Year-end transfer pricing adjustment in Hungary for corporate income tax | News Flash

Within the operations of international corporate groups, it is commonplace for affiliated entities to engage in intercompany transactions. These transactions can take various forms, such as:

• the sale of components,
• the provision of engineering services,
• the operation of IT systems, or
• contract manufacturing.

The Hungarian Corporate Income Tax Act (Tao. tv.) sets out specific rules for such transactions and requires that their pricing comply with the arm’s length principle.

The arm’s length principle and the range

The arm’s length principle requires that the pricing of intra-group transactions be consistent with the price that would have been agreed upon between independent parties under comparable circumstances.

To determine the appropriate price, a benchmarking analysis is typically conducted using a database, which groups market data into a range based on profitability indicators. Within this range:

• the lower quartile (Q1) represents the lower bound, meaning that 25% of the data falls below this value,
• the median (Q2) is the midpoint, where half of the data lies below and half above,
• the upper quartile (Q3) represents the upper bound, with 25% of the data falling above this value.

The arm’s length range therefore consists of the values between Q1 and Q3. If a company’s profit level falls outside this range, Hungarian regulations require it to be adjusted accordingly.

Adjustment to the median

As of 2022, the regulations have become stricter: by default, the target of the adjustment is no longer any point within the arm’s length range, but specifically the median value.

This means that if the pricing of a related-party transaction falls below the arm’s length range, the company is required to adjust its corporate tax base up to the median. In many cases, this requirement can significantly increase the taxable base.

Year-end transfer pricing adjustment – a more flexible solution

The legislation also allows for a more favorable approach: the year-end adjustment. In this case, the taxpayer does not need to adjust the transaction’s profitability up to the median, but only up to the lower quartile (Q1).

The Hungarian Accounting Act treats such adjustments as an option, meaning that related parties may adjust the acquisition cost of assets, their expenses and costs, as well as their revenues, by the difference between the applied transfer price and the arm’s length price.

If the taxpayer opts for this approach, the retrospective transfer pricing adjustment is handled either through invoice modification (where possible at the individual transaction level) or by issuing a corrective accounting document.

This year-end adjustment is implemented in practice either through corrective invoicing or by issuing an accounting document, and it offers several advantages:

• the transaction complies with the arm’s length principle,
• there is no need for a corporate income tax base adjustment, and
• it reduces the risk of findings during a tax audit by the Hungarian Tax Authority (NAV).

Numerical example

Base data:

• Cost of services: HUF 400,000,000
• Applied profit margin: 8.5%
• Arm’s length range: 10.21% – 32.01%
• Median: 21.10%

Initial situation

The company applied an 8.5% profit margin on costs of HUF 400 million, which results in a profit of:

HUF 400,000,000 × 8.5% = HUF 34 million

Since this profit falls below the arm’s length range of 10.21% to 32.01%, an adjustment is required.

Adjustment to the median (corporate tax base adjustment)

If the company does not carry out a year-end adjustment, it must increase its corporate income tax base to the median level.

The median is 21.10%, so the arm’s length profit would be:

HUF 400,000,000 × 21.10% = HUF 84.4 million

This means the difference between the actual profit (HUF 34 million) and the median-based profit (HUF 84.4 million) is:

84.4 – 34 = HUF 50.4 million

In this case, the company must increase its corporate tax base by HUF 50.4 million.

It is also important to note that local business tax and the innovation contribution are subject to separate methods for determining the tax base.

We emphasize that adjustments to these tax bases may also be required.

Adjustment via year-end accounting entry or invoicing

If the company opts for a year-end adjustment, it is sufficient to reach the lower quartile profitability level, i.e. 10.21%.

In this case, the calculation is as follows:

HUF 400,000,000 × 10.21% = HUF 40.84 million

Given that the actual profit is HUF 34 million, the amount of the required adjustment is:

40.84 – 34 = HUF 6.84 million

At year-end, an accounting document or corrective invoice must be issued for HUF 6.84 million to the related party. This ensures that the profitability level reaches the lower bound of the arm’s length range, and the transaction is deemed compliant with the arm’s length principle.

In such cases, no corporate tax base adjustment is required. Moreover, if an actual settlement is made between the parties in connection with the transfer pricing adjustment, no further tax base modification is necessary for local business tax or the innovation contribution either.

Comparison

The table below compares the key financial figures of the two adjustment methods, clearly illustrating the difference between a corporate tax base adjustment to the median and a year-end adjustment up to the lower quartile.

Based on the table, it is clear that an adjustment to the median results in a significantly higher increase in the tax base (HUF 50.4 million), whereas a year-end adjustment to the lower quartile can be achieved with a much smaller accounting entry (or in some cases, invoicing) of only HUF 6.84 million, without triggering any further tax base modification.

This comparison clearly demonstrates that the year-end adjustment is a far more cost-effective option, while still ensuring full compliance with the applicable regulations.

Risks and consequences

If a company fails to adjust its profit level that falls below the arm’s length range:

• the Hungarian Tax Authority (NAV) may determine a tax shortfall,
• impose a 50% tax penalty, and
• charge late payment interest.

This poses a significant financial risk, especially in the case of high-value transactions.

Practical recommendations

• Prepare and regularly update the transfer pricing documentation on an annual basis.
• Support the applied pricing with a benchmarking analysis using reliable databases.
• Conduct regular audits of intercompany transactions with the involvement of a transfer pricing specialist.
• Plan the year-end adjustment process in advance, in close cooperation with the accounting and tax advisory teams.

Conclusion

Year-end adjustments offer companies a cost-efficient way to ensure compliance with the arm’s length principle.

The key advantages of this approach include:

• avoiding a significant increase in the corporate (local business, innovation contribution) tax base,
• reducing financial exposure, and
• providing a solid basis for defensibility in a potential NAV audit through appropriate documentation.

This solution allows businesses to achieve both tax compliance and economic efficiency at the same time.

Köő-Tóth Zénó

Senior Transfer pricing Specialist | Accace Hungary

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