Thanks to the virtual mobility afforded by the internet, a growing number of people today are using online trading platforms to buy and sell foreign securities through brokers abroad. However, these investors in foreign stock markets are often gambling not only with their money, but with the tax system, too – often without even being aware of it.
Taxable or not
Depending on the tax system of the country in question, in most cases withholding tax is not deducted from the gains made by a Hungarian individual on the purchase and sale of securities and financial instruments on foreign stock markets and other financial markets. This could give many people the idea that there is no tax liability at all on profits earned in foreign stock markets.
This assumption is wrong. Private individuals incur a tax liability – under the Hungarian rules on personal income tax – on their income earned in foreign stock markets, just the same way as on any other income earned either in Hungary or abroad. And in today’s world of information sharing between tax authorities, simply “forgetting” your foreign stock trading gains when filling out your Hungarian tax return does not look like a particularly sensible solution either. Quite apart from the fact that it’s difficult to open a bank account anywhere in the today’s world without the Hungarian tax authorities finding it out, the consequences of getting caught are serious: forgetful traders potentially face not only the tax bill and a tax fine of up to 200% of the original tax liability, but also the threat of sanctions under criminal law.
So how do I pay tax on this income?
People who trade on the stock exchange and invest in money market contracts usually buy several different kinds of securities and financial instruments in order to reduce their financial risk. Many also buy and sell very frequently in the hope of earning a high return. However “good”, or perhaps lucky investors such private individuals may be, some of the many transactions will inevitably make a loss. This “you win some, you lose some” situation is part and parcel of risky financial investments, and the tax system makes allowances for this with its special rules on “controlled capital market transactions”. Besides the fact that income from these transactions is only subject to 15% income tax (with no other tax or contributions payable), the Personal Income Tax Act also permits the offsetting of losses and gains so you only have to pay tax on the “net” gain.
In order for a stock market or forex deal to be classified as a controlled capital market transaction, numerous legal and administrative conditions have to be met. What’s more, in the case of foreign investments it’s up to the taxpayers to obtain certainty that their income is derived from a controlled capital market transaction, and as such they can enjoy the tax benefits described above. It is also the taxpayers who have to be certain that they have accounting documents and records that comply with the Hungarian tax laws in every respect.
When is a capital market transaction “controlled”?
An “entry condition” for a controlled capital market transaction is that it must be concluded by an investment service provider that operates in an EEA country or a country that has signed a double taxation treaty with Hungary – and, if the service provider does not operate in an EEA country, information sharing must be assured between the financial supervisory body of the tax treaty country, and the National Bank of Hungary. This information sharing is in place in most of the popular countries for investing (e.g. USA, Hong Kong, Singapore), but when it comes to other non-EEA countries it’s best to check this on the National Bank of Hungary’s website.
Another important condition is that the transaction must be for commodities, or – based on the definition given in the Hungarian Act on Investment Firms – for “financial instruments”. So it may be the case that certain “exotic” investment instruments are not classified as financial instruments under Hungarian law, which disqualifies them from the favourable tax treatment.
Taxpayers also need to have a certificate, issued by the foreign service provider, which proves the fulfilment of the above conditions (name of stock exchange, object of the transaction, buy price, sell price, time of sale or purchase, details of the investment service provider, confirmation of financial settlement). In practice, however, the foreign providers do not always provide this.
Other potential sources of errors
Experience has shown that trading on foreign exchanges creates other practical difficulties in terms of taxation. For example, even if the investment does meet the conditions for classification as a controlled capital market transaction, the income certificates obtained from abroad often contain a large quantity of raw information. Frequently, it takes a closer study of the statements to reveal that the revenue items include income not derived from a controlled capital market transaction. For example, the income could include interest or dividends, which are subject to other tax rules, and are revenues against which trading losses may not be deducted.
Another common misconception is that a tax liability is only incurred if you withdraw cash from the service provider or online platform. In reality, however, if a gain or loss is realised on the transaction, then this creates a tax base in the year when the yield is generated, not at the time of “cashing in” the earnings. It’s also important to know that trading income and losses have to be converted into forint at the daily exchange rates for the purpose of determining the tax base, and not calculated at the year-end rate.
What are the lessons to be learned?
Trading on foreign exchanges is certainly more exciting and offers more variety than sticking to the Hungarian markets. But you should be careful to ensure that the transactions, including their records and accounting documents, meet the criteria for classification as controlled capital market transactions eligible for the favourable tax. If you don’t do this, it may turn out that you’ve realised income that is subject to a higher rate of tax, or you might lose the opportunity to offset your losses against your gains. In extreme cases, this could even mean that you end up paying your entire net gain realised on the foreign stock market in tax.