When does a foreign company’s site become a permanent establishment for tax purposes?
Our clients are often foreign companies that sell production lines or other technical equipment to Hungarian or foreign customers, but also undertake to install or commission the equipment in Hungary. In order to perform the engagement, it is usually necessary to assign personnel to Hungary on behalf of the foreign company who have the necessary expertise and equipment for the installation. Completion of the project usually takes only a few months and does not normally involve a VAT registration obligation, but delays may occur due to disruptions in the supply of spare parts. There are also many examples where the project is so successful that new orders are placed and the installation project takes longer than planned. But even the size of the project may result in the foreign company carrying out work in Hungary, even though temporarily, still on a permanent basis, i.e. for more than six months.
The existence of an establishment should be examined separately for VAT and for corporate income tax purposes, although the definitions for both tax types are similar. If the conditions are fulfilled, the taxpayer is deemed to be established for business in the country in question, the main tax consequences of which are set out below.
What qualifies as a fixed establishment for VAT purposes?
For VAT purposes the "fixed establishment” (FE) shall mean a geographically isolated and durable facility away from the registered office established or intended for conducting economic activities, where the conditions for the economic activity are in fact available independent from the registered office, including the taxable person’s commercial representation insofar as the taxable person’s commercial representation is most directly involved in the provision of the service. For VAT purposes, a company is therefore established for business purposes in the place where it has its registered office or a fixed establishment.
According to the above definition of the VAT Act, a fixed establishment is therefore only created if the foreign enterprise has a sufficiently permanent and stable character and is properly organised in terms of both personnel (e.g. its own workforce) and material conditions (technical resources, equipment).
As we can see, the assessment of whether these conditions are met is uncertain and can always be made on a case-by-case basis, taking all the circumstances into account. There is no specific period of time defined for the permanent presence, but if it exceeds 6 months, there is a good chance that a fixed establishment for VAT purposes is created, which in the above example would also give rise to a VAT registration obligation.
Why is the fixed establishment qualification important?
The existence or absence of a fixed establishment is an important issue for several reasons: the correct classification is essential for the determination of the place of supply of services and the person subject to VAT (application of the so-called ordinary or reverse charge method),and is also of particular importance for the entitlement to a foreign VAT refund.
However, for the correct VAT treatment from the point of view of both the service provider and the customer, we must also note that if any legal ramifications are attached to the place of business, and the taxable person - apart from the registered office - has one or more fixed establishments, the said legal ramifications shall apply to the registered office or fixed establishment that is most directly involved in the transaction in question. Thus, for example, if the non-resident company has a fixed establishment in Hungary, but it is not involved in the provision/use of the given service, it should be disregarded for the purposes of determining the place of supply.
According to the implementing regulation of the VAT Directive, the most direct establishment is the establishment which receives or uses the service for its own purposes or through which the service is provided and which has the facilities, both personal and material, necessary for receiving the service and for providing it. The fact that an establishment has a VAT number is not in itself sufficient to establish that the taxable person has a fixed establishment.
In order to resolve the issue, it is advisable to obtain a declaration from the parties to this effect, thereby avoiding any prejudice to the taxing rights of any country.
PLEASE CONTACT OUR TAX EXPERTS FOR ADVICE.
When is a permanent establishment created for CIT purposes?
As outlined in the introduction, the definition of permanent establishment (PE) specified in the conventions for the avoidance of double taxation and the fixed establishment for VAT purposes described above are not the same. The VAT registration obligation of a non-resident company does not necessarily entail a corporate income tax obligation.
For direct taxation purposes, in addition to the domestic legislation, the definition of the permanent establishment should be sought in the overriding double tax conventions with the country of establishment of the foreign enterprise (where such conventions exist),but the OECD Model Tax Convention also provides examples to help with the definition.
According to the general definition set out by the Model Tax Convention, the term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried out.
The above definition, in line with the definition of a fixed VAT establishment, consists of three main elements which must be met together: a specific location through which the company carries on business activities on a permanent basis usually by its staff. Staff includes employees, but also other persons who receive instructions from the enterprise (e.g. so-called dependent agents). Again, there is no clear guidance on permanence, as the Model Convention Commentary states that the activity must be of a regular nature, but is not expected to be continuous and uninterrupted. Individual double tax conventions usually make a special distinction for construction, building, assembly or fitting work, in which case a permanent establishment for corporate income tax purposes arises if the work is normally carried out for more than 12 months, or for a different period in some double tax conventions.
Thus, if a foreign company establishes a permanent establishment in Hungary for CIT purposes under an effective double tax convention, the profit attributable to the Hungarian permanent establishment is subject to corporate income tax at the rate of 9% in Hungary. Please note that when registering a permanent establishment, a foreign company applies for a Hungarian tax number, which is not registered in the company register, unlike in case of a branch office.
Branch offices in the tax regime
If the foreign company establishes a permanent establishment in Hungary, it must be examined whether its planned activity requires the establishment of a branch in addition to the registration of the permanent establishment. The branch is an organisational unit of a non-resident company without any legal personality, vested with financial autonomy, registered in the Hungarian register as an independent company form, the branch office of a non-resident company. The branch is subject to the Accounting Act, is required to keep books and prepare financial statements and is subject to corporate income tax.
Although a branch is not an independent entity, it is a separate taxable entity for tax purposes and has its own tax number, similarly to the permanent establishment.
When is financial representation needed?
For VAT purposes, a taxable person from a third country who is liable to pay taxes in Hungary on the supply of goods and services in Hungary must appoint a financial representative in Hungary. Please note that if these non-EU businesses have a fixed VAT establishment (including a branch) anywhere in the EU, they are no longer considered to be third country taxable persons and are therefore not obliged to appoint a financial representative (although the possibility exists).
Determining whether your company has a permanent establishment may require a thorough examination of your business processes and commercial arrangements, and our advisory team is happy to assist you in this.
