The Hungarian Civil Code

The rules of the legal institution of debt assumption are laid down in the Chapter XXX of the Civil Code[1]. Accordingly, debt assumpton is an obligation whereby the debtor and the creditor of the underlying legal relationship may agree that a third party shall take the position of the debtor in the underlying legal relationship and thereby assume the debtor’s obligation towards the creditor. The tripartite agreement will release the debtor from the obligation, which will instead be borne by the third party assuming the obligation, and from that moment on, unless otherwise provided, the creditor can claim payment of the debt only from the assuming party. An essential element of the assumption of the debt is the consent of the creditor, in addition to his acknowledgement of the substitution of the debtor, whether this consent is given in the agreement or beforehand.
Consent or lack thereof is the fundamental difference between assumption of debt and assumption of performance as a sibling institution governed by the same chapter of the Civil Code. In the case of assumption of the performance, the parties to the underlying relationship retain their contractual position unchanged, but the debtor may be released from his obligation if it is performed by a third party on its behalf for the benefit of the creditor without the consent of the creditor or even without the latter having knowledge of the atypical performance. In such a case, the third party who assumes the performance is under an obligation to put the obligor of the underlying relationship in a position to perform in accordance with the contract. The person performing does not pass on to the debtor the rights and obligations of the underlying obligation; thus the creditor, even if aware of this ancillary agreement, cannot claim performance from the third party.

Accounting

 Given that in the case of assumption of performance, the underlying obligation is not transferred to the third party, it is worth mentioning first that this obligation is not entered in the books of the party assuming performance, but a technical effect on profit or loss is recognised as an expense when performance is made. This technical ‘negative’ effect on profit or loss may be offset by the consideration due for performance, which appears in the balance sheet as a receivable and in the profit and loss account as revenue, thus producing a neutral effect on profit or loss.
The accounting treatment of debt assumption is different from the above, as in the two-part process, the debtor first transfers the liability and the assignee recognises the liability in its books, and thus the effect on profit or loss is not at the time of settlement, but at the time of assumption of the liability (debt). If consideration is recognised when the liability is assumed, this revenue will offset the expense recognised when the liability is assumed. The settlement with the beneficiary, as the second element of the transaction, will have a purely balance sheet effect.
It is important to note that on the debtor’s side, whether we are talking about assumption of performance or assumption of debt, there will be a technical income in the absence of payment of consideration, just as there will be a technical expense on the side of the person assuming the debt.

Corporate tax on the transaction

The question of the treatment of a given transaction under the corporate tax system is not determined by the differences between the assumption of performance and the assumption of debt, but by the fact that the assuming person has performed for consideration or for no consideration on behalf of the debtor. Indeed, the CIT Act.[2] only contains a rule for a transaction without consideration when it states that “[The pre-tax result is increased by:] the amount recognised as an expense, which is included as a reduction in the pre-tax result, including depreciation of intangible and tangible assets, which is not related to the entrepreneurial, income-generating activity, in particular with regard to Annex 3 […]”. Furthermore, the said Annex 3 to the CIT Act[3] also provides expressis verbis for the case of a liability assumed by the taxpayer without consideration and thus obliges the taxpayer to recapture the tax base equal to the amount of the expense, regardless of whether it was incurred when the liability was recorded in its books or when it was actually performed.
It is important to note, however, that the taxpayer is liable for the reverse charge if any of the following conditions apply. Accordingly, a taxpayer is obliged to reverse charge the expenditure realised in the transaction to the tax base if

• It assumed the liability from a non-resident; or
• has assumed the liability from a resident CIT Act taxpayer that has not provided it with a statement to the effect that, first, it has recognised revenue in its profit or loss in respect of that expense; second, neither its profit before tax nor its tax base would be negative in the absence of the revenue; and third, that it has paid the appropriate tax on that revenue and subsequently certified that it has done so; or
• has assumed the liability from a resident taxpayer under the CIT Act. that has not provided a declaration to the taxpayer that it did not carry out any business activity in the tax year in question, or that the assumed liability was not related to such activity, or that it does not incur a tax liability for its business activity.

The essence of the regulation is that corporate tax must be paid to the Hungarian treasury after the transaction, i.e. the transaction cannot be used for tax avoidance purposes.
It should be stressed that the regulation only applies to transactions where the assumption of the liability is without consideration. If the liability is assumed for consideration, it is obvious that the debtor will have revenue included in its pre-tax profit, which will also form part of its tax base.

Value-Added-tax implications

The question may arise whether the transactions in question are affected by VAT, whether they are subject to the VAT Act[4] and, if so, what kind of tax liabilities arise in this respect. As we have seen in the case of the CIT., it is also the consideration – i.e. the determination or lack thereof – that will be decisive as regards VAT liabilities.
According to Section 14 (2) of the VAT Act, a supply of services for consideration is deemed to be a supply of services if the taxable person “provides services free of charge to another person for purposes other than those of his business“. Consequently, an obligation assumed without consideration falls within the scope of the VAT Act as a supply of services. However, the legislation contains a condition that the transaction is subject to VAT only if the taxable person is entitled to a right of deduction for the supply of the service, in whole or in part. In addition, the law[5] also establishes the taxable amount of the transaction as “[…] the taxable amount is the amount in money’s worth of the expenditure incurred by the supplier of the service in order to carry out the supply.” The expenditure incurred in the course of the supply will therefore constitute the taxable amount for VAT purposes, provided that it is subject to a right of deduction. Thus, for example, if the taxable person satisfies the obligation by transferring a property exempt from VAT, no right of deduction will be available and the transaction will not fall within the scope of the VAT Act. On the other hand, if the taxpayer has opted to make the sale of the property taxable, then – since it is entitled to a right of deduction – the said supply will fall within the scope of the VAT Act.  And in the case of a VAT transaction, the obligation to provide evidence pursuant to Section 159 of the VAT Act should not be forgotten.
In contrast to the assumption of an obligation without consideration, if the debtor pays consideration to the assuming party for the performance, the transaction will be void under Section 13 (3) of the VAT Act provided that the debtor merely reimburses the debtor for the expense of the performance of the obligation and provided that he does so in cash, cash substitute payment instrument or cash substitute instrument. In this case, the assuming party assumes the obligation at ‘face value’, in exchange for which the debtor compensates it in cash. If the transferee receives a higher or lower amount for the performance compared to the “face value”, this transaction would be given a different title, the VAT impact of which will be dealt with in a separate article.

The content of this post does not constitute legal or tax advice and does not create a contract of engagement. In each case, detailed knowledge of the individual case is necessary to assess it and to find a tailor-made solution. If you have any questions, please do not hesitate to contact us at http://www.bekespartners.com/.

[1] Act V of 2013 on the Civil Code (“Civil Code”)

[2] pursuant to Section 8 (1) (dz) of Paragraph (1) of Act LXXXI of 1996 on Corporate Tax (“Act on Corporate Tax”)

[3] Taotv. annex 3, point A), subpoint 13

[4] Act CXXVII of 2007 on Value Added Tax (“VAT Act”)

[5] VAT Act § 69