Many of our clients have encountered situations where their Hungarian-registered company also conducts economic activities through a related foreign branch. If a Hungarian company generates profits at a foreign branch, corporate tax typically needs to be paid abroad according to the relevant foreign regulations on the income earned by the foreign branch. However, to avoid double taxation, the income generated at the foreign branch is not taxed again in Hungary. International treaties and domestic laws provide the opportunity to exempt this income from Hungarian taxation or to credit the corporate tax paid abroad against the domestic corporate tax.
Income Allocated to Foreign Branches in Corporate Taxation, Avoidance of Double Taxation
To avoid double taxation, relevant international agreements and domestic laws identify two methods: the exemption method and the credit method.
To select the appropriate method, it is first necessary to examine whether a double taxation agreement exists between the country of the branch and Hungary. If such an agreement exists, the method to be applied for avoiding double taxation must be determined based on the provisions of the agreement. In the absence of an international agreement, the relevant laws prescribe the application of the credit method. Below, we briefly outline the main rules related to the application of both methods.
When applying either method, the income attributable to the foreign branch must first be determined. It is important that, to avoid double taxation, the income allocated to the foreign branch must be determined based on Hungarian regulations. Therefore, the foreign income calculated for the avoidance of double taxation and the tax base calculated according to local foreign laws for determining the local corporate tax liability may not necessarily coincide.
In determining foreign income, costs directly attributable to the acquisition of foreign revenue must be taken into account. Costs that cannot be directly attributed to the acquisition of foreign income but were not incurred solely for the acquisition of domestic income should be apportioned in proportion to the ratio of foreign revenue to total revenue.
Avoidance of Double Taxation Using the Exemption Method
When applying the exemption method, the taxpayer deducts the income derived from the foreign branch, as determined above, from the total corporate tax base. The domestic corporate tax liability must then be calculated only on the amount remaining after this deduction, thereby exempting the foreign income from domestic taxation.
If the taxpayer wishes to further reduce their tax base using any available carried-forward losses, the amount of the exempted tax base must be used as the basis for determining the maximum amount of the carried-forward loss that can be utilized.
Avoidance of Double Taxation Using the Credit Method
The tax paid abroad cannot be credited without limitations. When applying the credit method, the tax deducted based on the foreign income cannot exceed the lesser of the tax paid abroad or the tax that can be credited abroad under an international treaty.
If there is no international agreement with the given country, the deductible tax cannot exceed 90% of the tax paid abroad on the income, but in all cases, it is limited to the tax calculated on the income using the average tax rate.
In summary, it can be concluded that exempting the income allocated to the foreign branch from domestic corporate tax liability or crediting the tax paid abroad against the domestic corporate tax obligation always requires detailed and careful calculation. For this, the income attributable to the foreign branch must always be determined according to Hungarian corporate tax regulations. Our staff is happy to assist you with any questions you may have regarding the taxation of profits generated at your branches.