While dozens of programmers, engineers and hairdressers continue to opt for KATA [the fixed-rate tax for enterprises categorised as “small taxpayers”] in Hungary, the tax is increasingly coming under fire from all sides. Apparently, the Hungarian Tax Authority (NAV) is stepping up its investigations into businesses who employ KATA payers, and at the same time rumours are also flying about a planned KATA tightening.
Is there reason to worry?
It’s no coincidence that KATA is seen as an attractive form of tax: those who opt for it can meet almost all their tax obligations by paying just HUF 50,000 in tax a month (or HUF 75,000 if the increased KATA is selected), and with virtually no administration to bother with. It’s not surprising, therefore, that the number of persons choosing this form of taxation has skyrocketed: when it was introduced, about 85,000 small taxpayers were registered, while today there are approximately 350,000.
At the same time, however, KATA has spawned a number of anomalies, with more and more employers replacing classic employment relationships en masse with work contracts signed with KATA-paying entrepreneurs. It is thus no wonder that the tax authority has started playing hardball in the last six months: the NAV has begun to conduct methodical compliance audits of KATA payers, the first findings of which are about to being published.
The critical link
There is an important condition for choosing KATA. If a small taxpayer derives income in excess of HUF 1,000,000 per year from the same client, he must prove, with regard to his working relationship, that at least two of the conditions for classing it as self-employment listed in the law are met. If he does not do this, his working relationship may be classified as a classic employment relationship. The problem is that most of these circumstances are hard to grasp and hard to prove. For instance, how can it be clearly decided whether the client may have instructed the small taxpayer or whether the small taxpayer was able to determine his own work schedule? There are also practical problems in proving that the taxpayer himself provided the equipment and materials needed for his activities or whether he could have used a substitute in the course of his work.
And then, even if you can show with relative certainty that at least two of the above circumstances exist, you’re not necessarily in the clear. The tax authority has a right, under the general anti-avoidance rules, to classify a legal relationship based on its actual content, taking all circumstances into account. Naturally, it remains to be seen whether it will be able to exercise this right under the very special rules of KATA.
What’s at stake?
It’s important to note that reclassifying a working relationship as a classic employment relationship has a serious impact not only on the small taxpayer but also on his employer. In the event of reclassification, the tax authority may assess a shortfall in social contribution tax and vocational training contributions, and levy a tax penalty, a late payment penalty and a default penalty on the amounts unpaid. Furthermore, the employer may also be slapped with a tax penalty charged on unpaid personal income tax and employee contributions. Not to mention that if the KATA-paying entrepreneur charged VAT on the invoices issued to the client, the client could lose the right to deduct VAT.
Is there life after KATA?
So if you feel that KATA is risky, what should you choose instead? It may seem a somewhat outdated solution, but there are an increasing number of incentives that facilitate working in a classic employment relationship. In addition to the continuous cuts in social security contributions, the various tax and social security breaks granted to retirees, young mothers and first-time employees plus the family tax and contribution allowances often reduce significantly the financial burdens of an employment relationship.
A business should also make a calculation to see if it would be better off with the corporation tax and social contribution tax tandem or with KIVA [the small business tax]. For businesses with higher employment costs, KIVA may be a much more favourable alternative, not to mention that opting for KIVA also means tax savings in local business tax. Depending on the industry and the activity of the persons employed, there is also the possibility of switching to EKHO [the simplified contribution to public revenues] as long as it can be clearly separated from the employment relationship.
Finally, it may be worth considering giving an ownership interest in the company to employees – or some of them – and remunerating them (in part) through dividends. This can be achieved with an employee stock ownership plan or through the provision of employee shares. There is no need to be afraid that the employees, as stockholders, will also have a say in business decisions: both forms of granting an ownership interest allow you to rule out this possibility.
By Peter Barta, Attorney and Tax Advisor, Jalsovszky