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Importance of reviewing the contracts concluded with the taxpayers under the itemised tax of small businesses (“KATA”)

Importance of reviewing the contracts concluded with the taxpayers under the itemised tax of small businesses (“KATA”)

IMPORTANCE OF REVIEWING THE CONTRACTS CONCLUDED WITH THE TAXPAYERS UNDER THE ITEMISED TAX OF SMALL BUSINESSES (“KATA”)

At the end of June the Hungarian tax authority announced that in the second half of year 2020 special attention is going to be paid to the tax audits of the companies subcontracting the private entrepreneurs who operate under the itemised tax of small businesses („KATA”). The tax audits will be aimed at uncovering and deferring the cases of veiled employment. 

Although the tax law sanctions imposed in case of irregular contracts concluded with KATA taxpayers are primarily targeted at the “employers”, the private entrepreneurs operating under the KATA scheme may also be negatively affected if they are in breach of the tax legal requirements. 

The KATA scheme allows the employers to enjoy a considerable tax advantage compared to regular employment contracts. According to the existing tax law requirements aimed at the prevention of veiled employment, the assumption stands that there is a regular employment relationship between the employer and the KATA taxpayer, provided the latter has earned an annual income of at least HUF 1 million with this particular employer. The assumption may be rebutted if at least two of the criteria set out by the relevant regulation as distinguishing the KATA subcontractor relationship from the employment one stand for the subcontractor. 

If none or only one of the distinguishing criteria can be established, then the tax authority should reclassify the existing relationship to the employment one. The reclassification involves that a social contribution tax and vocational training contribution underpayment, as well as default on tax deduction liability should be assessed on the company now specifically regarded as acting as a regular employer. Along with the payment of the tax shortage, a tax penalty amounting to 50 percent of the tax shortage, as well as the default penalty may be imposed on the employer. Additionally, the social contributions at an overall rate of 18.5 per cent which are normally deducted from the income of the employee, in this particular case should be levied on the employer, the earned income being regarded as the employee’s net income. 

The private entrepreneurs (employees) either cannot escape the negative consequences of the relationship reclassification, because they become liable to the personal income tax payment out of the income earned. On top of that, they cannot reclaim the tax amounts they have paid under the KATA scheme.

Obviously, the reclassification of several KATA-subcontractor relationships may put a strain on the company, and even may imply labour law sanctions. Therefore, with a view to the special tax audits of KATA subcontractor relationships planned by the Hungarian tax authority, it is recommended to review the existing contracts with KATA taxpayers from the tax legal perspective (including the verification of the distinguishing criteria standing for particular subcontractors) and to settle as soon as possible any irregularities found.

It is worth noting that a tax law bill is currently before the final vote of the Hungarian Parliament that comprises further restrictive provisions related to the KATA scheme. Among others, the bill includes that starting from 1 January 2021 employers should be liable to a 40 per cent tax if they pay out an income exceeding the annual HUF 3 million to a single KATA-taxpayer. Only the part of the amount that exceeds the HUF 3 million limit is subject to this tax.

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Should you have any questions regarding this newsletter or the review of the KATA subcontractor relationships,
the tax expert colleagues of VGD Hungary are at your disposal with their effective methodology providing the tax legal compliance

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