When a business embarks on genuine innovation, one of the first questions that almost always arises is: is it worth it financially? Genuine innovation can not only determine the development of the business itself but also contribute to the technological and economic growth of the country. That is why a good idea can be worth its weight in gold today, especially if the company recognises how it can take advantage of the available government incentives.

However, research and development requires significant investment, while the return on investment is often only noticeable years later. For this reason, Hungary offers various incentives to companies that create new knowledge or utilise existing knowledge to create new products, services and technologies. One of the most important tools for this is research and development (hereinafter: “R&D”) tax incentives, which are found in corporate tax, social contribution tax and local business tax. The corporate tax incentives are described in more detail below.

How do research and development tax incentives work?

The allowances are based on R&D activities as defined in Act LXXXI of 1996 on corporate tax and dividend tax (hereinafter: “CIT Act”). The legislation distinguishes between three types of R&D activities. Basic research is aimed at discovering new scientific knowledge whose direct practical or commercial use cannot yet be outlined, but which may later form a decisive basis for a technological breakthrough or further development directions. Applied research serves a more specific purpose: it generates knowledge that is necessary for the development of products, services, or manufacturing processes, and is therefore more directly linked to the company’s innovation strategy. Experimental development focuses on putting existing knowledge into practice – this is the stage where prototypes, new solution,s and improved technologies are created. If the company carries out any of the above activities, it may be eligible for a tax base reduction benefit under the CIT Act or a tax credit that can be deducted directly from the calculated corporate tax.

R&D activities and tax base reduction

In order for a company to take advantage of the tax benefits provided by the CIT Act, it must first determine whether its activities qualify as R&D activities. The company can do this itself, but if it does not have the necessary expertise or wants the most reliable classification possible, it can seek the assistance of the National Research, Development and Innovation Office (hereinafter: “NKFIH”), which will determine whether a project qualifies as R&D activity upon request from the company. It is important to note that the opinion of the NKFIH is not legally binding, but the tax authority generally accepts the NKFIH’s position.

If their activities qualify as R&D, companies can take advantage of the benefits provided for in the CIT Act. The first such benefit is a reduction in the tax base, within the framework of which companies can deduct the costs of their own research and development activities (e.g. expenses related to the development of new products or technologies) from their pre-tax profits. If the costs are capitalised as “intellectual property”, the tax benefit can be claimed each year up to the amount of depreciation. It is important to note that the benefit only applies to costs incurred from own resources, so if the development was covered by subsidies, it cannot be deducted twice. In this way, the CIT Act. ensures that the R&D tax benefit truly serves to encourage innovation.[1]

It should be noted that, unlike the tax credit, the tax base reduction can be applied in conjunction with the reductions in local business tax and innovation contribution.

Rules for corporate tax credit

Companies can claim a tax credit of 10% of the costs of their own research and development projects, whether they involve basic research, industrial (applied) research or experimental development. The allowance can be claimed in the year in which the costs are incurred and in the following three years, on a project basis, in the order in which the expenses were incurred.

The upper limit of the allowance varies per project and per taxpayer: it is equivalent to EUR 55 million for basic research, EUR 35 million for applied research and EUR 25 million for experimental development. Only actual costs incurred by the taxpayer are eligible, so expenses covered by subsidies or costs not related to the operation of the business cannot be deducted.

To take advantage of the benefit, the choice must be reported to the tax authority in the first tax return, and the unused portion will be automatically paid out by the state after three years, provided that the taxpayer has no significant tax liabilities.

It is important to note that R&D tax incentives do not only apply to corporate tax. Businesses should also consider the possibilities offered by local business tax and social contribution tax. In the case of local business tax, the tax base can be reduced by allowances related to R&D projects, thus reducing the amount payable to the local government. At the same time, social security contribution continues to be payable on R&D-related wages, although the actual burden can be reduced by taking advantage of certain contribution allowances, such as the researcher’s contribution.

What should you pay attention to in advance?

Claiming the R&D tax credit is mutually exclusive with certain other tax benefits, for example, the tax base reduction described above, and the tax credit cannot be claimed at the same time, and, as mentioned above, it cannot be combined with other similar tax credits or with a reduction in business tax. It is therefore particularly important for businesses to assess which solution is most advantageous for them in the long term when planning their project, as, according to the rules, they can only choose one tax benefit from the options listed.

In addition, there are businesses that are not eligible for the allowance in the first place. These include, for example, companies in financial difficulties, certain real estate investment companies, those that have previously received illegal state aid, and certain organisations involved in the production of agricultural products, where the aid is not applicable due to EU rules.

Taking all this into account, it can be said that although the R&D allowances provided by the CIT Act may seem simple, the detailed rules are complex, so if you wish to take advantage of R&D allowances, it is advisable to consult a tax advisor beforehand and plan the entire process in detail.

Disclaimer: this article is a translation of our original article written in Hungarian, which you can find here

[1] CIT Act. Section 7(1)(t)