Policies Towards Foreign Direct Investment
Hungary maintains an open economy and its high-quality infrastructure and central location are features that make it an attractive destination for investment. Attracting FDI is an important priority for the GOH, especially in manufacturing and export-oriented sectors. In other sectors, including banking and energy, however, government policies have resulted in some foreign investors selling their stakes to the government or state-owned enterprises. Hungary was a leading destination for FDI in Central and Eastern Europe in the mid-nineties and the mid-two-thousands, with annual FDI reaching over $6 billion in 2005. The pace of FDI inflows slowed in subsequent years as a result of the 2008 global financial crisis and increasing competition for investment from other countries in the region. In 2016, net FDI amounted to $4.6 billion while total gross FDI amounted to $84 billion.
As of 2016, the Hungarian Central Bank (MNB) calculates investment positions by ultimate controlling parent investors (which defines an investment made by a U.S. company operating for example in Germany or in any other country as a U.S. investment), in addition to figures on immediate investors made by a country. As a block, in 2014, the EU accounted for 79% of all FDI in Hungary in terms of direct investors and 58% in terms of ultimate controlling parent investors. In terms of ultimate controlling parent investors, Germany is the largest investor, followed by the United States, Ireland, Austria, France, the United Kingdom, Italy, the Netherlands, and Japan. As ultimate controlling parent investor, U.S. firms account for 19% of total investments, second only to Germany. As direct investor, U.S. firms are the largest non-EU investor, holding 2% of all FDI stock, amounting to $1.7 billion. The majority of U.S. investment falls within automotive, software development, and life sciences sectors. Approximately 400 companies of U.S. origin are established in Hungary, although the figure is closer to 800 if representation offices, sales offices, and sole proprietorships owned by U.S. citizens are considered.
The GOH in 2010 implemented a number of tax changes to increase Hungary’s regional competitiveness, including a reduction of the personal income tax rate to 16% in 2010 and 15% in 2016, the reduction of business income tax rates to 9% in 2017. The GOH offset these rate reductions with a series of “crisis taxes,” large tax increases targeting specific industries. Through the combination of these actions, the GOH was able to maintain the budget deficit below 3% of GDP and exit the EU’s excessive deficit procedure (EDP). (Hungary was under the EU’s EDP procedure at the time of EU accession in 2004. The Commission lifted the EDP in 2013, after the GOH budget deficit fell to less than 3% of GDP for two consecutive years.)
Many foreign companies have expressed displeasure with the unpredictability of Hungary’s tax regime, and its retroactive nature, speed, and volume of legal and tax changes. They have also complained that the GOH introduced many recent tax measures with little or no consultation with the affected businesses. Some companies operating in Hungary have also claimed that recent “crisis taxes” are inconsistent with EU regulations as they target industries dominated by foreign firms and fail to reflect the actual costs of regulating the affected sectors. Both the EU and the IMF have requested the gradual phasing out of the sectoral taxes, observing that they distort competition, reduce foreign investment and economic growth, and adversely offset the economic benefits of cuts in personal and corporate tax rates.
Ongoing crisis taxes, along with other regulatory measures and fees implemented in 2010-2012, targeted the banking, energy, telecommunications, and retail sectors. In 2014, Parliament approved a series of new, progressively-tiered taxes that disproportionately penalized foreign businesses in the tobacco, retail, and media industries, while simultaneously favoring Hungarian companies.
The 2014 Advertisement Tax levied a one-time, retroactive tax on revenue, rather than profit. Tax experts and Hungarian MPs noted that the law, which had several tax brackets, included a 50 % levy on all revenue over $80 million, a provision clearly designed to hit German-owned TV group RTL Klub – the only firm that fell into the top tax bracket and notably the most prominent independent voice in the broadcast media landscape. RTL turned to the European Commission to challenge the law. In March 2015, the EC launched an in-depth investigation and implemented a suspension/ injunction which prohibited Hungary from applying progressive rates, determining that the tax was discriminatory and in breach of EU rules on illegal state aid and on competition. The EC has released the injunction and the GOH has complied with the ruling, introducing a flat 5.3 % tax on all advertisement revenue in May 2015.
A 2014 health contribution tax and food retail chain supervisory fee also targeted large foreign firms, including Philip Morris, Tesco, Spar, and Auchan. The EC determined in July 2015 that the tobacco and retail taxes gave unfair advantage to companies with smaller turnover, suspended the implementation of the taxes, and initiated infringement procedures against Hungary. In response, the GOH reversed the food retail chain supervisory fee and restored the flat tax in November 2015. In addition, the EC determined in February 2016 that Hungary’s 2014 retail law, which requires retail companies with over $53 million in annual sales to close down if they report two consecutive years of losses, was discriminatory and violated the freedom of establishment. The EC subsequently launched an infringement procedure, which is still ongoing.
The GOH has also levied special taxes on energy companies in recent years. Although the energy crisis tax was phased out in January 2013, the GOH simultaneously raised the “Robin Hood tax” – a levy on energy companies’ earnings – from 11% to 31%, which is paid in addition to the corporate tax. As the corporate tax rate decreased to 9% in 2017, the effective tax currently stands at 40%.
The GOH also launched a public utility tax in 2013 on water and sewer pipelines, natural gas, heat and electricity lines, and telecommunication lines. The GOH has failed to fulfill pledges made in early 2015 to decrease the telecom tax, a move expected to improve the business climate; no modification have been made to date.
The GOH has committed to gradually phasing out special bank taxes, but will maintain the 2013 Financial Transaction Tax imposed on cash withdrawals from bank offices and ATMs, and money transfers from bank accounts, even though the banking sector as a whole posted significant losses until 2016.
The GOH has publicly declared that reducing foreign bank market share in the Hungarian financial sector is a priority. Accordingly, GOH initiatives over the past several years have targeted the banking sector and reduced foreign participation from about 70% before the financial crisis in 2008 to just over 50% by the end of 2016. In addition to the 2010 bank tax and the 2012 financial transaction tax levied on all cash withdrawals, new regulations in 2015 obligated banks to retroactively compensate borrowers for interest rate increases on certain consumer loans, even though these increases were spelled out in the original contract with the customer, and were permitted by Hungarian law.
The GOH later mandated that banks that issued loans denominated in foreign currencies convert the outstanding balances to Hungary’s domestic currency, the Forint, following a fixed, sub-market exchange rate. While Parliament softened the law by using a balanced spot rate for currency exchange that was more in line with market exchange rates, the law caused billions of dollars in losses to banks, with heavy exposure to foreign currency-denominated mortgages. These regulations affected the lending capacity and balance sheets of several banks so severely that banks required major recapitalization in order to meet Hungarian capital reserve requirements.
On the positive side, as of 2016, as part of a previous agreement with the European Bank for Reconstruction and Development (EBRD), the GOH reduced its onerous bank tax from 0.53% to 0.31% on 2009 balance sheets, and pledged to lower it further until 2018.
The GOH defends its sectoral targeting with political and populist rhetoric. Prime Minister Orban told supporters during a March 2014, rally that Hungary had proved its strength by battling the world of money, a reference to Hungarian regulation of the banking sector. Other GOH officials have publicly criticized investors in targeted sectors for earning “excessive profits” although the GOH has offered no definition of what constitutes “excessive profits.”
While the pharmaceutical industry is competitive and profitable in Hungary, multinational pharmaceutical companies complain of numerous financial and procedural obstacles. Specifically, pharmaceuticals complain of high taxes on pharmaceutical products and operations, prescription directives that limit a doctor’s choice of drugs, and obscure tender procedures that negatively affect the competitiveness of certain drugs. Pharmaceutical firms have also taken issue with GOH moves to weigh the cost of pharmaceutical procurement as more important than efficacy when issuing tenders for public procurement.
The GOH continues to cultivate foreign investors in manufacturing for export and has not yet targeted those sectors with punitive taxes. However, some U.S. firms involved in high-volume export have reported they are often under audit by the Hungarian Tax and Customs Authority. These audits generally take a week or more and involve an auditor visiting the business and requesting reports and paperwork to corroborate VAT reimbursements and tax declarations. VAT reimbursements are often delayed as a result of these audits, resulting in substantial cost – VAT is 27% in Hungary on most products. Additionally, firms report that auditors apply a strict liability system with regard to errors. Human error, including calculation mistakes or using the wrong form, can result in fines worth several hundred dollars per infraction. At the end of 2015, the GOH announced plans to transform the National Tax and Customs Authority (NAV) into a streamlined, more efficient organization that would focus on high-risk areas and customers, and fast-track companies with proper internal controls in lower risk sectors. Although NAV has cut 10 % of its staff and tax revenues have increased, there is a general consensus that there is still room for improvement in NAV’s dealing with its customers.
Multinational executives in manufacturing and technical fields identify labor shortages as the single largest obstacle to investment. Hungary’s highly-qualified labor force presents an important competitive advantage. However, as Hungarians increasingly seek work abroad, shortages of highly-educated and skilled labor are negatively affecting growth in certain regions and industries. In addition, declining OECD Program of International Student Assessment (PISA) scores — a global exam measuring abilities in math and comprehension — may signal that the workforce is losing its ability to learn new skills and adapt to changing labor market conditions. Other obstacles include a persistent lack of transparency and predictability, reports of corruption and favoritism (particularly in GOH procurement and construction), and excessive red tape.
The GOH established the Hungarian Trade and Investment Agency (HITA) in 2011 to encourage foreign companies to invest in Hungary, facilitate bilateral trade, and support the activity of Hungarian small and medium sized enterprises (SMEs). In 2014, HITA was split into HIPA, which encourages and supports inbound FDI, and the Hungarian National Trading House (MNKH), which promotes Hungarian exports abroad. Both HIPA and the MNKH are currently under the authority of the Ministry of Foreign Affairs and Trade (MFAT). HIPA offers company and sector-specific consultancy, recommends locations for investment, acts as a mediator between large international companies and Hungarian firms to facilitate supplier relationships, organizes supplier training, and maintains active contact with trade associations. Its services are available to all investors. For more information, see: https://hipa.hu/main
Starting in 2012, the government has concluded a number of strategic agreements with selected large investors and business representations. To date, the total number of such agreements is 79, including with the American Chamber of Commerce. The government provides individual tax preferences to such partners within EU limits, which cap tax allowances. In 2017 the government additionally established a Competitiveness Council, chaired by the Minister of Economy, that includes representatives from multinationals, chambers of commerce and other stakeholders to increase Hungary’s competitiveness. For more information, see: http://www.kormany.hu/en/ministry-for-national-economy
Limits on Foreign Control and Right to Private Ownership and Establishment
Foreign ownership is permitted with the exception of some “strategic” sectors including defense-related industries and farmland.
According to the Land Law, passed in 2013 and entered into force on May 1, 2014, only private Hungarian citizens or EU citizens resident in Hungary with a minimum of three years of experience working in agriculture or holding degree in an agricultural discipline can purchase farmland. Eligible individuals are limited to purchasing 300 hectares (741 acres). All others may only lease farmland; non-EU citizens and legal entities are not allowed to purchase agricultural land. All farmland purchases must be approved by a local land committee and Hungarian authorities, and local farmers and young farmers must be offered a chance to purchase the land first before a new non-local farmer is allowed to purchase the land. For those who do not fulfill the above requirements or for legal entities, the law allows the lease of farmland up to 1200 hectares for a maximum of 20 years. The GOH has invalidated any pre-existing leasing contract provisions that guaranteed the lessee the first option to purchase, provoking criticism from Austria and Austrian farmers. Austria has reported the change to the EC, which initiated an infringement procedure against Hungary in October 2014. In March 2015, the EC launched another infringement procedure against Hungary concerning its restrictions on acquisitions of farmland.
Since 2012, the GOH has invested in state-owned enterprises with the objective of lessening the participation of foreign-owned competitors, especially in the energy sector. Foreign investors interested in financial institutions and insurance companies must officially notify the GOH of their intentions, but do not need advance authorization. Foreign financial institutions may operate branches and conduct cross-border financial services in Hungary, in keeping with OECD commitments. Currently, foreign firms control 66% of the manufacturing sector, 90% of the telecommunications sector, and 35% of the energy sector. The private sector currently produces about 80% of Hungary’s economic output.
In September 2016, PM Orban told an international audience of the Krynica Economic Forum in Poland that at least half of the banking, media, energy, and retail sectors should be in Hungarian hands. Through windfall taxes, the financial transaction tax, and rescue schemes designed to ease burdens of foreign currency mortgage holders, analysts say the GOH has pushed several foreign-owned banks to sell off their Hungarian business units. German-owned MKB , GE-owned Budapest Bank, and Citi’s retail banking operation have sold their operations to the GOH or other Hungarian investors. In 2014, press reported that Austria’s Raiffeisen Bank and Italian-owned CIB considered exiting the market. Raiffeisen’s situation has since stabilized and the financial sector has returned to profitability. In 2014-2015 the GOH also established control over the locally owned network of savings cooperatives. These developments, along with the government’s existing holdings (including state ownership of savings cooperatives) bring state participation in the financial sector to nearly 60%, including EximBank, the Hungarian Development Bank, and the Clearing House. In commercial banking, state participation is below 50%.
Ownership of companies in Hungary is highly concentrated. It is common for one or two stockholders to have a controlling stake in large corporations. Crossholdings are common and the independence of directors sometimes difficult to establish.
The registration of business associations is compulsory in Hungary. Firms must contract an attorney and register online with the Court of Registration. Registry courts must process applications to register limited liability and joint-enterprise companies within 15 workdays, but the process usually does not take more than three workdays. If the Court fails to act within the given timeframe, the new company is automatically registered. If the company chooses to use a template corporate charter, registration can be completed in a one-day fast track procedure. Registry courts provide company information to the Tax Office (NAV) eliminating the need for separate registration. The Court maintains a computerized registry and electronic filing system and provides public access to company information. The minimum capital requirement for a limited-liability company is HUF 3,000,000 ($10,800); for private limited companies HUF 5,000,000 ($17,900), and for public limited companies HUF 20,000,000 ($71,400). Foreign individuals or companies can establish businesses in Hungary without restrictions.
Further information on business registration and the business registry can be obtained at the Company Information Service: http://ceginformaciosszolgalat.kormany.hu/index
The stock of total Hungarian investment abroad amounted to 7.9 billion Euros in 2016. Outward investment is mainly in manufacturing, services, finance and insurance, and science and technology. The GOH neither promotes nor restricts investment abroad.