Navigating The New Era: Understanding Hungary's Updated Transfer Pricing Rules

I. Introduction

Recently there were some changes in Hungary in the transfer pricing documentation obligations, which is applicable to the financial year of 2023. Since the 2023 corporate income tax return filing deadline is fast approaching, we hereby summarize the changes that should be considered for the 2023 financial year (however, these have been published for a year now) The changes outlined indicate that in the future, the Tax Authority will scrutinize even more closely the substantiation of the market nature of related-party transactions. Most of the changes can be regarded as tightening. Additionally, the Tax Authority will exercise greater scrutiny during audits. In our series of articles, we will present the renewed rules, the direction of the changes, the most frequently asked questions, and the experiences of audits conducted so far.

According to the new directions outlined by legislation, it is definitely worth paying more attention to transfer pricing in the future, as the penalties have significantly increased.

In addition to the reporting and disclosure obligations in the corporate tax return, as of 2023, the transfer pricing documentation obligation consists of a three-element register, each element of which will be considered a separate document when determining fines.

If the tax authority detects any deficiencies in any of these elements or if any of them are not completed by the statutory deadline, a fine can be imposed per document. In practice, for a first violation, this could mean a penalty of three times HUF 5 million (approximately EUR 13,000) per registration. In the case of repeated violations, a penalty of up to HUF 10 million (approximately EUR 26,000) per registration may be imposed.

The administrative elements of transfer pricing rules in the Hungarian tax system can be summarized as follows:

• Reporting related-party transactions to the Tax Authority within 15 days from the conclusion or execution of the transaction. Failure to do so may result in a fine of HUF 500,000 (approximately EUR 1,300) per related party.
• Preparation of transfer pricing documentation (Main document + Local document (the local document should include the common part and the transaction part)). Failure to comply may result in fines of 3 times of HUF 5 million (3 x approximately EUR 13,000), and for repeated violations, fines of 3 times of HUF 10 million (3 x approximately EUR 26,000) may be imposed by the Tax Authority.
• Transfer pricing data should also be reported as part of the Corporate Income Tax return, providing an abstract of the essential parts of the transfer pricing documentation and pricing. Failure to do so may result in the imposition of a "general" fine of HUF 500,000 (approximately EUR 1,300).

II. Details of the Changes

Exemption from documentation due to value threshold:

The new rules in effect can be interpreted as tightening with one exception. The only easing is the increase of the previous HUF 50 million value threshold (approximately EUR 125,000) to HUF 100 million (approximately EUR 250,000). Therefore, for transactions not exceeding HUF 100 million annually - calculated at market prices - there is no need to prepare transfer pricing documentation (which does not mean that related parties can disregard the principle of applying "market prices").

Prohibition of merging transactions:

In recent tax audits, it has been observed that the tax authority does not necessarily prefer presenting transactions merged, which is now also enshrined in law. Although merging transactions is still possible - if it does not jeopardize comparability and if the products, services, conditions, performed functions, and assumed risks are similar or identical - according to the wording of the decree, it is now prohibited to document procurement transactions jointly with the sale of products, or expenses with revenues. The change must be applied for the first time starting from the tax year beginning in 2023.

Linking transfer pricing determinations to accounting:

While it was already mandatory in transfer pricing documentation to demonstrate how the taxpayer's results are linked to the specific pricing method, the new regulation further details this by requiring a precise presentation of which general ledger accounts, cost bearers, and cost centers are involved. Additionally, it is mandatory to present the method of cost allocation, the applied allocation keys. This change is also mandatory for the tax year starting in 2023.

Reporting of Corporate Income Tax Return (ATP Sheets):

As of the tax year starting in 2022, it was already mandatory to provide data reporting as part of the corporate income tax return for transactions covered by transfer pricing documentation. Reporting per transaction includes:

• specifying the nature of the transaction from the decree's 53-item exhaustive list (e.g., performing contract manufacturing, using agency distribution, lending, etc.);
• specifying the name, tax number, registration number, and jurisdiction of the related party involved in the transaction;
• annual transaction value broken down per related party;
• if there is a modification of the corporate tax base, then the amount per related party; and
• the designation of the transfer pricing method used for documentation.

In addition to the above, profitability indicators should be presented differently for each method from the perspective of the company for the specific transaction, and accordingly, the usual market value of the indicator should also be indicated. In the case of loan agreements, the interest rate or premium for commission agreements should also be included in the data reporting.

Narrowed content reporting obligation:

Narrowed content reporting must be made in the following cases:

• transfer of free cash;
• contracts with individuals;
• transfer pricing adjustments without profit margins. For transfer pricing adjustments originating from an independent party, data reporting was not required in the corporate income tax return for the tax year starting in 2022, only from the tax year starting in 2023.

III. What Does This Mean in Practice?

Previously, some corporate groups regarded transfer pricing documentation as a kind of mandatory element, which only required attention after the end of the tax year. The current changes make it essential for corporate groups to deal with transfer pricing not only at the end of the tax year but continuously. To be able to fully comply with the data reporting to be submitted as part of the corporate income tax return, it is advisable for corporate groups to consider the following for each transaction within the group:

• What transactions do we engage in with related parties?
• For what business reasons are transactions between related parties conducted?
• What risks and functions do the parties involved perform in terms of the nature of the transaction? (contract manufacturing, consignment distribution, limited-risk distribution, agency distribution)
• Are we participating in the transaction as a routine entity or entrepreneurial entity?
• It must be determined what transfer pricing method is used to determine the price, and how we can substantiate the pricing of the corporate group.
• What profit margin does the transaction include, and how is it calculated?
• If multiple related parties are involved in a transaction, the allocation key must be determined.
• Consistent calculation or result derivation should be planned behind the transaction.
• It is advisable to document the above in advance in a transfer pricing policy applicable to the corporate group.

It is important to note that transfer pricing fines have more than doubled from their previous amount. If we haven't done so already, from 2023, we must pay special attention to intercompany transactions within the corporate group. It is also advantageous to review and change entrenched practices now: if, until now, transfer pricing documentation was prepared solely at the end of the year or after the end of the tax year without prior planning, this practice is likely not sufficient to meet all the expectations of the tax authority in the future. Furthermore, it is even more important to adopt a mindset of thinking transaction by transaction and to have adequate documentation for each transaction. As a consequence of data reporting, the number of transfer pricing audits is expected to increase, as the tax authority can examine taxpayers with risky accounting systems based on the incoming data from data reporting.

IV. Changes in Transfer Pricing Reporting Obligations

There have been no structural changes to the format of transfer pricing reporting sheets compared to previous financial years; the data relating to the specific transaction and its arm's length price must still be provided, while data concerning related parties and transactional values must also continue to be indicated. However, two new pieces of information must be provided for specific transactions:

• Indication of Aggregability for the Transaction
• As part of the transfer pricing data reporting, taxpayers are now required to indicate in their 2023 corporate income tax returns if they are filling out the transaction sheet for an aggregated transaction. In addition to indicating the fact of aggregation, it is also necessary to provide information on whether the aggregation pertains to identical transactions/series of transactions or to different types but closely related transactions.
• Identification of the Tested Party
• In the 2023 transfer pricing data reporting, a new element is introduced whereby, when choosing the resale price method, cost-plus method, or transactional net margin method, taxpayers must indicate which related party was chosen as the tested party for determining the arm's length price in terms of profitability. If the tested party is not the taxpayer filling out the return but rather its related party, it must also be indicated whether the tested party is a domestic or foreign related party of the taxpayer, or a member of the corporate income tax group.
• Marking Exemption from Record-keeping Obligations for the Transaction
• Marking exemption from record-keeping obligations for the transaction is not a new element; however, for transactions involving cost transfers for the tax year ending in 2022, there was no reporting obligation. However, for the 2023 business year, even for these transactions, albeit to a limited extent, data must be provided in the corporate income tax return.

In subsequent parts of our series, we will continue to address the most common questions and discuss the practices of Tax Authority audits.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.