Law & Numbers - News Tax

Auditor’s approval is no guarantee that NAV won’t fine you...

22.09.2016 (Hungary)

It’s common knowledge that in Hungary, calculation of the corporate tax liability is based on the items recognised in the accounting books. But a nasty surprise could lie in store for taxpayers who think they can apply the principles of accounting recognition fully in the course of calculating corporate tax.

The tip of the iceberg

The accounting act is based largely on the principle of prudence. This is to ensure that a business takes all the expected losses into account in good time, and that it can only state a profit in the balance sheet (and pay out dividends against it) if it appears certain that the profit will actually be realised. The logic of the corporate tax act, however, is fundamentally different. Here, the aim is to enable the tax authority to collect the highest possible amount of tax as soon as it can, while ensuring the lowest degree of flexibility for the taxpayer.

Owing to the differing logic of accounting and taxation, when calculating the tax base, the tax law differs in many respects from the recognition of accounting items that provides the basis for taxation. For example, the act on corporate tax does not allow depreciation to be recognised in line with the accounting act, does not permit provisioning, and only allows impairment to be recognised under certain conditions; but it is even very strict about determining when a claim is to be deemed non-recoverable. The purpose of all these provisions is to protect the tax base: the system should not provide taxpayers with an opportunity to exploit certain flexibilities in the accounting rules with the sole purpose of reducing their tax liability. And this is probably fair.

Below the surface

The practice of the tax authority and the courts in past years, however, has shown that the differences between accounting and corporate tax are not limited to the areas that are expressly defined in the corporate tax act as tax base modifying items. In the recent past this has led to the determining of a tax shortfall in many instances.

In a recent case, a prudent enough company wrote off one of its investments, having realised that its business objectives related to a project would not be achieved. In the view of NAV (the Hungarian tax authority), however, it was too cautious, because it was still too early to determine with absolute certainty that the project had failed. On these grounds the tax authority determined a tax shortfall for the year in which the business wrote off – both in its accounts and in its tax return – the assets related to the investment in question. The sting in the tail was that the company was also subject to the Robin Hood tax, where losses cannot be deferred, and so when exactly the write-off was accounted for was far from irrelevant.

In another case, the business already knew that a product, almost at the end of its shelf life, was entirely unsaleable in the market, and so it wrote off its value in the company’s books. NAV, on the other hand, concluded that even if a product’s sell-by date expires in a few days, it can still be sold, and therefore – at least from a tax perspective – recognising the loss was not warranted. This case also ended with the imposition of a substantial tax penalty.

Recent judicial practice reveals many other similar cases. These usually centre on the fact that while the business recognises a loss in accordance with its accounting policy, the tax authority does not accept the grounds for doing so, and accordingly, does not permit its impact to be stated in the tax return. This is an alarming tendency, especially given that it is not clear where the boundary lies beyond which a loss is recognisable in accounting terms but not for the purposes of the tax laws. It is also to be noted that, the tax laws do not even give an explicit mandate for the tax authority to challenge the accounting, and so the legal basis for this practice on the part of the tax authority is also highly questionable.

The way ahead

It’s clear that just because an event is correctly booked in accounting terms, it is by no means certain that NAV will also approve of it. Even where the auditor has signed off on the accounting recognition of a given item, the tax authority may still call into question the recognition of that item for the purposes of corporate tax. When booking every major accounting event, therefore, it is advisable to give special consideration to how the business intends to state the item in question when it is time to fill in the corporate tax return.

The option of switching to IFRS, which will be introduced from 2017, is likely to bring further complications. This is because IFRS allows much greater freedom with respect to certain accounting matters than the currently effective accounting act. It is not clear at the moment how this will influence the already ambiguous boundaries between the accounting act and the act on corporate tax.






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