With the increasingly rigid and aggressive approach from the Hungarian tax authority that taxpayers have been experiencing in the past few years, areas of tax controversy are steadily growing. The Hungarian tax authority works to achieve set yearly targets of amounts to be collected from each type of tax through audits, which they usually achieve. For this reason, the tax authority very rarely revises its own proposed resolution of a tax audit, and instead requires taxpayers to take their case to courts, where, in the majority of cases, disputes are decided in favor of the tax authority.
Hungarian taxpayers generally have little awareness of their rights and therefore limited opportunities to actively represent their position early enough in a tax audit, as the tax inspector most often fails to initiate any kind of communication with the taxpayer about the processes, peculiarities and goals of the inspected business during the audit process. The audits are conducted through the review of documents requested from the taxpayer, and carried out at the headquarters of the tax inspector, rarely sharing with the taxpayers information on potential areas of concern, unless the taxpayer actively requests a dialogue through, for example, offering to submit more information on particular matters of interest. In many cases, unless the audit is carried out at the premises of the taxpayer, information about the tax authority’s progress, problematic areas and issues of concern are very difficult to obtain until the audit phase is closed and the tax authority has prepared the official “minutes” of the audit, which include the tax authority’s findings of the facts and circumstances.
As a basic and fundamental problem, taxpayers often fail to ensure that their conduct of business administration, systems and procedures are robust enough to withstand the scrutiny of the tax authority should they be selected for a tax audit. This is partly due to the frequent changes in Hungarian law, which often leaves very little or no time for the taxpayers to digest and prepare for significant changes of law.
The tax authority has the right to challenge transactions and business payments serving the purposes of the company’s business if there is a tax advantage generated by such transactions. Oftentimes, the documents required to be kept by taxpayers with respect to transactions that may be audited are not expressly required by any legislation, but are determined through the tax authority’s audit experiences. In addition, the number of unfavorable tax authority challenges to transactions, taken on the basis of substance over form reclassifications or the infringement of the rule of law doctrine is rapidly increasing. This is because Hungarian anti-avoidance legislation is very generally phrased, which provides the tax authority with relative freedom of interpretation when it comes to cases where substance over form and rule of law clauses may be called upon. It is therefore advisable to collect and maintain as many supporting documents as possible in case the need later arises to present them to the tax authority during an audit to support the fact that certain events have indeed occurred and the conduct of the taxpayer has been exercised diligently and out of genuine business interest.
Another problematic point is the unclear and uncertain nature of the tax legislation that prevents the taxpayer from clearly understanding what constitutes proper business conduct and the tax implications, a fact that has even been realized by the Hungarian legislature. At the end of 2011, the legislators created a new institution as of January 1, 2012, called the “notification of uncertain tax position”. Under this new opportunity, if a taxpayer makes an appropriate notification in its tax returns, the taxpayer could be released from the obligation to pay a tax penalty with respect to the tax deficiency resulting from mistaken legal interpretation, and may be obliged to pay only a default penalty. The protections afforded by this new institution were short-lived, however, as—another good example of turbulent law-making practice in Hungary—it was abolished effective March 31, 2012.
Taxpayers may gain certainty of the correctness of their business conduct with respect to transactions by obtaining a binding advance tax ruling from the Ministry for National Economy, usually costing rather hefty statutory fees in the range of US$35,000. Since the beginning of 2012, binding rulings of the corporate income tax treatment of a transaction may also be obtained to survive any legislative changes for three years, irrespective of future changes to the respective legislation. Advance pricing agreements also remain available to taxpayers to ensure the correctness of the applied method of transfer pricing in related party transactions.
On the other hand, informal discussions, cooperation between the taxpayer and the tax authority concerning the proper interpretation of tax legislation, is not a customary exercise in Hungary, as the tax authority is viewed as an unapproachable institution that is rather avoided by the taxpayers. Written guidance issued by the tax authority is caveated as merely an opinion, which cannot be relied on in court. Further, unless the question is very basic, no assistance in interpretation of the tax law is available to taxpayers through the telephone. The written guidelines received from the Ministry for National Economy pursuant to a request from a taxpayer are more useful and informative. However, these guidelines, like the tax authority’s own written guidance, are not binding to the tax authority and cannot be relied on in court. Taxpayers, therefore, mostly rely on the assistance and representation of professionals with respect to their business conduct in order to identify tax audit and controversy risks and exposures and, once risks are identified, develop and implement appropriate measures in order to mitigate the taxpayer’s risk profile.
During the audit process, taxpayers and their representatives have the right to be present at any audit event conducted by the tax authority, unless expressly refused, and may provide proof of any relevant fact or circumstance that may help in unfolding the background of any business transactions under inspection.
Once the tax authority has completed the audit process, it issues its minutes. The minutes detail all the findings of facts of the audit and serves as the background of the tax assessment, and the basis on which the tax authority will pass its resolution. Upon receipt of the minutes, the taxpayer has the opportunity to submit its remarks to the minutes and raise any disagreement with the findings of the audit. In addition, further facts may by introduced by the taxpayer in expectation that the content of such submission will be taken into consideration by the tax authority when passing its resolution.
It is very rare that the fact pattern of the minutes is changed based on the taxpayer’s remarks, and the resolution containing the tax assessment itself is usually reciting the content of the minutes.
In case of a dispute, the tax assessment of the tax authority may be appealed and challenged before the second-instance tax authority, which has the right to annul the first-instance resolution and decide on the merits of the case, or to instruct the first-instance tax authority to carry out a new audit if the facts and circumstances have not been appropriately and fully developed. As previously mentioned, settlement discussions between the taxpayer and the tax authority are not routinely carried out; the dispute is generally handled in a formal fashion from the outset and very likely to end up before the administrative courts, despite the fact that litigation is uncertain, costly and time-consuming.
The decision of the second-instance tax authority is final and binding. This decision must be issued within five years from the end of the calendar year in which the tax return in issue was required to be filed, otherwise the tax authority becomes time-barred from issuing a tax assessment with respect to the given tax period. This deadline is extended by six months in cases when the decision of the second-instance tax authority is annulled by the courts and the tax authority has to carry out a repeated audit. While the court procedure suspends the lapsing period, it continues to run once the tax authority restarts its audit.
The final and binding resolution of the second-instance tax authority serves as the basis for the execution of the tax assessment. The taxpayer may request the suspension of the execution of the tax authorities’ tax assessment in an appeal submitted to the courts within 30 days from the date of receipt of the resolution. Rather controversially, the tax authority may exercise its right to execute its assessment should the taxpayer not voluntarily pay within 15 days from the date when its resolution becomes binding, meaning that the tax authority may collect the tax it asserts is due before the court has the opportunity to decide the suspension request of the taxpayer. This procedural disharmony puts many taxpayers in the rather difficult position of having to pay disputed tax liabilities before the contentious remedies would have been exhausted.
Prior to the commencement of tax litigation, the head of the tax authority or the Minister for National Economy may take a supervisory measure upon the request of the taxpayer or ex officio if the resolution infringes the relevant legislation or if the resolution has been adopted in violation of the law. The petition for such supervisory decision is a useful tool in the hands of the taxpayer as it does not have a time bar for submission, as long as a court claim has not been filed by the taxpayer in the matter.
Tax litigation in Hungary is conducted under the rules of administrative litigation, which since 1999 is a one-instance procedure. When the taxpayer challenges the second-instance resolution of the tax authority before the administrative courts, the court may only decide in the question whether breach of law—either procedural or substantive law—has occurred in the previous stages of the procedure. Before the administrative courts, the substantiation of facts and circumstances of the case only arises in the context of, and as a basis for, breach of law. The courts rarely question or elaborate further on the factual background of any case during the litigation phase by, for example, hearing witnesses or experts. For this reason, it is imperative to clarify the background of all relevant events relating to a transaction, to the fullest extent possible, in the early stages of audits. Having capable representation in the audit stage, and preferably before an audit begins, is therefore very important.
During the audit phase of any tax controversy, the burden of proof principally falls on the tax authority, which has the duty to unfold all relevant facts and circumstances of the case and must substantiate its tax assessments with evidence in the minutes of the tax audit. This, however, changes in the litigation phase, where it is for the taxpayer to prove that the tax authority’s assessment is unlawful or unfounded and demonstrate the facts and evidence supporting the taxpayer’s case.
There are certain types of subject matters where the burden of proof practically shifts from the tax authority to the taxpayer, even in the procedures undertaken before the litigation phase. One current item on the tax authority’s agenda is the capturing of VAT invoicing between business partners. In numerous cases, the tax authority denies the taxpayer’s VAT deduction claiming that the provision of services with respect to which the invoice has been issued did not in fact occur between the parties indicated in the invoice or the taxpayer receives the VAT invoice from a business partner other than the one who actually provided the services.
At first glance, it may seem easy to prevent such a situation, but in many transactions, it is rather complicated to discover which entity has indeed provided the services in question. For instance, with respect to construction work, the tax authority considers an invoice to be fictitious even if the issuer is an existing taxpayer, the services have indeed been provided and their results may clearly be examined, but the subcontractor of the issuer of the invoice does not have any legally employed workforce that could have performed the services. The European Court of Justice has established (the Optigen Case) that the right of tax deduction may not be denied to the taxpayer on the basis that the supplier of the seller is fictitious, provided that there was actual performance between the taxpayer and its seller and the taxpayer was not aware of, and exercised reasonable prudence to become aware of, that fact. The Hungarian tax authority does not seem to accept the ECJ’s case precedent by placing objective liability on the taxpayer to the extent of the deductable VAT amount.
From March 1, 2012, tax litigation cases are principally decided by the administrative court without any hearing, and purely on the basis of the documentation presented. At the request of any of the parties, however, the court must hold a hearing. The court may decide to hold a hearing by its own initiative as well. This new procedural rule aims to make deciding tax disputes as quick and cost-effective as possible. Having said that, however, taxpayers with competent legal representation will almost certainly opt for the possibility to call a court hearing to present their case and present their arguments more effectively. In practice, we believe only a small number of cases will be deterred by the new rules.
The judgment passed by the administrative court is final and binding and as administrative litigation is a one-instance procedure, only extraordinary remedies, such as the judicial review by the Supreme Court, are available against such judgment. A petition for judicial review of a final judgment may be submitted to the Supreme Court on the grounds of infringement by the party, the intervener, or by any person to whom any provision of the decision may be of concern, against the appropriate section. Judicial review in practice, however, is exhausted in most cases, without any effective forum of appeal against the judgments of the administrative courts.
According to statistics, administrative courts pass judgments in favor of the tax authority in more than 70 percent of the cases. Such numbers make one wonder whether the taxpayer and the tax authority step into the courtroom with equal chances. While the answer to that question seems to be discouraging, during the total length of the life cycle of tax controversies—that may be as long as three to five years from the start of an audit until appearing before the Supreme Court—there are numerous opportunities for the taxpayer to influence the outcome of its case.