring grants out of domestic and EU public funds. The original intention of the legislation seriously distorted, however. Numerous innocent foreign-owned firms, including Hungarian subsidiaries of US-based multinational firms got trapped by the rules.
The “transparent organisation”
The act on national assets introduced in 2011, re-regulated the conditions for the application to public funds. One of the main purpose of the new regulation was to prevent off-shore companies from acquiring public funds. To this end, the act introduced the concept of “transparent organisation”. All enterprises that apply for governmental or European Union grants need to comply with this definition - not only at the time of the application, but also as long as the applicant has any obligation arising from the subsidy agreement. Participants of public procurement tenders need to comply with a very similar set of criteria.
The concept of transparent organisation is extremely complex. It combines the related tax and money laundering regulations, developed to fight against off-shore companies. However, the new legislation become far more strict and inflexible than its predecessors.
US-based firms locked out
While the purpose of the rules is undisputable, the wording unduly qualifies many domestic enterprises (with multinational background) as a non-transparent organisation. one of the key points of the regulation states that Hungarian companies, having a foreign shareholder (owning directly or indirectly at least 25% of the shares) established outside the European Union, EEC, OECD or in a country which has signed a double taxation treaty with Hungary, are qualified as non-transparent. In practice this affects almost all US-owned firm, because US multinationals generally hold their non-US subsidiaries through an otherwise transparent Bermudian holding. Since no double taxation treaty is in force between Hungary and Bermuda, and the latter is not a member of the organisations mentioned above, the Hungarian subsidiaries of such US entities qualify as non-transparent entities and they are not eligible for state subsidy, as a consequence.
Firms held through holding companies are also under threat
Those companies which are held through foreign holding companies can easily be victims of the regulation, provided that the holding company only or mainly invests in Hungarian firms. These holding companies typically do not have taxable income in their country of establishment. If such a foreign company realises its income primarily from Hungarian sources and such income is not taxable in its residence state then its Hungarian subsidiary will qualify as a non-transparent entity under the state subsidy rules.
Besides a clear set of criteria, the law qualifies all such companies as non-transparent “the ownership structure of which cannot be identified”. The rule does not exactly define what the content of this condition is, which makes the application of this criteria very difficult in practice. This condition does not trigger problems for small firms or firms with simple ownership structure. Enterprises with more complex or often changing ownership do, however, face difficulties when identifying properly their full ownership structure.
Firms listed on recognised stock exchanges as well as subsidiaries of such firms are usually automatically exempt from the off-shore regulations. Under the definition of transparent organisations, this kind of exception applies to listed companies only, it does not apply to the subsidiary of such company. As a result the subsidiaries of listed companies will also have to comply with the criteria and requirements set by the law, creating unnecessary administrative burden for these companies.
The off-shore restrictions introduced to the public funds regulation unduly exclude such companies from public tenders which do not have any intention or even possibility to unlawfully utilize public funds. Furthermore, this regulation affects those enterprises the most which are the most desirable target for the Hungarian economic policy. These foreign enterprises need to re-structure their ownership structure in order to be eligible for government subsidies or to participate in public procurement procedures. Even worse, if the company does not recognise the traps laid by the legislation and the authority reveals its non-transparent status in a subsequent audit, then the company could be obliged to repay the received subsidy with interest.