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The most recent developments in taxpayer classification

A brand new era began in Hungarian tax administration practices on 1 May in terms of the cooperation between NAV and the taxpayers as this day marked the actual entry into force of the new taxpayer classification rules in force since January.

A few days after the entry into force of the first classifications, NAV began to send the standard information letters on the results of the classifications.

There were a number of open questions before the delivery of the letters. Whether NAV will rather act as a service provider or as an authority? Whether the information will be insightful enough, i.e. whether it will clearly explain the classification or the reason for the absence thereof? Whether the letter will contain sufficient data to challenge the result of the classification?

Reliable vs risky taxpayers

It was known in advance that the classification of taxpayers into the reliable and risky categories will not give a major headache to the entities concerned. The number of the latter category is very small for the time being, as the conditions providing a basis for that classification only occur after 1 January and the first quarter.

However, those who became reliable taxpayers on 1 May are now aware of the conditions they need to meet to maintain their favourable classification. The information letter lists the 10 conditions for being classified as a reliable taxpayer of which only 9 must be met, since the first condition, namely being continuously in business for at least 3 years, should not pose a challenge going forward. However, taxpayers should be careful about the remaining 9 conditions!

Of these, we would like to highlight the condition related to enforcement. This condition states that only those entities can be reliable taxpayers against whom the tax authority has not instituted enforcement proceedings in the year of classification and in the preceding five years. Based on experience to date, at the onset of the classification system, many businesses failed to become a reliable taxpayer merely due to this condition. This is probably particularly painful for many of them as they no longer recall why and when enforcement proceedings were conducted against their company. Either because it was such a long time ago that they do not even remember, or because the amount subject to enforcement was so marginal that the electronic collection order imposed on them did not result in a disruption in the company's business. Yet, now they may find themselves outside the circle of reliable taxpayers for 5-6 years due to that long-forgotten collection order.

Others are absolutely positive that they have always paid their taxes in due course, however, many of them are not aware that enforcement proceedings initiated by the tax authority do not only affect taxes but also other public-law debts that may be collected as taxes. Failure to become reliable taxpayers may also have come as a shock to them.

The traces of enforcement proceedings

Even worse off are the companies against whom enforcement proceedings were conducted that may not have been justified, however, they had failed to challenge the proceedings back then. Now these companies are facing a situation where the formerly unchallenged (and no longer challengeable) enforcement procedure prevents them from becoming reliable taxpayers. Probably only those have a chance to overcome the negative consequences that were able to prove back then that enforcement was unlawful and now they are only required to draw NAV's attention to the fact that no legal consequences can be derived from such former unlawful enforcement, i.e. it is to be regarded as if it never occurred in the first place.

It is an overall deficiency of the information letters sent by NAV in relation to the classification that they do not provide adequate information about the time of the enforcement procedure and the type of tax or public-law debt for the collection of which it was conducted due to which not all conditions of classification as a reliable taxpayer were met. If the information letter contained the data related to the enforcement procedure, all companies could check before filing an objection, whether the classification by NAV was performed on the basis of accurate and genuine data, and could also find out in which year following the enforcement procedure they will first have a chance to become reliable taxpayers, assuming that the regulations remain unchanged until then. Therefore, it is expected that many companies will file an objection against their classification in the absence of adequate information.

Legal consequences of tax difference

Similarly to the above, the problem is also the lack of information for companies that are not classified as reliable taxpayers due to the failure to meet the condition related to the amount of the tax difference or default fine in comparison to their tax performance assessed for the current year.

There is at least one thing that the managers and accountants of these companies can reliably determine, namely the amount of the tax difference or default fine imposed on them during the monitoring period. It is not certain, however, that they are able to determine the amount of their tax performance for the current year. And this figure may be decisive in the case of micro and small companies, in particular.

It is easy to see that for a company whose tax performance is HUF 10 million, the 1 percent rule allows no more than HUF 100 000 in default fines, which is not an excessively high fine in the current practice. The same 1 percent condition allows the imposition of several tens of millions of default fines for a high tax performance company, e.g. one of the key taxpayers, without threatening the company's reliable taxpayer status.

And sticking to the subject of key taxpayers, it is interesting to note that even though the concept of "tax performance" is defined in the Act on the Rules of Taxation, so far the true significance did not lie in this statutory definition, but rather in the tax performance calculation method used for identifying key taxpayers and companies with the highest tax performance which is provided for in a decree. Unfortunately, the two methods are not equivalent as they yield different results for tax performance. For the time being, it is unknown which tax performance calculation method will be applied by NAV for taxpayer classification. However, in the future, this will only have a bearing on reliable taxpayer classification.
According to the Bill submitted last week, starting from 1 July 2016, those companies will be classified as risky taxpayers in the case of which the total amount of tax differences assessed in the year of classification and in the preceding five years and the amount of default fines falling due in the 2 years preceding the year of classification exceeds 70 percent of the company's tax performance for the current year.

Although it will be an important amendment from 1 July 2016 in respect of the condition of reliable and risky taxpayer classification associated with the amount of the tax difference that the total amount of the tax difference assessed in favour of the taxpayer will be deducted from the total amount of the tax difference assessed against the taxpayer, yet it does not remedy the deficiency that companies will not be able to calculate the amount of their tax performance for the current year themselves.

This, however, may pose a problem for all companies, irrespective of their classification as taxpayers, as the amount of the tax difference assessed and the default fine imposed against the company may be a decisive factor for any company going forward.

Therefore, it would be a most welcome development if NAV publicly announced the calculation method for determining the tax performance of companies because without this all companies will be forced to file an objection against the tax performance calculation leading to its taxpayer classification or the absence thereof individually, even if – as a result of such objection – it becomes clear that NAV has been right in the classification.

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