The purpose of the personal income tax is to make Hungarian tax residents liable to tax on all their personal income irrespective of where the income is sourced and in which form it is realized. The personal income tax laws, therefore, create a net around the individuals and any item of income can only get through the net if it has been taxed. On this net a rather big hole was cut by the introduction of the so called long-term investment account (“TBSz”) in 2010.

The long-term investment account became a popular form of saving as a consequence. Its popularity may further increase in the future due to the transferability of such accounts which was introduced by the tax law amendments adopted for 2014.
Key features of long-term investment accounts
The long-term investment account is, essentially, a special type of securities account. The individual account holder can put funds on this account and he or she can purchase shares, treasury or other bonds, securities or other financial instruments out of such funds. These securities as well as the dividends, interests, capital gains or other yields of the securities are recorded on the long-term investment account. If the amount paid to, or accumulated on, the long-term investment account is not withdrawn for at least five years, then the account holder can receive the balance of the account tax free.

A novelty in income tax planning: private enterprises on long-term investment account

In the modern capital markets various forms of investment facilities are available and all these investment products could be put on the long-term investment account. This made the long-term investment account a widespread form of saving. According to the original version of the law, the only conditions for an investment to be put on a long-term investment account were that, on one hand, the asset the investment was made into had to qualify as securities and, on the other, the transaction had to be concluded via a licensed securities broker.

In short time, inventive tax and financial advisors discovered that these conditions can be fulfilled by the shares of private companies limited by shares (“zrt”), as shares qualify as securities and the laws do not exclude securities brokers from participating in the sale of private companies. Therefore, owners of limited liability companies (“kft”) started to convert these companies into zrt-s and placed the shares issued in such a way on long-term investment accounts so that in five years they can realize the profits produced by their companies tax free. The hole on the net of the income tax provisions has, as a result, became wider and wider and individuals with sufficient creativity could easily extract tax free profits from their private companies. This was, obviously, not in line with the original intention of the legislator.

Life after closing the hole

As a reaction to the abusive utilization of the long-term investment account, the law had been changed as of 1 January 2013. As a result, private individuals could no longer place shares issued by zrt-s on the long-term investment account. In spite of this, tax planning opportunities using the long-term investment account have not been definitively closed down.

Shares of public companies limited by shares (“nyrt”) can still be placed on long-term investment accounts. Although the costs of acquiring and operating a public company are significantly higher than those of a private company, and a public company is subject to numerous public disclosure obligations, tax advisors more and more often propose tax structures with the involvement of public companies. Although, from March 2014, the shares of public companies must be listed on the stock exchange, with the introduction of a “technical” category at the Budapest Stock Exchange, the listing of shares that are not intended for actual trading will not trigger extra requirements. In essence, the main question is whether the tax savings that can be achieved by private individuals will outweigh the extra hassles and costs linked to the acquisition and operation of a public company.

It is to be noted that private companies might still be used for tax planning with the involvement of the long-term investment account. Whilst the rules introduced early 2013 excluded zrt-s from the scope, they did not exclude derivative transactions with shares in private companies. Therefore, if the account holder places on the long-term investment account not the shares of private companies themselves but the derivative position linked to such shares, he or she can still be entitled to the tax exemption. Obviously, similar to the transformation into public company, such transactions require thorough preparation and professional expertise.

Let the competition start

The transferability of long-term investment accounts starting from next January will likely increase the popularity of such investment vehicle. Up to now, long-term investment accounts were “immovable”: once a long-term investment account has been opened at a certain securities broker, it could no longer be transferred to another. Naturally, this excluded the competition between investment service providers with respect to the already existing accounts. This will change from 2014. From now on, long-term investment accounts can be transferred to a new securities broker without losing the tax advantages linked to the accounts. In this way, the tax savings which can be achieved on the long-term investment account will likely be accompanied by an increasing level of service.