On 7 June 2016, the Hungarian parliament passed the tax bill that includes changes to the existing intellectual property (IP) regime, in line with action 5 of the OECD's base erosion and profit shifting (BEPS) project ("Countering Harmful Tax Practices More Effectively"). The bill introduces the modified nexus approach to limit the beneficial tax treatment of intangible assets and royalty income, and will substantially reduce the scope and amount of benefits under the IP regime.
The new rules apply as from 1 July 2016, although "grandfathering" rules provide a limited window of opportunity for companies to qualify under the previous regime and maintain benefits for an additional five years.
Previous IP regime
The following benefits were granted under Hungary's tax regime that applied through 30 June 2016:
- 50% of income (revenue) qualifying as royalties could be taken as a special deduction in calculating the corporate income tax base, with the adjustment capped at 50% of the total accounting profit before tax;
- Unconditional availability of amortization expense for tax purposes;
- A super deduction from the corporate income tax base for certain R&D costs, resulting in a double deduction of such costs;
- A full exemption for capital gains realized on the alienation of qualifying IP after a one-year holding period (subject to an election filed with the tax authorities at the time of acquisition); and
- An exemption of qualifying royalty revenue from local business tax and the innovation contribution.
The definition of royalties for purposes of the deduction encompassed a broad range of licensing income, including income from the licensing of patents and other industrial IP, know-how, trademarks, trade names, business secrets and copyrights, including "author" rights.
Amendments to the IP regime
The above tax benefits effectively remain in place, but substantial changes have been made to the scope of qualifying IP, the approach to determining the amount of qualifying IP income (royalties) and the extent of the relevant tax benefits.
Scope of qualifying IP and related income
The amendments significantly narrow the definition of "royalties" as qualifying IP income, to harmonize it with Hungary's current copyright legislation and the OECD report on action 5.
Under the new rules, IP income qualifying for the IP regime is restricted to:
- Income (profits) from the use of exclusive rights to the following types of IP (hereinafter referred to as "IP assets"):
- Utility model protection;
- Plant variety rights;
- Supplementary protection certificates;
- Topography of micro-electrical semi-conductor products protection;
- Copyright-protected software; and
- Drug designations related to rare diseases;
- Income (profits) from the sale or in-kind contribution of an IP asset; and
- Embedded IP income from the supply of products and services directly related to an IP asset.
It should be noted, however, that under the new rules, the amount of the special 50% deduction related to the income from IP assets is calculated based on profits from IP (rather than revenue, as was the case under the old regime).
For local business tax and innovation contribution purposes, IP qualifying for the royalty revenue exemption does not include drug designations related to rare diseases; additionally, sales revenue from embedded IP and income from an in-kind contribution of IP are not exempt under the new regime.
Nexus approach to calculate tax benefits from IP income
The nexus approach focuses on establishing a connection between expenditure, IP assets and income. The purpose of this approach is to grant benefits only to income that arises from IP in relation to which the actual R&D activity was undertaken by the taxpayer itself (or by a third party commissioned by the taxpayer).
In the base case, if a taxpayer owns an IP asset and incurs all of the expenditure related to the development of that asset, the nexus approach allows all of the income from the IP asset to qualify for the benefits of the IP regime. If the taxpayer commissions external, third-party service providers to (wholly or partly) develop the IP asset, that also will qualify for full benefits.
In cases where there is a full or partial related-party contribution to the IP asset, or where the taxpayer acquired the IP asset, the new rule will allow only partial benefits. The benefits will apply to a portion of the IP income calculated according to the following formula:
"Own direct expenditure" includes the arm's length direct expenditure for the basic and applied research and experimental development incurred in relation to the acquisition and development of the IP asset, but excludes the direct expenditure for the R&D services purchased from a related party and the acquisition cost of the IP assets.
"Total direct expenditure" includes the total arm's length direct expenditure for the basic and applied research and experimental development and the cost incurred in relation to the acquisition and development of the IP asset.
Where it can be reasonably established that the taxpayer that acquired the IP or outsourced a portion of the R&D to a related party is itself still responsible for much of the value creation contributed to the IP, a maximum 30% uplift in the numerator is available to take reasonable nonqualifying expenses into account. However, the uplifted amount may not exceed the amount of the denominator.
The tax deductibility of losses related to IP assets is limited under the new regime. If IP tax benefits were applied in a given tax year to profits related to IP assets, 50% of losses adjusted by the OER related to such assets will not be deductible in the following tax year.
The new IP regime applies as from 1 July 2016. Transition rules apply to IP assets acquired or developed before 30 June 2016, with the result that the benefits of the old regime may continue to apply for the period from 1 July 2016 to 30 June 2021. To qualify for the grandfathering rules, the taxpayer must have benefited from the IP regime in relation to the relevant IP asset in a tax return filed before 30 June 2016, or must be otherwise entitled to such benefits between 1 January 2016 and 30 June 2016 (if no tax return is due before 30 June 2016 in this respect).
For IP assets acquired from related parties during the period from 1 January 2016 to 30 June 2016, further restriction applies. The grandfathering rules are available on these IP assets after 31 December 2016 only if the seller was entitled to benefit from any corporate income tax incentives related to the IP asset at the time of the transfer. IP assets acquired from unrelated parties during the period from 1 January 2016 to 30 June 2016 are entitled to benefit from the grandfathering rules without having to fulfill further specific conditions.
IP acquired or developed after 30 June 2016 falls fully within the scope of the new rules.