In 2012 a simplified lump sum tax, known as KATA, was introduced for small businesses. The rules of KATA allowed small businesses, including private entrepreneurs, to opt to pay a lump sum monthly tax of HUF 50,000 (EUR 145) per person employed by the business. Businesses paying the lump sum tax are relieved of any other income or payroll taxes. The regime is applicable to income of up to HUF 12 million (approximately EUR 34,000) revenue per year. Above this limit, a tax rate of 40% is applied to the excess.
The new tax regime quickly became popular, and in 2020, more than 300,000 businesses are using it. It also became apparent to the government that many individuals using KATA had formerly been employed by an enterprise which subsequently became the client of the small enterprise opting for KATA; in other words, KATA was being used to re-characterize employment relationships for the purpose of avoiding employment-related obligations. In particular, service sectors such as IT were affected, where the assets employed and means of work have less relevance to the outcome of the activity.
The Hungarian Government had been aware of this risk when introducing KATA, as contracting of employees through small businesses for tax-saving purposes has a long history in Hungary. Therefore, the KATA law introduced a rebuttable presumption that an employment relationship exists between a client of a small business and the person employed by the small business (including when the small business is actually a private entrepreneur).
The presumption can be rebutted if certain circumstances are proven (such as that the place of work is in the control of the “employee” or the equipment or materials used for the activity are not provided by the presumed “employer”). The circumstances for rebutting the presumption of an employment relationship, implemented as legal provisions, were crystallized by the tax authority’s long-standing practice of challenging hidden employment. Unsurprisingly, as alleged employers and employees had been preparing arguments to answer the tax authority’s inquiries during tax audits for a long time, the legal presumption of employment was not very effective in discouraging abuse. The high number of businesses applying KATA did not ease the burden on the tax authority.
During the fall of 2019, rumors spread that the Government had decided to focus on and challenge the improper use of KATA. In line with this the tax authority published 2020 auditing guidelines indicating that combatting hidden employment – and in particular, the fraudulent application of KATA – would be a focus.
The plans for extensive audits with a focus on hidden employment were apparently distracted by the COVID-19 pandemic. Nevertheless, on July 14, 2020, Hungary’s Parliament amended the KATA Act (Act CXLVII of 2012) in a way that severely limits the use of the KATA regime. The amendments, which become effective on January 1, 2021, provide that: a) if the payer of the income (i.e., the client of the small business) pays more than HUF 3 million to the same small business, it shall pay 40% tax on any amount exceeding this limit; and b) if the payer of the income is a related party of the small business, the 40% tax is payable regardless of the amount.
In our view these heavy-handed amendments will not achieve their intended goal. The HUF 3 million limit is low. This amount roughly equals the 2020 net average salary of an employee. There are no available statistics for typical (median) salaries, but they will be significantly lower than the average salary, so low-income sectors can still use KATA without the 40% punitive tax rate. However, in the case of genuine independent professionals, it is not uncommon for the fees for one client’s work over a period of time to exceed this limit.
The current KATA regime has been easy to manage financially and light on administration for small businesses. There is a risk that the amendments in their current form will suffocate this tax regime, because they focus on an artificial monetary limit instead of focusing on the development of more sophisticated tools for determining the genuine nature of the relationship between the parties involved.
By Balazs Kantor, Head of Tax, and Petra Rozsahegyi, Associate, Lakatos Koves & Partners