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ECJ Rules Hungarian Business Tax Is Compatible With EU Law

by Ulrika Lomas,, Brussels

16 October 2007

The European Court of Justice has struck a blow against companies in Hungary after it ruled that an unpopular local business tax is compatible with European VAT laws.

The ECJ had been asked by two Hungarian courts to rule on the compatibility of a local business tax known as HIPA, after several companies contested the levy upon the country's accession to the European Union in 2004. The companies were seeking a declaration that HIPA is incompatible with the Sixth VAT Directive because it is too similar in form to a value-added tax. EU law prohibits member states from introducing or maintaining tax schemes which can be characterised as turnover taxes.

However, the ECJ found that HIPA does not share the same characteristics as VAT. Under the common system, VAT applies generally to transactions relating to goods or services; is proportional to the price of the goods or services; is charged at each stage of the production and distribution process; and the amounts paid during the preceding stages can be deducted from the VAT payable by a taxable person, with the final burden resting ultimately on the consumer. But according to the ECJ, HIPA is, by contrast, based on the difference between, on the one hand, the turnover linked to the goods sold or the services supplied during a fiscal period and, on the other, the purchase price of the goods sold, the value of the intermediary services and the costs of the materials.

According to the judges, since HIPA is therefore calculated on the basis of periodic turnover, it is not possible to determine the precise amount of that charge which may be being passed on to the client when each sale is effected or each service supplied, such that the condition that this amount should be proportional to the price charged by the taxable person is not satisfied.

Furthermore, the court noted, the characteristics of HIPA mean that not all taxable persons have the possibility of passing on, or passing on in full, the burden of the tax to the final consumer.

"Accordingly, the Court concludes that HIPA differs from VAT such that it cannot be deemed to be a tax which can be characterised as a turnover tax for the purposes of the Sixth VAT Directive. If follows that a charge to tax with characteristics such as those of HIPA is compatible with the Sixth VAT Directive," the ECJ stated.

The local business tax has been cited by many as a major disincentive to investment in Hungary, especially from foreign sources, primarily as it is based on a firm’s revenues, as opposed to profits. Nevertheless, it represents the main source of income for local governments (accounting for as much as 92% of their total income). Hungarian politicians have talked about reforming or scrapping the system, but with HIPA raising an estimated HUF300 billion (US$1.6 billion) in revenues, the government is likely to be relieved by the ECJ's verdict.

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