dr. Czoboly Gergely

At the beginning of April, a new OECD standard came into force, by virtue of which tax authorities will be better placed to monitor the activities of companies registered in tax havens and to access their key financial data. Although it remains to be seen how the Hungarian Tax and Customs Administration (NAV) will use this information, several popular tax minimisation strategies may be at risk.

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So far, tax authorities have needed ‘work-arounds’ to obtain information from offshore databases (e.g. Panama Papers, Bahama Leaks, Paradise Papers) about the activities of companies operating in the given countries. As of 1 April, however, the situation changed, and tax authorities are now able to access these data automatically.

Indeed, from that date, 12 countries with no or nominal corporate taxes had to start reporting relevant data automatically. These countries are the following: Anguilla, the Bahamas, Bahrain, Barbados, Bermuda, the British Virgin Islands, the Cayman Islands, Guernsey, the Isle of Man, Jersey, Turks and Caicos Islands and the United Arab Emirates. The purpose of this new standard is to identify companies that were established in these countries for tax planning purposes only and do not carry out real economic activities there.

What data need to be reported?

The authorities of the above countries will first have to identify corporate shells with no real economic activity. OECD has compiled an itemised list of criteria for determining whether or not real economic activity occurs.

Subsequently, tax havens must identify what income and expenses are recognised by the companies established in their territories, what economic activities they engage in, and whether they have employees assisting them in performing these activities. Authorities are required to share this information with the company owners’ country of origin. Furthermore, this information needs to be reported not only to the country where the shell company’s direct parent company is established, but also to that of the ultimate parent entity as well as that of the final beneficiary.

What can NAV do with such information?

This exchange of information will give the tax authority a clearer picture of the tax havens where Hungarian private individuals have companies and of the business activities carried out by these companies. The information thus obtained also provides an opportunity to detect several popular tax minimisation schemes.

Hence, the tax authority will be able to investigate whether a company based in a tax haven has the necessary infrastructure to provide its services or an adequate number of employees. This is particularly important in cases where a Hungarian company recognises payments made to an offshore company (for example as service fees or, perhaps, as interest or royalty payments) as costs. For example, for companies established in Dubai paying directors’ fee to their Hungarian board members in a tax-efficient manner, NAV will now be able to examine what proportion of the company’s revenues are paid out as directors’ fee. Based on these data, NAV may even question the plausibility of such payments and benefits.

What’s next?

A natural question arises: is there still a loophole in the current system? Yes, but companies’ room for manoeuvre is becoming increasingly limited. For the time being, it still seems practicable for companies to have a real economic presence in a tax haven (e.g. by renting real offices and hiring employees). This solution, however, may incur significant additional costs and, what’s more, does not always guarantee that no information will be exchanged. 

It seems that those owning shell companies in tax havens will sooner or later be forced to reconsider their tax structure. This is further reinforced by the fact that those affiliated with a company established in a tax haven are facing increasing difficulties (e.g. when wishing to open a bank account or applying for state subsidies). The Hungarian tax authority recognises a number of tax-efficient and lawful alternatives for preserving company owners’ assets, and it is definitely worth examining these options. There is a good chance that companies often unnecessarily maintain expensive structures abroad, while they could be operated cheaper and risk-free in Hungary.