With the abolition of the “old” rules on small taxpayers (so called KATA), not only self-employed individuals who did not opt for or not allowed to opt for the new KATA rules, but also individuals who are willing to start a business, are facing a serious decision: under which tax regime and in which form should they operate, and where, in which country (in Hungary or abroad) should they set up a business?
The exceptionally favourable tax environment provided by the former KATA rules cannot always be replaced by another Hungarian tax regime. Thus, many entrepreneurs have now considering starting a business abroad. Service providers and favourable offers stimulate relocation abroad as they encourage businesses moving to a country with a lower (or even minimal or zero) income tax rate compared to Hungary.
In this article we briefly examine the tax considerations and risks that an individual should consider before starting a business abroad.
- Issue of tax residence
Tax residence is one of the cornerstones of the taxation of individuals. Tax residence is an indicator of which country's tax system an individual is most closely related. Where someone is (tax) resident, his/her tax liability is unlimited. What does this mean?
It means that if someone is tax resident in one country, his/her income tax liability is based on his/her worldwide incomein that country. Only the various bilateral conventions on the avoidance of double taxation (concluded between two countries) provide tax exemptions or tax reliefs.
Tax residence must first be determined on the basis of the tax laws of the countries concerned. So, for a Hungarian individual, the knowledge of the provisions of the Hungarian Personal Income Tax Act is essential. As a Hungarian citizen, with a Hungarian permanent home or a family located in Hungary, with investments in Hungary (the so-called centre of vital interest), there is a good chance that the tax residence of the individual is (remains) in Hungary. By declaring a foreign address, the tax residence of a Hungarian individual is not automatically transferred to the foreign country, e.g., if it exists only "on paper" and the circumstances do not support the relocation abroad (e.g., bank account or credit card usage data, internet usage or mobile phone usage related cell information, to mention only the most well-known items). Thus, the income from the foreign business of a Hungarian individual (e.g., wages, dividends) will (may) be taxable in Hungary regardless that they are already taxed abroad or not taxed abroad at all.
- Issue of permanent establishment (PE)
For a business, the place (country) of taxation is largely influenced by where the business is actually carried out. The place of taxation of the income attributable to the permanent establishment will be the country where the permanent establishment is actually established in substance and carries out its economic business.
It is important to note that a permanent establishment may not only be a designated area or a formally registered office, however, any physical place which is at the disposal of the business, a place of work or place of management which is used habitually and regularly by the entrepreneur for its business operation (e.g. a physical place from where the individual manages his/her business as a whole, important decisions are carried) and where the physical conditions are suitable to perform the business activities. Thus, a PE may even (can) be the entrepreneur's living room.
Therefore, if, for example, a self-employed software developer relocate his/her business to one of the currently popular locations - such as Dubai, Switzerland, Luxembourg, Romania, Slovakia, Croatia, Singapore or to one of the tax havens/offshore islands - formally only, but in substance carries out the business activities online from his/her flat/house or from his/her office located in Hungary, it is very likely that his/her income will be entirely attributable to the Hungarian PE and therefore it will be taxable in Hungary.
- Worldwide and EU information exchange
As it is a trend to shift income and profits among countries for individuals and businesses having presence in various countries and, therefore, the increase tendency of tax avoidance internationally, there is a global focus on identifying and preventing these tax avoidance techniques. For this purpose, several international agreements have been concluded among countries to facilitate the exchange of tax related information ( see our previous series of articles on information exchange at EU level ).
Conclusion: to take advantage of the preferential tax regime of a foreign country, for an entrepreneur it is essential that he/she "moves out" of Hungary both from an individual and a business activity point of view. From this angle, the “moving out” (from Hungary) is not just a tax issue, but also a serious organisation and administration task as well. Therefore, it can be very expensive and last but not least, it will (or could) have an impact on the individual's family life, relation to friends and his/her financial situation. As a result of the international exchange of information, in the event of possible abuse of any tax systems, the question will no longer be whether it will be discovered in the future, but rather when...