Tax saving opportunities in connection with royalties

Corporate income tax

As per the Hungarian Act on CIT, profit derived from certain exclusive rights shall qualify as royalty, including the following:

• patents;
• utility model protection;
• plant variety protection;
• supplementary protection certificates;
• protection of the topography of microelectronic semiconductor products;
• licences or usage rights for copyrighted software; and
• orphan drug designation.

According to the Hungarian Act on CIT, the term ‘royalty’ covers the (i) profits derived from the use of the above exclusive rights, (ii) profits realized from the sale or in-kind contribution of such rights, and (iii) the portion of profit from product sales or service provision attributable to the value of such rights.

The Hungarian regulations (in line with the approach set forth by the OECD) ensure that profit realized as royalty income related to a given intangible asset may only qualify for tax relief in proportion to the taxpayer’s own contribution to the creation and development of that asset. The amount of the following CIT base adjustments must/can be determined considering this ratio:

Local business tax (‘LBT’) and Innovation Contribution (‘IC’)

As a general rule, the LBT base is the net sales revenue (as defined under the Hungarian Act on Accounting) decreased by, amongst others, the consideration recognized as revenue from royalties. However, the Hungarian Act on Local Taxes defines the concept of royalty more narrowly compared to the definition set forth in the Hungarian Act on CIT. For instance, the orphan drug designation does not qualify as an exclusive right, or the income derived from the in-kind contribution of exclusive rights is also excluded from the royalty definition under the Hungarian Act on Local Taxes.

Since the tax base of the IC is the same as that of the LBT, tax savings may also be achieved for IC purposes.

Pitfalls in applying tax benefits

While the above incentives can result in significant tax savings, the complexity of the rules gives rise to a number of potential risks. Therefore, it is crucial that taxpayers claim these benefits on a proper legal basis and with appropriate professional support.

Common mistakes to avoid include:

• Misjudgement of the legal basis: The concept of royalty under both the Hungarian Act on CIT and the Act on Local Taxes is considerably narrower than everyday understanding (e.g., trademarks, know-how, or trade secrets do not qualify as royalty-generating assets).
• Using revenue instead of profit: For CIT purposes, tax base adjustments should be calculated based on the profit (i.e. the difference between revenues and related costs), rather than on revenues alone.
• Ignoring the nexus rule: Taxpayers that have acquired/received an intangible asset, or developed one with the involvement of related parties, must or can apply CIT base adjustments only in proportion to their own direct R&D costs and expenses. If the taxpayer fully purchased the asset without ‘contributing’ to its development, there are no qualifying costs to be considered.
• Failure to meet the 60-day reporting deadline: Post-notification of the intangible asset is not possible. Without timely notification, the related benefit under the Act on CIT cannot be applied.
• Improper separation of complex services: Licence fees often comprise multiple components (e.g., trademark + know-how + software). A common mistake is that taxpayers treat the entire amount as royalty income.
• Subsequent loss adjustment: If the taxpayer claimed a CIT base reduction for 50% of royalty profit in one tax year, but a royalty loss incurs in the subsequent year, then 50% of that loss must be applied as a tax base increasing item.
• Failure to create tied-up reserves: If omitted, post-creation is not possible; without the transfer, the taxpayer is not entitled to the related tax benefit.

How Forvis Mazars Can Assist

Forvis Mazars’ tax advisory services provide both general guidance and tailored support in specific cases.
Our experts accompany clients throughout the entire process:

1. We determine whether the company’s assets qualify as royalty-generating intangible assets for tax purposes.
2. We identify which tax benefits the company may be eligible for.
3. We verify whether the statutory conditions for any applied tax benefits are met and whether the company’s current practice complies with the relevant legal requirements.
4. We provide recommendations for establishing an appropriate administrative system to ensure proper utilization of the benefits.

Should you have any questions regarding the tax benefits outlined above, our experts will be pleased to assist you.