Hungary: tax authority raises objections against certain forms of debt-to-equity conversionApril 5, 2013
Debt-to-equity conversion is a frequently used technique in Hungary to restore equity in a tax-neutral way. One such technique is where the shareholder of a company contributes in kind its loan receivable to the company against its capital during the voluntary dissolution of the company.
As explained above, the aim of this technique is to restore the equity of the company to ensure that the company can be dissolved voluntarily. Otherwise, the company, being insolvent, could only be liquidated.
A recent guideline of a middle-level directorate of the National Tax and Customs Administration (tax authority) is aimed at restricting such practice. In its guideline, the tax authority declares that such practice is unlawful from the viewpoint of the tax laws, even if it is allowed by company law.
According to the guideline, the transfer of the receivable is unlawful since there are no funds of the company being dissolved available to settle such receivables contributed by the shareholder, nor is it expected that such funds would be available in the future.
Hence, the receivables do not have real value and the debt-to-equity conversion is not in line with the principle of prohibition of abuse of rights as its only aim is to settle the liabilities of the company being dissolved in a tax-neutral way. Therefore, the tax authority argues that the transaction should be treated as a waiver of receivables by the shareholder, taxable at the company being dissolved, if the debt-to-equity conversion is made in the course of a voluntary dissolution procedure.
The guideline, however, does not state explicitly that such conversion would be unlawful under all cases (e.g., outside of a voluntary dissolution). In addition, it is unclear whether all of the directorates of the tax authority share the viewpoint of the directorate issuing the guideline. However, the guideline may mark a change to the approach of the tax authority to debt-to-equity conversions. Any company planning such a transaction should take into account this increased level of risk.
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