Hungary introduced a supplementary tax of 23% on dividends paid or declared by a Hungarian company from profits earned by the company after 1 January 1995.

The new supplementary tax applies to dividends paid (or declared) minus the amount of any dividends received by the company. This means that Hungarian holding companies do not pay supplementary tax twice - first at the subsidiary level and then at the holding company level.

The supplementary tax applies to dividends paid from profits earned by the company after 1 January 1995. If a company has pre-1995 retained earnings which it pays out as a dividend, that dividend will not be subject to supplementary tax. However, the Hungarian Accounting Act would suggest that pre-1995 retained earnings can only be paid as a dividend to shareholders if current year profits are not sufficient to cover the amount of the desired dividend. In other words, there is a LIFO basis of distributing dividends assumed by the Accounting Act. This view has been confirmed by the Ministry of Finance. It means that a Hungarian company cannot automatically designate pre-1995 profits as the pool from which it pays a dividend today or in later years.

This supplementary tax is more like a second tier corporate tax and is not a withholding tax in the classical meaning of that term. It is the payer company that is responsible for the tax and the tax is not calculated by means of withholding from the gross amount of the dividend.

An example best illustrates the point. Assume a Hungarian company has pre-tax profit of 100 Hungarian Forint (HUF) and it decides to pay the maximum dividend possible to its sole shareholder, another Hungarian company. In such a case, the tax is calculated as follows:

				HUF
Pre-tax profit			100.0
Corporate tax			(18.0)

Available			82.0
Supplementary tax		(15.3)
Dividend			66.7

The supplementary tax of HUF 15.3 is calculated as 23% of the net dividend payable of HUF 66.7. In the above example, the Hungarian company's total tax burden is thus HUF 33.3.

The Ministry of Finance has ruled that the supplementary tax should be treated as a withholding tax for double tax treaty purposes. This means that the supplementary tax can be reduced to 5% in many cases where the recipient of the dividend is tax resident in a country which has a double tax treaty with Hungary.

In the following example, assume that the Hungarian company is 100% owned by a US or Dutch parent company and it again wishes to distribute the maximum dividend possible. The supplementary tax in such a case is calculated as follows:

Pre-tax profit			100.0
Corporate tax			(18.0)

Available			82.0
Supplementary tax		(3.9)
Dividend			78.1

The supplementary tax of HUF 3.9 in the above example is calculated as 5% of the net dividend of HUF 78.1. The following example is more interesting and illustrates the calculation of the supplementary tax where there is a mixed shareholding in the Hungarian company.

Assume the Hungarian company is owned 50% by a US company and 50% by a Hungarian company. The calculation of the supplementary tax in such a case is as follows:

				HUF
Pre-tax profit			100.0
Corporate tax			(18.0)

Available			82.0
Supplementary tax (Note2)	(10.07)
Dividend (Note 1)		71.93

Note 1: The net dividend payable to both shareholders is calculated as follows:
HUF 82 = X + 0.5 X @ 23% + 0.5 X @ 5%

X = HUF 71.93

Note 2: Calculated as the difference between HUF 82 and HUF 71.93 = HUF 10.07

The total net dividend payable to both shareholders is therefore HUF 71.93 and based on a 50% ownership stake in the company, each shareholder receives HUF 35.965 net dividend.

The supplementary tax of HUF 10.07 can also be calculated by multiplying HUF 35.965 by the applicable tax rates as follows:

US shareholder - HUF 35.965 @ 5% = HUF 1.798
Hungarian shareholder - HUF 35.965 @ 23% = HUF 8.272
HUF 10.070

Once again, it has to be emphasized that the supplementary tax is paid by the Hungarian company as its own tax liability and not as a withholding tax on behalf of the recipient company.

Foreign investors are urged to review the supplementary tax from the point of view of their own home country tax legislation. It is important to know, for example, whether the home country rules will allow a tax credit for Hungarian supplementary tax. This has to be examined on the basis of each country's own tax rules.

Peter Gerendasi, Price Waterhouse.

For further information please contact Peter Gerendasi at Price Waterhouse, Budapest: tel: +36 1 269-6910, fax: +36 1 269-6938, or enter a text search 'Price Waterhouse' and 'Business Monitor'.